October 24, 2002
PREDATORY LENDING LAWS
By: Jennifer Gelb, Research Attorney
You asked if Connecticut has laws regarding predatory lending. You also wanted examples of other states' predatory lending laws.
Regulators and consumers have become increasingly aware of predatory lending incidents, in which mortgage lenders (1) use aggressive and deceptive tactics to entice potential mortgagees to borrow and (2) lend money at terms that make it difficult or impossible to repay, making the borrowers' homes vulnerable to foreclosure. Predatory lenders routinely prey on subprime borrowers, typically members of low-income households, the elderly, and minorities. Some predatory lending practices identified by the federal Department of Housing and Urban Development include (1) employing a “bait and switch” approach, (2) using balloon payments that require refinancing, (3) structuring loans the borrower cannot afford, (4) victimizing minority and elderly borrowers, and (5) charging excessive fees.
In addition to existing laws prohibiting unscrupulous lending practices, the Connecticut General Assembly recently passed two laws aimed at combating predatory lending. These laws are similar to new legislation in North Carolina, Georgia, and certain other states that is receiving national attention. Georgia's new law, considered to be the strictest in the nation, regulates both the primary and secondary mortgage lending markets.
CONNECTICUT PA 01-34 — AN ACT CONCERNING ABUSE HOME LOAN LENDING PRACTICES
Disclosures in High-Cost Home Loans
PA 01-34 requires a lender to make certain disclosures to prospective borrowers seeking high-cost home loans. It defines a “lender” as a person who makes one or more high-cost home loans. A “high-cost home loan” is a mortgage (1) for a one-to-four family residence; (2) made to someone who lives or plans to live there; and (3) whose interest rate when the loan is made is more than 10% higher than the most recent rate for Treasury bills, notes, and bonds. High-cost home loans do not include reverse mortgages.
The lender must tell the buyer that he is not required to complete the loan agreement and the consequences of putting a mortgage on his home, including the possibility of losing the home. The act sets out the precise language the lender must use. The lender must also disclose the interest rate, the payments that will be due, and information about possible changes in interest rates and the amount of the single maximum monthly payment for variable-rate mortgages.
Limitations on Loans and Lenders
The act requires lenders to follow certain rules when making high-cost home loans. A lender or its assignee must refund or credit the borrower for any default charges, prepayment penalties, or prepaid finance charges collected in excess of the limits established under the act.
Prohibited provisions in high-cost home loans. The act prohibits the following terms in high-cost home loans:
1. a payment schedule that does not fully pay off the principal balance by the end of the term for a loan with a term of less than seven years;
2. a payment schedule that causes the principal balance to increase;
3. a payment schedule that consolidates more than two payments and pays them in advance from the proceeds;
4. an increase in the interest rate after default, or default charges of more than 5% of the amount in default;
5. an interest refund calculated by a method less favorable than applying payments first to finance charges, with any remainder applied to the principal;
6. a charge for paying all or part of the principal before it is due (“prepayment penalty”), except in the first three years of the loan;
7. a mandatory arbitration clause or waiver of participation in a class action suit; and
8. a call provision allowing the lender, in its sole discretion, to accelerate the indebtedness. This prohibition does not apply when the loan is repaid on an accelerated basis because of actual default, under a due-on-sale clause provision, or another provision of the loan agreement unrelated to the payment schedule, such as bankruptcy or receivership.
The act allows a lender to assess a prepayment penalty during the first three years of the loan, with the maximum permissible penalty being 3% in the first year, 2% in the second, and 1% in the third. But the lender can charge this penalty only if (1) the borrower's prepayment funds are not from a refinancing by the lender or its affiliate and (2) the borrower's total monthly debts at the start of the loan, including amounts owed for the high-cost home loan, are not more than 50% of his monthly gross income.
Prohibited actions by lenders making high-cost home loans.
When making a high-cost home loan, a lender may not:
1. pay a contractor under a home improvement contract from the proceeds of the loan, except by an instrument payable to the borrower or jointly to the borrower and contractor or, if the borrower chooses, through a third-party escrow agent under the terms in the written agreement;
2. sell or otherwise assign the loan without giving prescribed notice to the purchaser or assignee that the loan is subject to the rules of the act and the purchaser or assignee could be liable for any claims the borrower has against the lender;
3. require the borrower to pay charges, such as points, as a condition of the loan before closing (“prepaid finance charges”) more than 5% of the principal amount of the loan or $2,000, whichever is greater. The same limits apply to prepaid finance charges on refinancing and earlier loans the lender made within two years before it or its affiliate makes a new refinancing loan to the borrower. A lender may, however, impose other prepaid finance charges up to 5% of any “additional proceeds” (the amount by which the new loan exceeds the current principal amount of a closed-end loan, or the amount that the line of credit on the new loan exceeds the maximum credit limit on an existing open-end loan) that the borrower receives;
4. charge a borrower any fees to modify, renew, or extend a loan if the loan will continue to be a high-cost home loan, or, if no longer a high-cost home loan, the interest rate will not be reduced by at least 2%. A lender can charge prepaid finance charges of up to 5% of additional proceeds the borrower receives as a result of modifying, renewing, or extending the loan. These provisions do not apply if the loan is 60 or more days past due and is modified, renewed, or extended as part of a work-out process;
5. make the loan unless the lender reasonably believes that the borrower will be able to make the loan payments, based on the borrower's income, debts, employment status, and other financial factors. The borrower is presumed to be able to make the payments if his monthly debts, including the mortgage, are not more than 50% of his gross monthly income;
6. advertise that refinancing preexisting debt with a high-cost home loan will reduce a borrower's monthly debt payments without also disclosing that the loan may increase the borrower's total number of payments and the total amount the borrower will pay over the term of the loan;
7. recommend or encourage default on an existing loan or debt before closing on a refinancing high-cost home loan;
8. make a high-cost home loan that refinances an existing loan unless the new loan will truly benefit the borrower;
9. make a high-cost home loan with an unconscionable interest rate. The interest rate must be based on appropriate factors, such as creditworthiness, other risk-related standards, and sound underwriting, or it may be considered unconscionable; or
10. charge the borrower fees for services that are not legitimate, reasonable or actually performed.
Under the act, a lender making a high-cost home loan must annually report the borrower's payment history to a nationally recognized credit reporting agency while the lender holds or services the loan.
Credit Insurance Offers
As of January 1, 2002, a lender who offers a high-cost home loan borrower the option to buy individual or group credit life, accident, health, disability, or unemployment insurance on a prepaid single premium basis must also offer him the option the buy the insurance on a monthly premium basis. A borrower who buys the insurance may cancel it at any time and get a refund of any unearned premiums paid. The lender must notify the borrower of his right to cancel, by mail, between 10 and 30 days after making the loan. The notice must also state the type of insurance purchased, its cost, and cancellation procedures.
Penalties for Violations
The act allows the banking commissioner to charge up to a $15,000 civil penalty per violation to any lender who (1) fails to make required disclosures to a prospective borrower about a high-cost home loan or credit insurance, (2) includes prohibited terms in a high-cost home loan, (3) fails to report annually a borrower's payment history to a credit bureau, (4) assesses excessive charges or penalties, or (5) engages in other prohibited behavior in making a high-cost home loan.
The act allows the commissioner to assess up to a $15,000 civil penalty against any lender who receives notice from the commissioner of a violation of the act and does not request a hearing within the time specified or fails to appear at the hearing.
Disclosure of Information
The act gives the commissioner the option of exempting creditors who comply with the Connecticut Truth-in-Lending Act from inconsistent provisions of state banking law regarding disclosure of information. Under prior law, he had to exempt them by regulation. The act specifies that its provisions concerning abusive home loan lending practices may not be deemed inconsistent with the Truth-in-Lending Act and will control where applicable.
Prohibited Actions by Lenders Making First Mortgage Loans
The act prohibits a lender making a first mortgage loan (whether or not it is a high-cost home loan) from requiring the borrower to pay prepaid finance charges totaling more than 5% of the principal amount of the loan or $2,000, whichever is greater. The same limits apply to prepaid finance charges on refinancing and earlier loans the lender made within two years before it or its affiliate makes a new refinancing loan to the borrower. A lender may, however, impose other prepaid finance charges up to 5% of additional proceeds that the borrower receives for the refinancing.
Exception to Prohibited Actions by Lenders Making Secondary Mortgage Loans
The act adds an exception to the law prohibiting a broker or lender in the secondary mortgage loan business from imposing loan fees, points, commissions, transaction fees, or similar prepaid finance charges in accordance with the Connecticut Truth-in-Lending Act which, when added to the broker's fee or commission, total more than 8% of the loan principal. It allows lenders and brokers to charge an additional fee for allowing a buyer to pay the purchase price in installments (“time-price differential”) rather than in one lump sum. The total of the time-price differential and any broker's fee or commission can exceed the 8% limit. The act defines a “broker” as a person who is paid to negotiate, solicit, arrange, place, or find a home loan for a lender to make.
Charge for Payoff Statement
The law requires a lender to give the borrower, his agent, or his attorney, upon request, a statement showing the loan account status, sums due, and daily interest rate (“payoff statement”). The act prohibits the lender from imposing any fee or charge for the first payment statement requested each year, unless the person making the request agrees to pay a fee for expedited delivery of the payoff statement and the lender delivers it on time.
PA 01-34 took effect on October 1, 2001.
CONNECTICUT PA 02-12 – AN ACT CONCERNING PREPAID FINANCE CHARGES
By law, a lender making a high-cost home loan may not require the borrower to pay charges as a condition of the loan before closing (“prepaid finance charges”) totaling more than 5% of the loan's principal amount or $2,000, whichever is greater. PA 02-12 expands the definition of prepaid finance charge to include a finance charge the borrower pays either (1) by cash or check before or at the loan consummation or credit extension or (2) by withholding funds at any time from the transaction's proceeds. The law already includes a lender or broker's commission or fee for selling prepaid credit life, accident, health, disability, or unemployment insurance or other goods and services that the customer pays for with the loan or credit proceeds and finances as part of the principal amount. Prior law defined a prepaid finance charge as a charge imposed as an incident to, or condition of, a loan or credit extension, including (1) loan fees, (2) points, (3) commissioners, (4) brokers' fees or commissions or (5) transaction fees.
The act removes the exclusion of the time-price differential from the definition of prepaid finance charges and instead exempts (1) premiums, fees, and other sums paid to, or escrowed by, a government agency and (2) interim interest. It defines “interim interest” as the interest the borrower pays during the period at or before consummating a closed-end loan, so long as the borrower starts paying off the loan within 62 days.
By law, high-cost home loan payment schedules may not consolidate more than two periodic payments and paying them in advance from the proceeds. The act allows such payment schedules if a government agency is required to escrow them. It makes a conforming change to a provision prohibiting a secondary mortgage broker or lender from imposing loan fees, points, commissions, or transaction fees determined in accordance with the Connecticut Truth-in-Lending Act, except the time-price differential, to prohibit all prepaid finance charges which, when added to the broker's fee or commission, total more than 8% of the loan principal.
PA 02-12 took effect April 10, 2002.
LAWS IN OTHER STATES
North Carolina passed the nation's first high-cost home loan law in 1999. The North Carolina Predatory Lending Act, which took effect in 2000, covers only residential mortgage loans of less than $300,000. It limits fees to no more than 5% of the loan amount, and caps the annual percentage rate at no more than 10% above a comparable Treasury note.
1. prepayment penalties for loans of $150,000 or less;
2. loan flipping (which involves refinancing a mortgage unnecessarily, with all of the fees and none of the benefit to the borrower);
3. single-premium credit life insurance;
4. recommending or encouraging default on existing debt in connection with a proposed refinancing;
5. lending without counseling for borrowers;
6. lending without regard for payment ability;
7. direct or indirect financing of points, fees, and closing costs;
8. call provisions;
9. points or fees on a high-cost home loan used to refinance an existing high-cost home loan held by the same lender;
10. home improvement contract loans where the proceeds go directly to the contractor;
11. balloon payments;
12. negative amortization (an increase in a loan's principal balance that occurs because the monthly payment is insufficient to pay the interest owed);
13. increased interest rates on default;
14. advance payments (two months maximum); and
15. modification or deferral fees.
Georgia's Fair Lending Act (GFLA), which took effect on October 1, 2002, applies to three types of loans: “home loans,” “covered home loans,” and “high-cost home loans.” A home loan is an open-end or closed-end consumer loan, secured by the borrower's principal dwelling, in which the principal loan amount is up to the Federal National Mortgage Association's (“Fannie Mae”) conforming loan size (currently $300,700). A covered home loan is a home loan (1) with an interest rate exceeding certain prescribed limits, which vary depending on whether the loan is a first mortgage or a junior mortgage; (2) with total loan points or fees greater than 3% of the total loan amount; or (3) that is a high-cost home loan. A high-cost home loan is a home loan (1) whose interest rate exceeds the level set in the federal Home Ownership and Equity Protection Act of 1994 and its regulations, with the triggering rate dependent on whether the loan is a first mortgage or a junior mortgage and (2) with loan points and fees in excess of certain prescribed amounts based on the loan amount.
The following provisions apply to all home loans:
1. credit insurance may not be financed;
2. lenders may not encourage default in connection with a refinancing of an existing debt;
3. late charges are limited to 5% and require a grace period of at least 10 days;
4. lenders cannot charge a fee for providing the loan payoff balance, except a $10 processing fee; and
5. mandatory arbitration clauses are prohibited.
Loan flipping is prohibited in covered and high-cost home loans. The law imposes additional limitations on high-cost home loans by:
1. limiting prepayment penalties to 2% of the amount prepaid in the first year after the loan closing and 1% of the amount prepaid in the second year;
2. prohibiting balloon payments;
3. prohibiting negative amortization;
4. prohibiting increasing the interest rate after default, with one exception;
5. limiting advance payments;
6. requiring certification that the borrower received counseling on the loan's advisability;
7. requiring proof of the borrower's ability to repay the loan;
8. prohibiting charging to modify, renew, extend, or amend a high-cost home loan or to defer payment due;
9. requiring notice of intent to foreclose at least 14 days before publishing legal advertisement;
10. giving the borrower the right to cure a loan default and reinstate the loan;
11. limiting fees charged to a borrower for exercising the right to cure a default;
12. prohibiting loan provisions allowing the lender to unilaterally decide to accelerate the loan; and
13. requiring high-cost home loan documents to contain references to the GFLA.
Colorado passed a predatory lending law during the 2002 session. The law is triggered when the points and fees equal 6% or more of the loan amount. It also:
1. prohibits balloon payments with less than 120 month (20 year) terms;
2. bans call provisions (with exceptions);
3. prohibits increasing the interest rate upon default;
4. forbids negative amortization;
5. limits mandatory arbitration clauses;
6. prohibits advance payments;
7. restricts prepayment fees;
8. requires loans to contain a prescribed cautionary notice;
9. prohibits lending without due regard to repayment ability;
10. places restrictions on refinancing high-cost loans within one year;
11. prohibits refinancing certain low-rate loans within 10 years after they are made, unless the current holder consents in writing;
12. limits using covered loan proceeds to pay home improvement contractors;
13. bans financing of credit insurance;
14. prohibits recommending default;
15. prohibits any fee for a remaining balance quote, and requires the quote to be delivered within five business days after receiving a written request; and
16. requires certain reporting to credit bureaus.
Similar legislation and regulations have been passed in a few states, and considered in others. States with new laws soon to take effect or already in place include Maryland, New York, and Florida.