May 2, 2002
Summary of The "Predatory Lending Consumer Protection
Act of 2002" Introduced Senator Sarbanes
Definition of "High Cost"
Mortgage: the legislation tightens the definition of a "high cost
mortgage" for which certain consumer protections are triggered. The
new definition, which amends the "Home Ownership Equity Protection
Act," (HOEPA) is as follows:
- first mortgages with APRs that exceed Treasury
securities by six (6) percentage points;
- second mortgages with APRs that exceed Treasury
securities by eight (8) percentage points; or
- mortgages where total points and fees payable by
the borrower exceed the greater of five percent (5%) of the total
loan amount, or $1,000. The bill revises the definition of points
and fees to be more inclusive. It allows for two bona fide
discount points outside of the 5% trigger.
Current law defines a "high cost mortgage"
as loans with APRs that exceed Treasury securities by 8% (reduced
from 10% this year by the Fed). The Fed, through regulation, has
also created a trigger for second mortgages at 10% above
Treasuries.
Current law: Protections are triggered when
points and fees equal 8%, not including "reasonable fees" to
unaffiliated 3rd parties, yield spread premiums, credit
insurance, unlimited discount points, and other fees.
NOTE: The bill allows for 2 bona fide discount
points, outside the 5% trigger, if those discount points are
knowingly paid by the borrower and used to buy down the interest
rate. In order to prevent this from being abused, the discount
points must buy the rate down from a "benchmark rate" set in the
proposed statute. The benchmark rate is defined at the yield on a
5-year Treasury security, plus 5%. Today, this would be about 10%,
just slightly higher than the best rates offered by some large
subprime lenders.
In addition, to ensure that the rate is actually
reduced, the borrower must recoup the dollar amount of the discount
points in lower monthly payments within 4 years.
This provision was added after testimony indicated
that, in some cases, even a subprime borrower may want to pay
discount points to lower his or her longterm rate. However, we have
seen so much evidence of points being packed in and piled on top of
yield spread premiums that do nothing but increase costs without any
consumer benefit, that we drafted this provision tightly.
The following key protections are
triggered for high cost mortgages only:
- Restrictions on financing of points and
fees. The bill restricts a creditor from directly or
indirectly financing any portion of the points, fees or other
charges greater than 3% of the total sum of the loan, or $600. The
lender cannot finance prepayment penalties or points paid by the
consumer if the originator of the loan is refinancing the loan.
Moreover, the lender or any affiliated creditor cannot finance
points and fees for the refinancing of a loan they originated
within the prior 36 months. These limitations and prohibitions are
designed to discourage lenders from"flipping" the mortgage in
order to extract additional excessive fees.
Current Law: No limitations on financing of
points or fees for HOEPA loans.
- Limitation on the payment of prepayment
penalties. The bill prohibits the lender from imposing
prepayment penalties after the initial 24 month period of the
loan. During the first 24 months of a loan, prepayment penalties
are limited to the difference in the amount of closing costs and
fees financed and 3% of the total loan amount. This approach is
designed to ensure that the lender is compensated for the costs of
originating the loan without being able to strip equity.
Current law: Allows unlimited prepayment
penalties within the first 5 years of the loan so long as the lender
independently verifies the borrower’s income. If the debt-to-income
ratio of the borrower is greater than 50%, there can be no
prepayment penalty. In practice, this latter limitation never seems
to come into play.
- Prohibition on balloon payments. The
bill prohibits the use of balloon payments. In the case of loans
with high interest rates, balloon payments are unnecessary.
Lenders typically offer balloon payments in exchange for keeping
the interest rate lower or keeping monthly payments affordable for
a borrower. In predatory lending, balloon payments are used as a
tool to mask the total cost of a high cost loan, and to force the
borrower to refinance the loan.
Current law: Allows for balloon payments
that are at least 5 years.
- Limitation on single premium credit
insurance. The bill would prohibit the upfront payment or
financing of credit life, credit disability or credit unemployment
insurance on a single premium basis. However, borrowers are free
to purchase such insurance with the regular mortgage payment on a
periodic basis, provided that it is a separate transaction that
can be canceled at any time.
Current Law: No equivalent provision. The
Federal Reserve did recently change its regulations to require the
cost of single premium credit insurance being financed into the
mortgage to be included in the calculation of points and fees in
determining whether a loan in covered by HOEPA. It is expected that
this will make it more difficult to "pack" in such products.
However, current law does not prohibit the sale or financing of
these products on HOEPA loans.
- Extension of liability for home
improvement contract loans. The bill would make lenders, or
subsequent holders of loans arranged by a contractor liable for
HOEPA violations if the contractor goes out of business to avoid
liability. This will help ensure that lenders work only with
bona fide contractors.
Current law: Requires that both the borrower
and the contractor endorse the check. HOEPA provides no other
protections if the loan was not made by the contractor, even if the
contractor fails to perform.
- Limitation on mandatory arbitration
clauses. The bill prohibits mortgages from including terms
which require arbitration or other non-judicial settlement as the
sole method of settling claims or disputes arising under the loan
agreement. The bill is not intended to limit the ability of a
borrower and lender to enter into any form of binding or
non-binding arbitration or other non-judicial settlement of a
claim or dispute at any time after a dispute arises.
However, an agreement by the borrower to settle a claim does not
waive any protection or right conferred by the bill. NOTE: The FTC
recommended in 2000, by a unanimous vote, that mandatory
arbitration clauses on high cost mortgages be prohibited.
Current Law: No equivalent
provision.
Other provisions in the bill:
- Increase statutory damages in individual civil
actions and class actions. The maximum amount that can be awarded
in individual actions is increased to $10,000. The maximum amount
that can be awarded in a class action is the greater of: (i) the
maximum amount of the liability available for an individual action
multiplied by the number of members or (ii) 2 percent of the net
worth of the creditor.
Current law: Individual damages up to $2000
in individual cases. The lesser of 1% of the firm’s net worth or
$500,000.
- Require that as a condition for making a high cost
loan, a creditor make a determination at the time the loan is
consummated, that the borrower will be able to make the scheduled
payments to repay the loan obligation. NOTE: This provision also
follows a unanimous FTC recommendation.
Current law: same requirement, but
violations can be punished only if a consumer can show a pattern or
practice of failing to meet this requirement. In practice, it has
been virtually impossible to meet the pattern and practice test,
thereby making it impossible to enforce this provision.
- Prohibit a lender from making a high cost loan
unless it certifies that it has provided the borrower with certain
information regarding the risks associated with high cost loans
and the availability of home ownership counseling.
Current Law: No equivalent
provision.
- Require additional disclosures related to the risks
associated with high cost mortgages.
Current Law: Some disclosures are
required.
- Prohibit a creditor/lender from: (i) recommending
or encouraging default on an existing loan or other debt prior to,
or in connection with, a closing on a high cost loan, (ii)
including any provision which permits the creditor, in its sole
discretion, to accelerate the indebtedness under the loan, or
(iii) charging a borrower any fee to modify a high-cost loan or
defer payment due under such high cost loan unless it provides a
material benefit to the borrower.
Current Law: No equivalent
provision.
- Require that a creditor annually report both
favorable and unfavorable payment history of borrowers to credit
bureaus.
Current Law: No equivalent
provision.
Source: Senator Sarbanes
Office |