Mortgage Banking Commentary
DECEMBER 2001
Thr
ough the Looking Glass—Pr
edator
y Lending
Through
Glass—Predator
edatory
Legislation in W
ashington, D.C.
Washington,
by: Costas A. Avrakotos (cavrakotos@kl.com)
Nanci L. Weissgold (nweissgold@kl.com)
The Washington, D.C. City Council voted to suspend
D.C.’s Protections from Predatory Lending and
Mortgage Foreclosure Improvements Act of 2000
(the “Act”) for four months. Without the Mayor’s
signature or veto, the legislation suspending the Act
took effect at midnight, November 27, 2001.
The four-month suspension proved necessary
because lenders found the Act unwieldy, with many
lenders suspending their mortgage financing
activities in D.C. altogether. In enacting the measure
last year, the D.C. City Council intended to
modernize its antiquated foreclosure laws and
supplement its lending laws in order to better protect
the interests of D.C. consumers. However, the Act
contains a number of provisions that are less than
clear and provide severe consequences for noncompliance. As a result, rather than risk converting
good faith mistakes into material penalties, many
lenders chose to abandon making residential
mortgage loans in the District, leaving borrowers
with fewer sources of credit.
The four-month suspension period will be used to
develop legislation with which the D.C. City
Council, consumer groups and the mortgage industry
can live. D.C. Mayor Anthony Williams has
indicated his belief that the four-month suspension is
too long, leaving D.C. residents vulnerable to
unscrupulous lenders during that period. We may see
emergency legislation enacted before the expiration
of the four-month suspension. The Mayor planned to
introduce emergency legislation by December 4th.
The date, however, now has been extended until
December 18th. What form the emergency legislation
will take is unclear. We understand that there are
three proposals up for consideration: (i) the Mayor’s
Task Force revision of the currently suspended
legislation; (ii) the proposal by D.C. Councilpersons
Cropp and Ambrose which we understand is based
on North Carolina’s predatory lending legislation;
and (iii) a bill drafted on behalf of a coalition of
mortgage lenders, which combines elements of
Pennsylvania’s and New York’s predatory lending
legislation.
Given the possibility that a revised version of the
currently suspended legislation may emerge, we
believe it is useful to highlight some of the biggest
problems contained in the suspended Act:
n
Guilty ‘Til Proven Innocent—The antipredatory provisions of the suspended law
apply only to “home loans.” Under the Act,
however, every residential mortgage loan is
considered a “home loan,” until it is proven
otherwise. Accordingly, even if a lender is
diligent in its efforts to ensure that it does not
make “home loans,” each loan essentially is
presumed to be a “home loan” unless the
lender can certify otherwise. With every deed
of trust or mortgage on residential real property
recorded in the District (not just those that
meet the definition of “home loan”), lenders
are required to file a six-part, thirteen-page
Information Form, executed by the mortgage
broker, mortgage lender, seller, borrower, and/
or the noteowner or the noteowner’s agent.
Kirkpatrick & Lockhart LLP
Five of the six parts of the Information Form
must be notarized separately. The purpose of
the Information Form is to determine whether
the loan is a “home loan,” and, if it is, whether
it violates the Act’s prohibited practice
provisions. The penalty for failing to execute
the Information Form properly or record the
Information Form once completed is severe—
lenders lose the right to foreclose by power of
sale, even if the loan by its terms does not
constitute a “home loan.”
Completing and recording the Information
Form is a logistical nightmare. Because the
Information Form must be recorded in the land
records, lenders must rely on title companies to
record the document. Some title companies
have refused to close a loan until the lender
provided a fully executed Information Form.
Despite the six-month, post-closing cure period
allowed under the Act to supplement the
recorded deed of trust or mortgage with the
recording of the Information Form, title
companies do not want to take on liability for
an improperly completed or missing
Information Form. Thus, no Information Form,
no loan. Moreover, in a table-funded
transaction, responsibility for executing certain
parts of the Information Form cannot be
readily discerned. The line distinguishing
broker from lender and noteholder is blurred.
The D.C. government could not offer practical
advice to clarify this uncertainty, but regulators
acknowledged this problem and said they were
working on suggested amendments to cure it.
One has to ask, why have such an Information
Form in any event? Besides clogging up the
land records, and increasing closing and
recordation costs for consumers, who will look
at it? There is little doubt that the delivery,
execution and recordation requirements
involved with this Information Form will spark
an endless stream of questionable litigation.
Lenders should not be presumed to violate the
District’s law with each loan made in the
District. They should be able to engage in their
lawful mortgage financing activities in the
District without being compelled to certify that
each loan is not a home loan. Any new
predatory lending legislation would be wellserved without such a cumbersome
requirement.
n
Through the Looking Glass—Following the
definition of “home loan” and its many
exclusions makes Alice’s journey through the
looking glass a walk in the park. As discussed
below, the definition of “home loan” and
exceptions from the definition cover more than
five single-spaced pages in the Act and almost
seven pages in the regulations. A full
paragraph is devoted simply to indicate that to
be a “home loan” the property must be owneroccupied! The definition of “home loan” is
written ambiguously, defining “home loan” in a
limited manner, excluding certain loans that are
otherwise covered by the definition, while
imposing conditions on certain other excluded
loans that are not covered by the definition.
Little clarity and certainty are provided under
the Act as to the loans covered as “home
loans.” Like Alice trying to make sense of it
all, lenders will need to solve the riddle of what
is a “home loan” under the District’s Act before
they can proceed with their business.
Understanding the types of residential
mortgage loans included in the definition of
“home loan” is all the more confusing when the
types of loans expressly excluded are taken
into consideration. The Act excludes loans
from the definition of “home loan” that would
not be covered by the “home loan” definition
in the first place, such as certain home equity
lines of credit or reverse mortgages.
Moreover, many loans excluded from the
definition of “home loan” are excluded only if
certain conditions are satisfied. Lenders are
kept guessing as to whether loans that are not
covered by the definition of “home loan”
remain subject to the Act because the loans do
not meet all of the conditions to satisfy the
regulatory exclusion under the definition of
“home loan.” A wrong guess and it’s off with
their heads.
The exemptions themselves, as defined, also
appear unreliable and may set the stage for
arbitrary and capricious enforcement actions.
Kirkpatrick & Lockhart LLP
2
One example is the exemption for loans made
in conformity with a documented loan program
of a government sponsored enterprise (“GSE”).
This provision seems clear. On its face, a loan
made in conformity with a Fannie Mae or
Freddie Mac program should be excluded from
the definition of “home loan,” and, thus, not
subject to the Red Flag Warning or any of the
prohibited practice provisions. However, one
sentence buried in the regulations suggests a
hidden meaning that could trap the unwary.
The regulations provide that “[a]ny loan not
actually purchased by Freddie Mac or Fannie
Mae shall not be exempted under this
subsection.” Thus, if for some reason the
lender determines at closing that a loan
originated in accordance with a documented
loan program of a GSE cannot be sold to the
GSE, the lender violated the predatory
provisions by failing to provide the Red Flag
Warning within the required time frame. The
loan also might contain a provision violating
the prohibited practice provisions for a “home
loan,” that otherwise would not apply to a loan
not meeting the “home loan” definition. The
lender would be unable to certify, as required
in the Information Form, that the loan does not
violate the prohibited practice provisions. The
lender could be subject to penalties for a loan
that was excluded from the definition of “home
loan” when originated. Consequently, many
lenders believe that they should provide the
Red Flag Warning and comply with the other
provisions on all loans in the District, not just
those the Act was designed to regulate.
principal dwelling, and where the
average home loan adjusted rate for
both loans is equal to or less than the
home loan reference rate, excluding
any loan where the first interest rate
adjustment or principal and interest
payment amount adjustment is
permitted before the fifth anniversary
of the date of the note secured by the
residential lien instrument; provided,
that any loan, commonly referred to as
an adjustable rate mortgage, where the
first interest rate adjustment or
principal and interest payment
adjustment is permitted before the
fifth anniversary of the date of the
note secured by the residential lien
instrument, shall not be exempted or
used to create an exemption under this
subparagraph.
The exemption is poorly drafted and hard to
follow. To make matters worse, long,
convoluted mathematical formulas are required
to calculate the home loan adjusted rate and the
home loan reference rate. An additional
mathematical formula is needed to calculate
the average home loan adjusted rate.
We have identified some of the issues arising
from the definition of “home loan” and from
some of the exemptions from the definition.
To top it off, there are another nine exemptions
from the definition of “home loan” that are not
covered here. The Mad Hatter kept Alice
guessing. The definition of “home loan” and
its exemptions will keep a lender’s head
spinning. A definition of “home loan” that is
clear and concise will go a long way towards
making any new legislation comprehensible,
fair, and reduce the risk of unnecessary
litigation or enforcement actions.
Another exemption from the definition of
“home loan” is particularly vexing. Under the
exemption, a “home loan” does not include:
[a] first-lien loan and second-lien loan
created simultaneously in the same
transaction and secured by residential
lien instruments encumbering the
same residential real property which is
the owner’s principal dwelling where
the primary purchase of the loan is for
the refinancing or additional financing
of the owner’s principal dwelling,
with or without improving the owner’s
n
The Weakest Link—If a determination is
made that the loan is a “home loan,” the loan
and lender would be subject to fourteen
specifically enumerated prohibited acts and
practices such as a prohibition on encouraging
or recommending default on an existing loan,
charging single-premium credit insurance,
charging prepayment fees, or overcharging for
Kirkpatrick & Lockhart LLP
3
a “home loan.” As many of these prohibited
acts and practices apply to the origination of
the loan or the contract entered into, the
prohibitions would appear to apply to a lender
making a “home loan.” However, the terms
“lender” and “making” are not defined as
expected based on their plain language.
Section 601 of the Act specifically provides
that “[t]he following acts and practices are
prohibited and shall be deemed ‘predatory’ in
the making, brokering, arranging, funding, or
servicing of a home loan (‘making a home
loan’) by any mortgage broker, mortgage
lender, or other person (‘lender’) to any owner,
borrower or obligor (‘home borrower’).” It is
worth noting that different definitions of
mortgage broker and mortgage lender are
contained in the regulations but it is unclear to
whom those definitions apply. In any event, as
worded in the Act, the prohibited practices
might be construed to make an entity involved
in a discrete component of the mortgage
financing process responsible for violations of
another entity in the process. If there is one
weak link in the process, all who come in
contact with the loan could suffer. For
example, few of the prohibited practices apply
expressly to mere servicers. Nevertheless, a
mere servicer might be construed to be subject
to the penalties for a predatory loan for
violations that occurred at the time of
origination. Moreover, as “making a home
loan” is defined to include an entity funding a
loan, an investor in a table-funded arrangement
could be responsible for the originating
lender’s errors. It also is unclear how these
prohibited practices will apply to an entity
providing a warehouse line of credit. If a
source provides the funding for a “home loan”
that was made in violation of one of the
prohibited practices, it may find that it also is
the source that borrowers will petition for
damages. The weakest link in the mortgage
financing chain could break the bank for any
investor.
n
Keep It Simple and Concise—The Act is
approximately 129 pages. Regulations and
accompanying forms promulgated under the
Act run an additional 99 pages. Lenders are
overwhelmed by the volume of paper.
Granted, not all of the Act relates to predatory
lending, as it also recodifies D.C.’s real
property provisions. However, the predatory
lending provisions are dispersed throughout the
legislation - the definitions, including the
unwieldy definition of “home loan,” are in the
beginning, the Information Form is sandwiched
in the middle of the Act and the prohibited
practice provisions are towards the end.
Moreover, many of the predatory lending
provisions are poorly worded, difficult to
digest and cumbersome. In contrast, North
Carolina’s predatory lending provisions run
approximately 10 pages, and New York’s run
approximately 11 pages. Separating the
predatory lending provisions from the real
property provisions, and clarifying their
application, would go a long way towards
helping lenders manage their compliance with
the legislation.
Consumer groups have attacked the lending industry
for criticizing the Act and withdrawing from the local
market, claiming that such a withdrawal is
irresponsible and tantamount to supporting predatory
lending. Resorting to such simplistic sound bites
belies the real issue. The Act was unintelligible,
responsible lenders acting in good faith could not
determine the requirements for lawful conduct, and
the risks far outweighed the possible benefits.
Hopefully, with the D.C. government having gone
back to the drawing board, they will come up with a
workable solution.
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This memorandum is for informational purposes
only. Nothing herein is intended or should be
construed as legal advice or a legal opinion
applicable to any particular set of facts or to any
individual’s or entity’s general or specific
circumstances.
If you have any questions about the Predatory
Lending Law, please contact one of the members of
our Mortgage Banking/Consumer Finance Group.
Kirkpatrick & Lockhart LLP
4
MORTGAGE BANKING/CONSUMER FINANCE GROUP
Kirkpatrick & Lockhart LLP was founded in 1946, and, with more than 600 lawyers, is one of the thirty-five
largest law firms in the United States. K&L attorneys are based in ten offices in key U.S. cities – Boston,
Dallas, Harrisburg, Los Angeles, Miami, Newark, New York, Pittsburgh, San Francisco, and Washington.
Our firm represents a broad range of clients in a wide variety of matters, including corporate and securities,
e-commerce, investment management, insurance coverage, financial institutions, mortgage banking and
consumer finance, creditors’ rights, intellectual property, tax, labor, environmental, antitrust, health care, and
government contracts. More than half our attorneys are litigators. We litigate class actions on a range of
financial issues, generally defending financial institutions, broker-dealers, public companies, and investment
companies and their officers and directors against claims of violations of securities laws, consumer credit
laws, and common law tort and contract claims. You can learn more about our firm by visiting our Internet
website at www.kl.com.
The Mortgage Banking/Consumer Finance Group provides legal advice and licensing services to the
consumer lending industry. We counsel clients engaged in the full range of mortgage banking activities,
including the origination, processing, underwriting, closing, funding, insuring, selling, and servicing of
residential mortgage loans and consumer loans, from both a transactional and regulatory compliance
perspective. Our focus includes both first- and subordinate-lien residential mortgage loans, as well as openend home equity, property improvement loans and other forms of consumer loans. We also have experience
in multi-family and commercial mortgage loans. Our clients include mortgage companies, depository
institutions, consumer finance companies, investment bankers, insurance companies, real estate agencies,
homebuilders, and venture capital funds. Members of the Mortgage Banking/Consumer Finance Group and
their telephone numbers and e-mail addresses are listed below:
ATTORNEYS
Laurence E. Platt
Phillip L. Schulman
Thomas J. Noto
Costas A. Avrakotos
Melanie Hibbs Brody
Irene C. Freidel
Jonathan Jaffe
R. Bruce Allensworth
Daniel J. Tobin
Anthony P. La Rocco
Emily J. Booth
Eric J. Edwardson
Suzanne F. Garwood
Tara Goebel
Steven M. Kaplan
Kristie D. Kully
Krista Patterson
Carol M. Tomaszczuk
Nanci L. Weissgold
(202) 778–9034
(202) 778–9027
(202) 778–9114
(202) 778–9075
(202) 778–9203
(617) 261–3115
(415) 249–1023
(617) 261–3119
(202) 778–9074
(973) 848–4014
(202) 778–9112
(202) 778–9387
(202) 778–9892
(202) 778–9261
(202) 778–9204
(202) 778–9301
(202) 778–9257
(202) 778–9206
(202) 778–9314
lplatt@kl.com
pschulman@kl.com
tnoto@kl.com
cavrakotos@kl.com
mbrody@kl.com
ifreidel@kl.com
jjaffe@kl.com
ballensworth@kl.com
dtobin@kl.com
alarocco@kl.com
ebooth@kl.com
eedwardson@kl.com
sgarwood@kl.com
tgoebel@kl.com
skaplan@kl.com
kkully@kl.com
kpatterson@kl.com
ctomaszczuk@kl.com
nweissgold@kl.com
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5
DIRECTOR OF LICENSING
Stacey L. Riggin
(202) 778–9202
sriggin@kl.com
REGULATORY COMPLIANCE ANALYSTS
Dana L. Lopez
(202) 778–9383
Nancy J. Butler
(202) 778–9374
Susan C. Curtin
(202) 778–9129
Joelle Myers
(202) 778–9093
Marguerite T. Frampton
(202) 778–9253
Jeffrey Prost
(202) 778–9364
Sharon L. O’Brien
(202) 778-9859
dlopez@kl.com
nbutler@kl.com
scurtin@kl.com
jmyers@kl.com
mframpton@kl.com
jprost@kl.com
sobrien@kl.com
LAW CLERKS
Mera C. Choi
mchoi@kl.com
(202) 778–9415
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This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein
should not be used or relied upon in regard to any particular facts or circumstances without first consulting with a lawyer.
© 2001 KIRKPATRICK & LOCKHART LLP. ALL RIGHTS RESERVED.
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