2425 Porter Street, Suite 10
Soquel, CA 95073
Phone: (831) 464-6884
Fax: (831) 464-6886
A. Who Is a Lender Under TILA?
Jim came into my office quite concerned. He had lent money to someone he knew and the balloon payment was due, but had not been paid. He showed me the loan documents, which consisted of a promissory note and short-form deed of trust, which had been recorded by the escrow company. Jim explained that the borrower was someone he was familiar with who had approached Jim for a loan on a house, and had come up with the loan amount, interest rate, and payment terms. Jim had lent $50,000, secured by a third deed of trust, at 12 percent interest; interest-only payments were to be made monthly, with a balloon payment due at the end of a year. Jim arranged the loan through a real estate broker friend of his and the borrower was charged an additional $4000 in "points" paid to the broker. Jim knew that the borrower was behind on his other mortgages and was borrowing the money to "catch up." The borrower had fallen behind on the loan due to illness, but he was going to list the house for sale--and it had plenty of equity. The deal had originally sounded great to Jim, but now the balloon was due and the money was not forthcoming. Jim was a plumber and had never made a loan secured by property to anyone before.
Poor Jim. The bad news was that Jim was a lender, as defined by TILA, and had failed to make the disclosures required under TILA and had used prohibited terms. The loan was therefore rescindable by the borrower. If that happened, Jim would lose not only all interest due on the note, but also the broker fee and all other closing costs. Moreover, he would be liable for statutory penalties and the borrower's reasonable attorney fees. The good news was that so few real estate attorneys know anything about this law that the issue would be missed by virtually any attorney whom the borrower might consult.
How is it possible that plumber Jim, a first time lender, ran afoul of federal law? TILA governs loans made by a lender to consumers for primarily household purposes. A lender is a lender for TILA purposes if the lender has made more than five loans secured by residential property last year or more than five loans this year. However, under HOEPA, a lender is defined as a lender who makes two HOEPA loans, in any 12-month period, secured by the borrower's residence; and if a lender uses a mortgage broker to make a HOEPA loan, that lender is a lender for all TILA purposes on the first HOEPA loan made. 15 USC §1602(f); Reg Z §226.2 n3.
B. Assignee Liability
Inherent in the business of making loans secured by residential property is a continuing need for capital to lend. As such, many home loans are sold to raise additional capital. Liability for violating TILA runs to the lender. Once the loan is sold, the liability, as related to rescission, extends to the assignee as well. 15 USC §1641(c).
When Does a Borrower Have a Right to Rescind?
The general rule is that a borrower whose loan is secured by his or her principal dwelling has the right to rescind, unless the loan is not intended primarily for personal family purposes or the loan is a purchase money loan. 15 USC §1635(f). There are, effectively, two separate rights to rescind. The first is the three-day right to cancel, which can be exercised by the borrower during the three business days after the loan documents are signed. During this three-day period, the lender should not release loan proceeds or record the security interest. This three-day right to cancel ends at midnight on the third business day after the loan documents were signed. A business day is Monday through Saturday, with certain holidays excluded.
The second right to rescind is the extended right to cancel. The statute of limitations on this extended right is three years; however, it can be tolled for certain reasons, and more importantly, a borrower can always rescind, if the loan is rescindable, if the lender starts foreclosure proceedings.
Under TILA, the extended right to rescind is created when the borrower is not properly notified of the three-day right to cancel or the TILA disclosures are not accurate within certain statutorily defined tolerances. Additional rights to rescind are also afforded under HOEPA, more fully discussed later in this article.
1. The Right to Cancel
Borrowers must be clearly informed when the right to cancel expires and where to cancel. Additionally, each borrower must be given two copies of the form that explains the right to cancel. One is for the borrower to give to the lender if he or she wishes to cancel the loan; the other is for the borrower to keep. Thus, if the person filling out the form miscounts the days, or leaves the form blank, or fails to give each borrower two copies of the right to cancel form, the borrower effectively has never received notice of the right to cancel and the right to cancel continues until either the borrower is given a properly filled out form (with a new current three-day cancellation period) or the statute of limitations expires.
2. The TILA Disclosure Form
Further, borrowers must be given an accurate disclosure of the terms of the loan (the TILA Disclosure). If no disclosure is made or if certain terms are not accurately disclosed within certain tolerances, the borrowers have an extended right to cancel. The TILA Disclosure is a form that has four boxes at the top of the page (undoubtedly you have seen them before) that disclose the APR, Finance Charge, Amount Financed, and the Total Payments. Some of the other necessary disclosures in the body of the form include the number of payments to be made over the term of the loan and the regular payment amount.
The Total Payments amount is equal to the monthly payment multiplied by the number of payments to be made during the term of the loan. When the loan is a fully amortized fixed-rate mortgage, this calculation is easy. The same holds when it is an interest-only loan with a balloon at the end. However, when the loan is a variable-rate mortgage, the calculation is more complicated. As an example, we will use the loan Jim made, an interest-only mortgage, with a balloon:
Our borrower has borrowed $50,000 with a fixed rate of 10-percent interest, interest-only payments payable in equal amounts over a one-year term. The first 11 monthly payments are $416.67, with a balloon payment due on the twelfth month of $50,416.63. Accordingly, the amount listed in the Total Payments box should be $55,000. Since the loan principal amount is $50,000, we can easily determine that $5000 is interest being paid on the $50,000 loan. However, our borrower also paid $4000 in broker fees, which were determined to be finance charges. Thus, the total finance charges that must be disclosed are $9000.
The APR is considered the true interest rate that will be paid by the borrower over the life of the loan. The Finance Charge is broadly defined as any charge, payable directly or indirectly by the borrower, that is imposed directly or indirectly by the lender as an incident to or a condition of the extension of credit. 15 USC §1605(a); Reg Z §226.4(a). Even for those familiar with the myriad charges incurred by borrowers for a loan secured by their home, the determination of which charges are or are not finance charges can be daunting. It is beyond the scope of this article to address those issues; however, it is important to know that many charges are included in the definition of finance charge and, for purposes of determining the APR, these fees are lumped together with the interest charges.
The Amount Financed is generally the amount of credit provided to the borrower. Essentially, it is the remainder after the Finance Charge has been subtracted from the Total Payments. So, by subtracting the Finance Charge from the Total Payments, the Amount Financed by our borrower is $46,000. TILA allows several methods of determining the APR. For this article, I used the APR calculator program offered by the Office of the Comptroller of the Currency, located at www.occ.treas.gov/aprwin.htm. Using that system, the APR on our loan is 18.8397 percent, which is considerably higher than the stated interest rate, due to the high fees charged.
3. TILA Disclosure Accuracy Tolerances
The amount disclosed as Finance Charge in the TILA Disclosure must be accurate, up to certain tolerances. The tolerance depends on what action or right the borrower is enforcing. If the borrower is seeking to rescind the loan transaction and the lender has not started foreclosure proceedings, the tolerance is one-half of one percent (.005). If the lender overstates the Finance Charge, there is no extended right to rescind. However, if the lender has started foreclosure proceedings, either judicial or nonjudicial, the tolerance is $35. Again, if the APR is overstated, there is no extended right to cancel.
The APR must be accurate as well. The tolerance for the APR rate disclosed in the TILA Disclosure is one-eighth of one percent (.00125). TILA states that the APR is inaccurate if it exceeds or is lower than the accurate APR by .00125; however, there is some disagreement about this. See Official Staff Commentary §226.22(a)(2)-1; 15 USC §1602(z); Ramsey v Vista Mortgage Corp. (In re Ramsey) (BAP 9th Cir 1994) 176 BR 183; Barber v Knox County School Employees Credit Union (In re Cox) (Bankr CD Ill 1990) 114 BR 165.
The accuracy tolerances listed above apply to "regular" transactions. An "irregular" transaction is one that has either multiple advances, irregular payment periods, or irregular payment amounts (other than an irregular first or final payment). Reg Z §226.22(a)(2) n46; Official Staff Commentary §226.22(a)(2)-1. The tolerance for an irregular transaction is one-fourth of one percent (.0025).
As discussed earlier, HOEPA is a section of TILA enacted to protect consumers from predatory lending practices. Loans governed by HOEPA not only have additional disclosures required, HOEPA also governs certain loan terms and practices. Violation of the disclosure rules or use of a prohibited loan term gives the borrower an extended right to rescind the loan.
Most commercial lenders are no longer making HOEPA loans because, generally,HOEPA loans are no longer accepted in the resale marketplace. As a result, HOEPA loans are becoming rare, although some small "hard money" lenders are still making these loans. Additionally, unsophisticated individuals, such as our "Jim," are also making these loans without ever realizing that they are governed by and have run afoul of HOEPA. I have encountered both very recently. My experience has been that, as interest rates drop to low levels, many retirees have looked for a safe place to make a higher rate of return (relative to, say, government bonds). Some of them have begun to lend money secured by residences, but they have no idea how regulated this area has become.
a. APR and Points and Fees Triggers. For loans in first position, made after October 1, 2002, HOEPA will be triggered if the APR exceeds by more than 8 percent the yield on Treasury securities having comparable maturities on the fifteenth day of the month immediately preceding when thel loan application was submitted. For junior loans the spread must be more than 10 percent. 15 USC §1602(aa)(1)(A); Reg Z §226.32(a)(i).
The other trigger that activates HOEPA is the points and fees trigger. If the lender charges points and fees totaling more than 8 percent of the total loan amount, it is governed by HOEPA. 15 USC §1602(aa)(1)(B); Reg Z §226.32(a)(1)(ii). In actual practice, a determination of the exact percentage rate of the points and fees, with respect to the total loan amount, is rather complicated and beyond the scope of this article.
b. HOEPA Disclosures. Borrowers obtaining a HOEPA loan are required to receive additional disclosures. These disclosures augment and do not replace the disclosures required under TILA generally. HOEPA disclosures must be given to the borrower three business days before the consummation of the loan. The disclosures require the following statements:
You are not required to complete this agreement merely because you received these disclosures or have signed a loan application.
If you obtain this loan, the lender will have a mortgage on your home. You could lose your home and any money you have put into it, if you do not meet your obligation under the loan.
Additionally, the lender must disclose the accurate APR and monthly payment amount, if the loan is a fixed-rate loan. If the loan is a variable interest rate loan, the disclosure must also inform the borrower that the monthly payment may increase and must state the amount of the maximum potential monthly payment. The monthly payment amount must also include disclosure of any balloon payment. The disclosure also must show the total face amount of the loan and state whether optional credit insurance or debt cancellation coverage is being sold to the borrower. 15 USC §1639; Reg Z §§226.31-226.32.
c. Prohibited Contract Terms. As discussed earlier, HOEPA prohibits certain loan contract terms. Inclusion of a prohibited term constitutes a failure to deliver the proper disclosures and creates an extended right to rescind the loan. The prohibited contract terms are: (1) Prepayment Penalties (15 USC §1639(c); Reg Z §226.32(d)(6), (7)). Allowed under the following conditions: Loan must not cause borrower to pay more than 50 percent of gross monthly income towards "monthly indebtedness payments"; income and expenses must be verified by a financial statement signed by borrower, a credit report, and payment records for any employment income; penalty must not apply when borrower refinances one of its or an affiliate's loans; repayment penalty can only be imposed for the first five years of loan term; and, must be valid under state law.
(2) Default Interest Rate Increases (15 USC §1639(d); Reg Z §226.32(d)(4)).
(3) Balloon Payments (15 USC §1639(e); Reg Z §226.32(d)(1)). Allowed if loan has term of five years or longer.
(4) Negative Amortization (15 USC §1639(f); Reg Z §226.32(d)(2)).
(5) Prepaid Interest Payments (15 USC §1639(g); Reg Z §226.32(d)(3)). Allowed if up to two months of payments are escrowed.
(6) Due-On-Demand Clauses (Reg Z §226.32(d)(8); Official Staff Commentary §226.32(d)(8)(ii)-(iii)). Allowed if there is fraud or material misrepresentation by the consumer in connection with obtaining the loan, the consumer fails to meet its financial obligations under the terms of the loan, or there is any action or inaction by the consumer that adversely affects the lender's security interest in the home.