Mortgage Lending: 9.8.9.1 State Law
A number of states impose restrictions on adjustable rate mortgage loans. Typical restrictions involve the size, frequency, and timing of interest rate adjustments.366
A number of states impose restrictions on adjustable rate mortgage loans. Typical restrictions involve the size, frequency, and timing of interest rate adjustments.366
Until the agency was abolished in 2011, an OTS regulation purported to preempt all state regulation as to ARMs originated by federal savings associations.369 The OCC still takes the position that its ARM regulation preempts state regulation as to ARMs originated by national banks.
Whatever the applicable restrictions of federal and state law, operation of an ARM must be consistent with the contract terms. Adjustment errors are common. The wrong index might be used, or the wrong reference date for valuing the index, and so forth.381 The typical claims raised are Truth in Lending Act,382 breach of contract, negligence, and fraud.383
Occasionally the index specified in a contract becomes unavailable or is subject to another unexpected change. In the past, this has happened for a variety of reasons. Examples include the failure of a bank whose prime rate was used as an index, a merger that leads an institution to stop contributing data to an index, and an index administrator’s decision to stop compiling or publishing an index.
The regulations governing Department of Veterans Affairs (VA) guaranteed loans require the schedule of payments to be set in accordance with a generally recognized plan of amortization for all loans with a term of at least five years.397 The payments must be in approximately equal amounts, and the payment schedule must require a principal reduction at least annually during the life of the loan.398 These requirements have the effect of banning negative amortization.
Federal Housing Administration (FHA) Title II single family loans must contain “complete amortization provisions satisfactory to the Commissioner . . .
For a broader universe of mortgage loans, the Dodd-Frank Act does not ban negatively amortizing mortgage loans but requires a special disclosure and, for some loans, documentation that the borrower received homeownership counseling from a Department of Housing and Urban Development-certified organization.413 The Consumer Financial Protection Bureau released a regulation implementing this mandate in 2013.414
Many state high-cost loan statutes address negative amortization. Under these laws, a high-cost loan may not include payment terms under which the principal balance will increase at any time over the course of the loan because the regular periodic payments do not cover the full amount of interest due. While most statutes that include this provision impose an absolute prohibition on negative amortization,416 some statutes are conditional.
Federal regulations preempt state limits on amortization of mortgage loans made by national banks and savings associations.426 Prior to 2011, this provision was found in a separate regulation for federal savings associations,427 but federal savings associations and national banks are now governed by the same regulation.428 National Credit Union Administration regulations also provide that the agency has exclusive authority to regulate “rates,
For mortgages originated prior to 2011, the Alternative Mortgage Transaction Parity Act (AMTPA) broadly preempted state law regarding ARMs, balloon payments, or loans “involving any similar type of . . . repayment, or other variation not common to traditional fixed-rate, fixed-term transactions.”433 This provision does not explicitly mention negative amortization, but negative amortization may imply the presence a balloon payment and it is not common in traditional types of mortgages.
The failure to provide a proper rebate of unearned interest upon the prepayment of a credit obligation is also, in essence, a form of prepayment penalty. Issues regarding rebates of unearned interest do not arise in the typical mortgage transaction, in which the consumer’s legal obligation as expressed in the note is to pay a principal amount plus earned interest at a specified rate or rates through the periodic payments.
Federal credit unions are prohibited by statute and regulation from charging prepayment penalties.446 The borrower has the right to prepay in whole or in part on any business day, except that for a first mortgage or second mortgage loan the credit union may require that partial prepayments be made on the regular monthly due date and be in the amount of that part of one or more monthly installments which would be applicable to principal.447
Federal Housing Administration (FHA) regulations restrict prepayment penalties on Title I loans, which are available for property improvements or to purchase a manufactured home or lot. The note for a Title I loan must include a provision permitting full or partial prepayment without penalty, except that the borrower can be assessed reasonable and customary charges for recording a release of the security interest, if allowed by state law.448
Effective in 2009, the Federal Reserve Board adopted new restrictions on prepayment penalties for a class of non-HOEPA “higher-priced mortgage loans” that carry interest rates a certain number of points above the prime interest rate.462 For these loans a prepayment penalty is allowed only if:
In addition to HOEPA’s prohibition of prepayment penalties, the Dodd-Frank Act added new restrictions on prepayment penalties that apply to a relatively broad segment of the mortgage loan market. For any residential mortgage loan, as defined by the statute,465 a creditor that offers a consumer a loan that has a prepayment penalty must also offer the consumer a loan product that does not have a prepayment penalty.466
While some state laws specifically allow prepayment penalties,476 many states forbid or restrict them in consumer credit transactions.477 Some states prohibit prepayment penalties altogether,478 while others cap them479 or restrict the circumstances under which they can be charged.480 Whether or not they restrict prepayment penalties, some stat
Prepayment penalties may be challenged on contract, fraud, or unfair and deceptive practices (UDAP) grounds.491 The size of a prepayment penalty, or the lender’s actions in imposing it, may render it unconscionable.492 Courts may find an unreasonable prepayment charge to be a liquidated damages clause that is unenforceable as a penalty.493 In the bankruptcy context, when a claim is oversecured, the bankruptcy court may disallow a prepayment p
HOEPA is explicit about preemption.
National and state-chartered banks, federal and federally insured state savings associations, and state credit unions can export “interest” rates from their home state to the state where a mortgage loan is made.504 Prepayment penalties fall within this use of the term “interest” for rate exportation purposes,505 and therefore depository institutions can utilize their home state rules on prepayment penalties.
Although OCC general preemption regulations do not specifically preempt state law on prepayment penalties,515 a particular OCC regulation that applies only to adjustable rate mortgages (ARMs), does preempt state law and allows national banks to impose prepayment penalties in ARMs, if permitted by the loan contract.516 The same rule applies to federal savings associations, effective for loans originated after July 21, 2011.
Effective for loans originated on or after July 22, 2011, the Consumer Financial Protection Bureau (CFPB)’s Regulation D implements the Alternative Mortgage Transaction Parity Act (AMTPA)521 by preempting state laws that restrict the authority of any state-chartered or state-licensed housing creditor522 to make ARMs.523 Regulation D does not preempt any state rules regarding prepayment penalties in ARM loans.
A due-on-sale clause permits a lender, upon the sale of a mortgaged property, to refuse to permit the purchaser to assume the outstanding mortgage. Instead the lender has the right to accelerate the debt, requiring full payment of the mortgage at the time of sale.
A balloon payment is a payment that is larger than the borrower’s regular periodic payment. For example, the payment schedule for a thirty-year mortgage loan might require 359 payments of $1000 and a final payment of $80,000. A balloon payment is often defined as one that is more than double the regular payment.
For Federal Housing Administration (FHA) Title I loans, which are available for property improvement or for the purchase of a manufactured home or lot,539 federal regulations require that the note provide for equal installment payments.540 The only exception is that the first or last payment, or both, may be up to 150% of the regular payment.541 These requirements effectively prohibit balloon payments.