A new federal law narrows the circumstances under which a borrower refinancing a home can exercise a three-year option to cancel the mortgage because of lender error.
It also makes it more difficult to obtain damages against lenders who miscalculate the finance charges on loans for purchasing homes.
The law, signed by President Clinton on Sept. 30, is designed to head off a predicted rash of class action lawsuits that conceivably could cost mortgage companies billions of dollars over what the lending industry claims are minor mistakes.
The new law extinguishes any individual lawsuits for damages or loan cancellation claims filed after June 1 and squashes any class action suits which did not receive final certification to proceed before last Jan. 1.
The Boston-based National Consumer Law Center, which represents low-income households, is among the consumer groups upset with the changes.
“There is nothing good in the new law for consumers except what is not in there,” said Margot Saunders, managing attorney of the group’s Washington office. “It could have been so much worse.”
At one point during consideration of the legislation, borrowers who refinance their homes were in danger of losing the three-day cooling-off period during which they can cancel the deal for any reason, Saunders said.
The lending community, though, hailed the measure, most of which takes effect immediately, as welcome relief from a potentially ruinous financial threat.
Kurt Schumacher, a staff attorney with the Federal Reserve Board, which enforces the lending disclosure law, said the recent amendments “give some protection to lenders for past compliance problems and, going forward, clarify how things will be treated.”
The new law, which amends the Truth-in-Lending Act, overturns a 1994 decision in the case of Rodash vs. AIB Mortgage Co. A Florida judge permitted Martha Rodash to cancel her mortgage because a $22 courier fee and a $204 state intangible tax were incorrectly recorded as part of the amount financed rather than as part of the finance charge.
Under the federal Truth-in-Lending law, borrowers who refinance their homes may terminate their mortgages within three years if the settlement information supplied by the lender is inaccurate beyond certain tolerances.
A borrower tends only to look for lender errors as a basis for rescinding a mortgage when facing foreclosure, a situation that only occurs a few hundred times each year nationwide, Saunders said.
Under a recision, the borrower repays the remaining principal due, but the lending company loses the right to keep any of the finance charge, which means it must refund any interest and loan points the borrower has paid already, she said.
The Mortgage Bankers Association of America calculated that $1.3 trillion worth of business was at risk from Rodash-inspired recisions in the form of the 11.8 million loan refinancings which have occurred over the past three years.
The mortgage banking group also said the Rodash decision had inspired close to 50 copy-cat class action suits on the verge of winning judicial approval to proceed, when Congress stepped in last spring, freezing the cases in place.
In floor debate on the issue, Rep. Jim Leach (R-Iowa) said the suits did not result from attempts by the lending industry to deceive borrowers. All of the fees in question, he said, were disclosed but simply miscategorized.
“The problem is that an honest mistake of no consequence to any of the parties involved attracted the) shark instincts of the plaintiff’s bar,” Leach said.
With the temporary moratorium set to expire Oct. 1, the proposed amendments to the Truth-in-Lending law passed swiftly in the end. The House cleared the legislation Sept. 27, the Senate passed an identical version Sept. 28 and the President signed the bill into law two days later.
The law also reduces a lender’s exposure to borrower claims for damages by raising the margin of error for mistakes made in revealing the finance charge.
The finance charge is the amount the credit costs, which includes interest; mortgage points, which each equal one percentage point of the loan amount; and other fees kept by the lender. The finance charge is also the basis on which the loan’s annual percentage rate is calculated.
“Lenders often try to exclude as many fees as they can, because the higher the finance charge, the higher the APR,” Saunders said. “Lower APRs make borrowers feel better about the loan they are getting.”
On a positive note, Saunders said that when errors that trigger Truth-in-Lending violations are made, borrowers can now seek damages of up $2,000, double the previous limit.
However, Saunders added, lenders can be off by $1,000 or more in the calculation of the finance charge and suffer no consequence.
Specifically, the new law replaces the previous $10 error tolerance with a handful of trigger points.
A refinancer simply lowering the interest rate on an existing loan amount can seek to cancel the mortgage only when errors exceed 1 percent of the loan amount. Borrowers who pull out cash as part of a refinancing deal can rescind for mistakes of 0.5 percent of the loan amount.
Less egregious errors are allowed when a mortgage is used to purchase a home. On loans made before the new law took effect, the new trigger point is a $200 error or more. From now on, the threshhold drops to $100.
Fewer types of misplaced fees count as mistakes now.
Lenders routinely find it difficult to deal with last-minute charges coming from third parties, such as a courier company or an overnight delivery service, said Sharon Canavan, deputy legislative counsel for the mortgage banking trade group.
Those fees no longer have to be reported as part of the finance charge, provided the lender does not require the fee or keep the money.
Other items that now are excluded from the finance charge include fees for preparing loan-related documents, pest inspections and flood hazard certifications.
The new law does make the disclosure of borrower-paid mortgage broker fees part of the finance charge. When the mortgage brokerage fee of 1 percent or higher of the loan amount is not captured, the APR on these loans appear artificially low, Canavan said.
“This is a big pro-consumer piece” of the new law, she said.
“Now mortgages originated by mortgage brokers will not be treated differently than those made by an in-house loan officer on salary and commission.”
