Livinglies's Weblog

Lots of loans have provisions that are illegal. As far as I know the only illegal provision of a loan that could make debt, note and mortgage go away, i.e., becomes void in its entirety (versus the provision containing the illegal language), or that entitles the borrower to recover all his payments or more is a usury statute in a state where the statute specifically provides that remedy. Thus negative amortization is illegal in many states (see below). But depending upon the statute, and the case law of each state, my opinion is that the provision in the note that contains the offending language is probably void as being against public policy. But be careful what you wish for. What happens next?

Hat Tip to Gene Stunkel, whose question got me thinking

see 2008 chart: http://www.ncsl.org/research/financial-services-and-commerce/mortgage-lending-practices-state-statutes.aspx

Unless there is a remedy for reformation or declaratory and supplemental relief available, cancelling the negative amortization provision could mean that payments go up to full amortization. But that rewards the pretender lender for trapping the consumer into an unaffordable loan. If a court were to rule that way the court would be reforming the instrument to violate the Truth in Lending Act (TILA) and probably state lending statutes as well — especially deceptive lending laws.

The counter argument is that if the negative amortization provision is contained in the note then the only way to keep the note enforceable (clearly a preference by the court) and within provisions of the applicable statute is to reduce principal down to the point where the negative amortization payment is equal to payments under a fully amortized loan.

As for Florida’s Fair Lending Act banning negative amortization here is what it says:

494.0078 Short title; purposes.—

(1) This act shall be known as the “Florida Fair Lending Act.”

(2)(a) The Legislature finds that abusive mortgage lending has become a problem in this state even though most high-cost home loans do not involve abusive mortgage practices. One of the most common forms of abusive lending is the making of loans that are equity-based rather than income-based. The financing of points and fees in these loans provides immediate income to the originator and encourages creditors to repeatedly refinance home loans. As long as there is sufficient equity in the home, an abusive creditor benefits even if the borrower is unable to make the payments and is forced to refinance. The financing of high points and fees causes the loss of equity in each refinancing and often leads to foreclosure.

(b) Abusive lending has threatened the viability of many communities and caused decreases in home ownership. While the marketplace appears to operate effectively for conventional mortgages, too many homeowners find themselves victims of overreaching creditors who provide loans with unnecessarily high costs and terms that are unnecessary to secure repayment of the loan. The Legislature finds that as competition and self-regulation have not eliminated the abusive terms from home-secured loans, the consumer protection provisions of this act are necessary to encourage fair lending.

494.00791 Prohibited acts.—

(1) PREPAYMENT PENALTIES.—

(a) A high-cost home loan may not contain terms that require a borrower to pay a prepayment penalty for paying all or part of the loan principal before the date on which the payment is due.

(2) DEFAULT INTEREST RATE.—A high-cost home loan may not provide for a higher interest rate after default on the loan.

(3) BALLOON PAYMENTS.—A high-cost home loan having a term of less than 10 years may not contain terms under which the aggregate amount of the regular periodic payments would not fully amortize the outstanding principal balance.

(4) NEGATIVE AMORTIZATION.—A high-cost home loan may not contain terms under which the outstanding 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 the interest due.

 

(6) EXTENDING CREDIT WITHOUT REGARD TO THE PAYMENT ABILITY OF THE BORROWER.—A lender making a high-cost home loan shall not engage in any pattern or practice of extending high-cost home loans to borrowers based upon the borrowers’ collateral without regard to the borrowers’ ability to repay the loan, including the borrowers’ current and expected income, current obligations, and employment.

(9) REFINANCING WITHIN AN 18-MONTH PERIOD.—

(a) A lender, its affiliate, or an assignee shall not refinance any high-cost home loan to the same borrower within the first 18 months of the loan when the refinancing does not have a reasonable benefit to the borrower considering all of the circumstances, including, but not limited to, the terms of both the new and refinanced loans, the cost of the new loan, and the borrower’s circumstances.

(b) A lender or assignee shall not engage in acts or practices to evade this requirement, including a pattern or practice of arranging for the refinancing of the lender’s or assignee’s own loans by affiliated or unaffiliated lenders or modifying a loan agreement, whether or not the existing loan is satisfied and replaced by the new loan, and charging a fee.

Anyway, here is a chart that was done in 2008. Claims under such laws may well be limited by statutes of limitation.

Definitions of provisions:

Flipping:  refinancing an existing mortgage loan with no benefit to the consumer; also referred to as churning.

Negative amortization:  payment terms under which the outstanding 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 or terms under which the aggregate amount of the regular periodic payments would not fully amortize the outstanding principal balance.

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