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Consumer Lending Laws

Avoiding Violations and Responding to Complaints

February 13, 2007

By Norman H. Roos, James R. Kinyon, Elizabeth M. Smith

In recent years, the residential mortgage lending industry, already burdened by a myriad of statutes and regulations, has been the subject of intense legislative and regulatory scrutiny as the result of “predatory lending practices” employed by a small number of unscrupulous lenders and brokers. As a consequence, federal, state and local officials have created yet more laws, including numerous anti-predatory lending measures, making it increasingly difficult for the vast majority of honest and law-abiding mortgage lenders and brokers to fully meet their statutory and regulatory obligations.

While sweeping regulatory reform is long overdue and sorely needed, the elimination of overlapping and inconsistent federal, state, and local mortgage laws is unlikely to occur anytime soon. Accordingly, this article offers some suggestions for avoiding violations of consumer lending laws and responding to complaints when they do arise.

Consumer Lending Laws

There are a number of laws with which mortgage lenders must comply. In addition to the Truth in Lending Act (TILA), the Fair Credit Reporting Act (FCRA), the Equal Credit Opportunity Act (ECOA), and the Real Estate Settlement Procedures Act (RESPA), there are scores of other federal, state, and local statutes, regulations, and ordinances, including those relating to licensing, disclosures, loan terms, limitations on loan fees, and servicing obligations. Now, in addition to the recent spate of new anti-predatory lending laws, regulators have begun promulgating guidance on nontraditional mortgage products, such as interest-only and payment option loans (the term guidance is a misnomer in some jurisdictions, where regulators are giving such guidance the force and effect of law).

At the same time that it is becoming more difficult for lenders to comply with the ever increasing numbers of mortgage laws, the consequences for violations of those laws are becoming more severe. A violation can lead to administrative actions (including license suspension or revocation), civil litigation, and even criminal prosecution.

Common Lender Errors

Disclosures—Undue Reliance. Ensuring proper completion of required disclosure forms can be particularly problematic, given the variations between federal (principally TILA and RESPA) and state laws, as well as the different requirements from one state or local jurisdiction to another. Many lenders rely upon computer-generated disclosure forms and audit software to ensure their disclosures are in compliance with applicable laws. These tools can be both effective and cost efficient, but it is crucial for lenders to take independent steps to ensure their forms and software are reviewed and updated regularly for each jurisdiction in which the lender operates.
Disclosures—Form Errors. The human aspect of consumer lending is another area that requires regular attention. Common human errors include using the wrong disclosure forms, completing forms improperly, or failing to provide the correct number of forms to the consumer. Thus, regardless of the tools and processes an organization has in place to assure compliance, if a lender does not take steps to properly educate and train its employees and third-party agents on the latest changes in regulations and procedures, violations may occur.
RESPA—“Good Faith Estimates.” RESPA requires the lender to provide a “good faith estimate” to a prospective borrower within three business days of receiving a loan application. The good faith estimate must disclose the anticipated settlement costs. National and regional lenders sometimes make the mistake of using generic cost information for the estimate that fails to reflect regional differences, resulting in a disclosure error. For example, the fees associated with an appraisal or title search might be significantly higher in Fairfield, CT than in Toledo, OH. In other instances, a lender might simply fail to list estimates for some fees and charges that should be included in the disclosure for a particular state or county. RESPA violations can also occur when a lender fails to disclose all of the appropriate fees and charges on the HUD-1 or HUD-1A settlement statement.
RESPA—Payment of Illegal Referral Fees. Another potential violation arises when a lender pays a referral fee or other “thing of value” to a person who refers business to the lender. Payments for goods or services actually performed are permissible under RESPA, provided they are reasonably related to the value of the goods provided or services rendered. However, the giving or receipt of a thing of value (including such items as trips, gifts, and tickets to events) that is not demonstrably related to services performed can trigger a RESPA violation, thereby exposing both the provider and recipient to liability.
TILA Violations—Failure to Properly Disclose. The TILA statutes and Regulation Z require lenders to provide borrowers with “clear and conspicuous” disclosures regarding a variety of the terms and costs associated with their loans. One of the more common TILA violations involves the improper inclusion or exclusion of certain fees and expenses in the amount financed, which leads to a misstatement of the finance charge and annual percentage rate on the loan. Another common error arises when the information in the loan documents is inconsistent with the information in the required disclosures. An example would be failing to modify standardized information in the loan disclosure to reflect specific terms of the loan in question. Other common errors include listing incorrect dates on the notice of right to cancel forms and failing to provide a sufficient number of copies of TILA disclosure statements and the notice of right to cancel forms to the borrower.
FCRA Violations. FCRA violations most often arise from improper disclosure or use of consumer credit reports. A lender’s unauthorized disclosure of a credit report can cause it to be regarded as a “consumer reporting agency,” subject to FCRA regulations with which most lenders are unprepared to comply.

Similarly, accessing a consumer report without a permissible purpose (e.g. without authorization from the consumer or when the consumer has not yet submitted an application for an extension of credit) can expose a lender to sanctions under FCRA. The failure to properly investigate a consumer complaint relating to an alleged error on a credit report, or the failure to take timely, appropriate steps to correct an error that is identified, may also expose a creditor to liability under FCRA.
ECOA Violations. One of the most common ECOA violations arises when a lender fails to provide a loan applicant with a timely notice of adverse action following the rejection of a loan application or a counteroffer on terms other than those requested by the applicant. Lenders can also trigger ECOA violations by requiring a co-signer on a loan, even when the loan applicant satisfies the lender’s loan standards in his or her own right, without the additional creditworthiness of the co-signer.
Inattention to Requirements. Lenders, mortgage brokers, and loan originators are required to be licensed or registered in many states. Common violations include failing to register as an originator prior to engaging in loan origination activities, a lender neglecting to obtain a license when opening a new location, changing an existing office location without providing timely notice to state regulators, or working with brokers who are unlicensed or whose licenses have lapsed.
New Laws and Pitfalls. Loan flipping, also known as “equity stripping,” is one of the more offensive predatory lending practices and one that has received a great deal of attention from regulators. In an effort to limit this practice, many states, including Connecticut, impose limits on fees that can be charged to applicants and borrowers in connection with the refinancing of a loan. Some jurisdictions have gone further and have adopted net benefits tests, which require the lender to provide a tangible net benefit to the borrower before a new mortgage loan can be made. The standards imposed upon lenders under these anti-predatory lending laws can vary significantly from state-to-state and can be extremely vague. Accordingly, particular attention to the each jurisdiction’s specific requirements is necessary.

Additional lending practices that have been deemed suspect by regulators include lending on the value of real estate without regard to a borrower’s capacity to repay the loan (other than through sale of the mortgaged property) and loans where the payment schedule is subject to significant increases, even though the borrower may lack the financial capacity to make the increased payments.

Avoiding Violations

No matter how careful a company is, mistakes can happen. The best means of avoiding the consequences of regulatory violations is to implement a comprehensive compliance program to avoid violations in the first instance. Some tips for reducing the odds of triggering a violation include the following:

Monitor the Regulatory Landscape. Watch for statutory and regulatory changes in every jurisdiction where you do business. Many lenders have internal departments devoted exclusively to such compliance issues. Those who do not should regularly consult with outside counsel experienced in the financial services industry and should have their forms and practices reviewed for compliance problems at least annually. Also, attendance at continuing education programs and subscriptions to trade newspapers and magazines can provide valuable information on new laws and regulatory “hot topics.” When changes occur, promptly take steps to update your lending documents and alert your employees and third-party vendors to the new requirements.
Respond Promptly to Regulatory Inquiries. Lenders should respond promptly to a regulator’s request for information. A delay in responding can only impair the resolution of issues and can lead to an escalation of the sanctions the agency is likely to impose for any violations found. It can also subject the lender to more intense scrutiny, because it leaves regulators with the impression that the company has “something to hide” or is being untruthful.
Respond Promptly to Consumer Inquiries. Many consumer complaints can be avoided simply by being responsive to consumer inquiries. If the consumer does not feel his complaint is being taken seriously, his next call may be to his attorney, your regulator, or the attorney general. Also, in some instances the failure to respond promptly to a consumer inquiry can itself trigger a violation. Even where a consumer’s complaint appears to be baseless, you should weigh carefully whether to seek a compromise or deny the claim outright. If an issue can be resolved with minimal expense to the company, it may be preferable to do so—even if the lender is in the right—in order to avoid the time and expense of formal litigation or a regulatory inquiry.
Regularly Audit Outside Vendors. If your company relies on third-party originators, brokers, or closing agents, you should have measures in place to audit their compliance with your policies and procedures, as well as with the relevant statutes and regulations. If a vendor is involved in a large percentage of your company’s loans in a given jurisdiction, it may not be enough to simply audit the loan documents submitted by the vendor. Instead, it may be appropriate for a member of your organization to conduct an on-site visit to inspect the vendor’s operations and review their procedures. Also, require that all vendors provide you with proof of current licensure (and if appropriate, financial statements, disaster recovery plans, etc.) when you begin a relationship, and insist they provide you confirmation annually that they are in good standing with the regulatory body that licenses them.

Consumer Complaints

As noted above, all complaints from consumers should be taken seriously and responded to without unnecessary delay. Since most consumer lending laws award attorneys’ fees and costs to a consumer who prevails in litigation, prompt settlement of claims that appear to have merit is advisable. In cases where the amount of damages to be paid will be minimal, settlement should at least be considered even if the claim is of questionable merit. Settling a claim for nuisance value is generally preferable to incurring the costs of protracted litigation, since those costs can include attorneys’ fees, disruption to the lender’s operations, and the potential of triggering a regulatory investigation. In addition to the extent that a loan has been assigned to a third party, the commencement of litigation may trigger an obligation to repurchase the loan or defend and indemnify the assignee. On the other hand, a lender should avoid developing a reputation for “rolling over” every time a claim is brought, lest it become a favorite target of plaintiffs’ lawyers.

Since some litigation is inevitable, here are some steps that lenders can take to limit their exposure and discourage unmeritorious claims:

Formalize Agreements With Your Vendors. Formalize agreements with third party vendors to hold them accountable for their errors. Be sure to review and update such agreements regularly to incorporate recent regulatory changes. Include language that clearly spells out your expectations and requires the vendor to defend and indemnify your company against claims that arise from their failure to meet those expectations. Whenever possible, ensure that the vendor has adequate assets or insurance coverage available to respond to such claims,
Challenge Questionable Claims. Vigorously challenge questionable claims as early in the litigation as possible. Although motion practice can be a costly aspect of litigation, if it weeds out questionable claims or narrows the issues in the case, it will likely save the lender money in the long run. It may also discourage others from bringing unmeritorious claims and convince the opposing party to drop a dubious claim, or at least to take a more reasonable view toward settlement.
Involve the Court Early On to Truncate the Litigation Process. Involve the court in the process as early as possible by requesting a pretrial conference or early settlement conference. The court can sometimes help both parties consider aspects of a claim they may not have thought about before and can limit a consumer lawyer from engaging in runaway litigation as a way of driving up fees.
Consider the Use of Offers of Judgment. Evaluate the jurisdiction’s rules for making offers of judgment. In some instances, if the consumer’s claim is limited to statutory damages that are readily ascertainable, an offer to pay those damages can cut off a claim before the consumer’s attorneys’ fees get very high.
Protect Your Proprietary Information. Take steps to protect proprietary or trade secret information from unnecessary disclosure through litigation. Whether intentionally or not, discovery requests often seek information that is commercially valuable to the lender and not something that should be accessible to its competitors, Ask the opposing party to enter into a confidentiality agreement preventing the disclosure of such information to outside parties. If they refuse, seek a protective order.
Insist Upon a Confidential Settlement Agreement. If a claim is settled, insist upon a confidentiality clause as part of the agreement. The Plaintiff’s Consumer Law Bar is very active and prone to sharing information about cases. If they are made aware of a vulnerability in a lender’s practices, or the amount of a settlement, it may make the vender a target for additional claims or more aggressive settlement tactics.

For more information on Consumer Lending Laws, please contact the Thelen attorney(s) with whom you work or the authors of this article:

Norman H. Roos
Managing Partner, Hartford
860.275.6429
nroos@thelen.com

James R. Kinyon
860.275.6431
jkinyon@thelen.com

Elizabeth M. Smith
860.275.6472
esmith@thelen.com

Click here to learn more about our Real Estate practice group.

©2007 by Thelen LLP. This article is published as an information service for clients and friends. Please recognize that the information is general in nature and must not be relied upon as legal advice. We would be pleased to discuss the information in this article, and its application to your specific situation, in greater detail. We welcome your comments and suggestions.

About Thelen LLP
Thelen LLP is an international law firm with approximately 630 attorneys, and offices in New York, San Francisco, Washington, DC, Los Angeles, Silicon Valley, Hartford, Northern New Jersey, Shanghai, and London. The firm provides superior legal services in complex commercial litigation; corporate and capital markets transactions; project and asset finance; construction; labor and employment; intellectual property; information technology, domestic and international tax; employee benefits; government affairs; and real estate.

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