O n May 1, 2003, Governor James (a) the primary tangible benefit to - - PDF document

Mortgage Banking Alert

November 2003

New Jersey’s Predatory Lending Law and Potential Assignee Liability

By Anthony Santoriello, Esq.; Edited by Gary M. Wingens, Esq.

(a) the primary tangible benefit to the borrower is an interest rate lower than the interest rate

• n a debt satisfied or refinanced in

connection with the home loan, and it will take more than four years for the borrower to recoup the costs of the points and fees and

• ther closing costs through savings resulting

from the lower interest rate, and (b) the new loan refinances an existing home loan that is a special mortgage through governments or nonprofit organizations, which either bears a below-market interest rate or nonstandard payment terms beneficial to borrower and where, as a result of refinancing, the borrower will lose one or more of the benefits of the special mortgage. A “high-cost home loan” is defined as a home loan for which the principal amount of the loan does not exceed $350,000 (to be adjusted annually in accordance with increases in the CPI) and for which: (a) the rate is equal to or greater than the allowable HOEPA rates, or (b) the total points and fees payable by borrower at or before the closing, excluding either a conventional prepayment penalty or up to two bona fide discount points, exceed 5% of the total loan amount if the total loan amount is $40,000 or more.

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n May 1, 2003, Governor James McGreevey signed into law the “New Jersey Home Ownership Security Act” (the “Act”), with an effective date

• f

November 27, 2003. The Act prohibits certain practices in the making of “home loans,” and enumerates additional prohibitions in the making

• f “covered home loans” and “high-cost home

loans.” A “covered home loan” is defined as “a home loan” in which: (a) the total points and fees payable in connection with the loan, excluding either a conventional prepayment penalty or not more than two bona fide discount points, exceed 4%

• f the total loan amount, or 4.5% of the total

loan amount if the loan is insured by the FHA

• r guaranteed by the VA, or

(b) the home loan is such that it is considered a high-cost home loan under [the Act].” Lenders are prohibited from “flipping” a covered home loan. “Flipping” occurs when a lender makes a covered home loan to a borrower that refinances an existing home loan within 5 years of the original loan when the new loan does not have reasonable, tangible net benefit to the borrower. The Act states that there shall be a presumption of flipping if:

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This document is published by Lowenstein Sandler PC to keep clients and friends informed about current issues. It is intended to provide general information only. 65 Livingston Avenue www.lowenstein.com

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Roseland, New Jersey 07068-1791 Telephone 973.597.2500 Fax 973.597.2400

With respect to high-cost home loans, lenders may not, among other restrictions: (a) include provisions for balloon payments (unless due to seasonal or irregular income of borrower), (b) include negative amortization terms, (c) increase the interest rate upon default, (d) increase require advance payments, (e) increase charge fees if the proceeds of the loan are used to refinance an existing loan, (f) increase charge fees for modification or deferral of the loan, (g) increase allow the borrower to finance points and fees in excess of 2% of the total amount of the loan, and (h) increase charge points and fees if the proceeds are used to refinance an existing high-cost home loan held by the same lender. As was the case in Georgia in 2002 when it passed (and subsequently substantially modified) the country’s strictest predatory lending law, industry response to the Act has been immediate, and secondary market purchasers have raised concerns over assignee liability. Proponents of the Act are quick to point out the explicit assignee liability protection provisions, as such provisions were not included in the initial Georgia law. While the Act allows the borrower to assert against an assignee all affirmative claims and any defenses with respect to the loan that the borrower could assert against the original lender, the amounts recoverable are more limited than under the

• riginal Georgia law. In addition, with respect to

high-cost home loans, such claims and defenses will not be available against an assignee if the assignee demonstrates by a preponderance of the evidence that a reasonable person exercising reasonable due diligence could not determine that such loan was a high-cost home loan. Under the statute, due diligence is presumed if an assignee demonstrates that it: (a) had in place at the time of purchase or assignment of the loan policies that expressly prohibit its purchase or acceptance of assignment of any high-cost home loan, (b) required by contract that the seller or assignor represented and warranted to assignee that either, (i) it would not sell any high-cost home loan to the assignee, or (ii) the seller or assignor was a beneficiary

• f a representation or warranty from a

previous seller or assignor to that effect, and (c) exercised reasonable due diligence at the time of purchase or assignment of home loans

• r within a reasonable period of time

thereafter intended by the purchaser or assignee to prevent the assignee from purchasing or taking assignment of any high- cost home loan. In a subsequent bulletin, the Department of Banking of New Jersey clarified that a 100% review

• f the loans being purchased is not required and

that the amount of random sampling that is commonplace in the secondary market should be the benchmark for review.

The OTS and Rating Agencies Weigh In

The OTS, Standard & Poor’s (“S&P”), Moody’s Investors Service (“Moody’s”) and Fitch Ratings (“Fitch”) have taken specific action with respect to the Act. The OTS, repeating its actions with respect to Georgia and New York, issued an

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• pinion exempting thrifts from the Act’s provisions

that regulate the terms of credit, loan-related fees, disclosures and the origination, servicing, refinancing and funding of mortgages. S&P has announced that after the effective date of the Act, it will not permit high-cost home loans or covered home loans to be included in its rated structured finance transactions. Moody’s has announced that loans that are neither high-cost nor covered home loans can be included in securitization pools without penalty, provided that the issuer can show that it has adequate compliance procedures in

• place. Moody’s will allow up to 2% of the

securitization pool to be high-cost home loans and up to 5% of the securitization pool to be covered home loans provided that such loans “fit neatly within clear objective standards for compliance.” However, in order to include high-cost or covered home loans in its securitizations, the issuer must agree to repurchase any loans which are in violation of the Act and indemnify the trust against any losses with respect to such loans. Fitch has announced that after the effective date of the Act, (a) it will not permit high-cost home loans to be included in its rated residential mortgage backed securities (“RMBS”) transactions, and (b) in order to rate any RMBS transactions which contain any loans originated in New Jersey after the effective date of the Act, Fitch must receive an acceptable certification from a third party unaffiliated with the originator of the loans that such third party has conducted due diligence on the New Jersey loans with respect to the relevant interest rates, points and fees of such loans and that such due diligence is in compliance with the Act and Fitch’s requirements.

NJ Regulator Addresses Key Issues

In a response to the rating agencies and as an attempt to allay the fears of secondary market players that New Jersey loans may be difficult to securitize on the secondary market, New Jersey’s bank and insurance regulator issued an interpretation of the Act on July 25, 2003 (the “Bulletin”). The Bulletin, among other things, addressed the following issues: (1) The application of the New Jersey Consumer Fraud Act (“Consumer Fraud Act”) to assignee liability in predatory lending cases. The Bulletin points out that although an individual can seek damages against an assignee under the Act or the Consumer Fraud Act, only in “rare circumstances” will a borrower have separate claims that can be brought simultaneously under both acts. In any case, however, damages awarded under the Consumer Fraud Act with respect to predatory lending are subject to the same cap as damages awarded under the Act. Further, individuals cannot reap a “double recovery” under both acts for the same loss. (2) Whether escrow payments for tax and insurance charges are included as points and fees when determining whether a loan is a covered home loan or high-cost home loan under the Act. The Bulletin clarifies that such escrow-related payments are excluded if they are “reasonable” and paid to a person

• ther than the lender or a broker, or their

affiliates. (3) Whether the “flipping” restrictions of the Act apply to all home loans. The Bulletin clarifies that such restrictions only apply to high cost home loans with respect to which the refinance occurs within five years of the closing of the prior loan.

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(4) Whether assignees of lenders who make cash-out refinance and junior lien loans where the proceeds are used to make home improvements could be liable under the Act’s home repair provisions. The Bulletin states that assignees can only be liable with respect to such loans if a home repair contractor was “sufficiently involved” in making the loan, and sufficient involvement can be determined by the “substantial guidance and precedent that underlies the FTC Holder Rule [16 C.F.R. 433].” As an example, the Bulletin points out that if a home repair contractor, in the ordinary course of business, is sending his buyers to a particular lender or lenders for a loan for which the proceeds are to be used in the contractor’s repair of the buyer’s property, such action makes the contractor “sufficiently involved” in making the loan. The Bulletin adds that assignees should have mechanisms in place to exclude such loans prior to purchase, including representations and warranties in the related purchase documents specifically prohibiting the sale of such loans. (5) The amount of due diligence required by an assignee to gain the safe harbor under the

• Act. The Bulletin explicitly states that a

100% review of loans being purchased is not required and that the amount of random sampling that is commonplace in the secondary market should be the benchmark for review.

Conclusion

S&P is still reviewing the Bulletin and has not issued a response. Moody’s has stated that if potential liability to assignees is increased by interpretation of the Act it would not allow high- cost loans in future securitizations. Fitch has stated that the Bulletin adds weight to its current approach to rating loans in states with strict predatory lending laws. Although there will likely be additional, specific responses from individual lenders and the rating agencies regarding the Act, it is anticipated that such responses will be less critical than the responses to the initial Georgia law, due to the explicit assignee liability protection provisions in the Act. In the meantime, the New Jersey Department of Banking has stated that it will “issue additional guidance and participate in compliance workshops in order to help the industry to prepare prior to the Act’s effective date, November 27, 2003.” For more information and counseling as to what appropriate steps your company should take at this time,

• r for a copy of the any of the laws or announcements

described here, please contact Gary M. Wingens at 973.597.2558 or gwingens@lowenstein.com, or Anthony Santoriello at 973.597.6216

• r

asantoriello@lowenstein.com.

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