Volume 23, Number 5 February 2007 Subprime Lending Lessons from the Ameriquest Settlement Joseph E. Mayk Joseph E. Mayk is of counsel s has been widely reported, early last above the comparable treasury security yield). in the consumer financial year Ameriquest Mortgage Company The oral disclosures, which are in addition to services/retail banking practice and related companies settled a multi- already existing Truth-in-Lending Act (TILA), group of Blank Rome LLP. A state investigation over certain allegedly decep- Real Estate Settlement Procedures Act (RESPA), He is resident in the firm’s Philadelphia office, where his tive consumer lending practices. The settlement and other mandated written disclosures, cover practice focuses on advising included $295 million to repay borrowers with the key loan terms, such as the repayment term, lenders on all aspects of loans originated between January 1, 1999 and interest rate, monthly payment, existence of a pre- consumer finance regulato- December 31, 2005, plus $30 million to pay for payment penalty, whether amounts are escrowed, ry compliance. Mr. Mayk 1 can be reached at mayk@ the investigations. amount and effect of any discount points, and blankrome.com. Like Household Finance Corporation’s nearly adjustable rate disclosures for adjustable rate mort- $500 million settlement with the states in 2002, and gages (ARMs). If the application is not submitted to a lesser extent Citigroup’s $215 million and $70 orally, the substance of the oral disclosures must be million settlements with the Federal Trade Com- provided in writing within three days of receiving mission and the Federal Reserve Board (which the application. did not explicitly require as many changes to Significantly, instead of imposing general require- Citi’s lending practices), the Ameriquest settlement ments, the settlement agreement provides scripted represents another mile marker in an emerging language for these disclosures, which Ameriquest “best practices” road map for subprime consumer must use, or alternative language that is substan- mortgage lending. As such, lenders are well advised tially similar. Over the years, lenders have had to compare the terms of this settlement to their different views on the utility of scripted oral current practices. The purpose of this article is to disclosures. While some have found them to be highlight certain terms of the settlement and sug- impractical or too restrictive to the sales process, gest issues that lenders may wish to consider with other lenders have seen the value in oral scripts respect to their own consumer mortgage lending (especially when coupled with listening programs) programs. Keep in mind, however, that no new in helping to ensure consistency in the sales proc- requirement imposed on Ameriquest is required ess, as well as in reducing the risk of deceptive of any other lender (at least not yet). sales claims. In addition to the specific scripted oral disclo- ORAL DISCLOSURES sures, the settlement agreement contains a number The settlement requires a number of oral disclo- of negative covenants that prohibit Ameriquest sures for “Non-Prime loans” (defined as first lien employees from making potentially misleading loans where the APR is equal to or greater than statements. For instance, Ameriquest cannot rep- two and a half percentage points above the yield resent that its interest rate or terms are “better,” for a treasury security of comparable maturity “lower” than, or “competitive” with those of and, for junior lien loans, five percentage points other lenders, unless the representations are, in Subprime Lending Lessons from the Ameriquest Settlement fact, true. The Household settlement also contained a number a decrease in the loan amount greater than one percent; the of provisions prohibiting Household from making misleading addition of a prepayment penalty; or a change from a fixed rate representations. to an adjustable rate loan. These are obviously prudent policies for lenders to have in The concept of redisclosure is currently the subject of place. While scripts can be very helpful in protecting a lender much discussion in the mortgage industry. For instance, it from claims of misrepresentation, it is also important that loan is expected that any RESPA reform on the horizon will officers and others understand that statements should not be deal with redisclosure of the good faith estimate if there is a made which contradict, undermine or obscure the more spe- change in the terms beyond some sort of tolerance. cific disclosures. The concept of redisclosure here seems to make sense, espe- cially for any lender that chooses to provide an early disclosure WRITTEN DISCLOSURE OF of material loan terms that is not otherwise required by state or LOAN TERMS federal law. For instance, if a lender provides an early disclosure The settlement also requires Ameriquest to provide consum- of material loan terms, it would not want to face a bait and ers with a single page disclosure of the key loan terms within switch claim if the final loan terms are different. Timely redis- three days after obtaining loan pricing information (but in closure helps protect against such a claim. no event later than three days after when an appraisal or loan documents have been ordered). This requirement applies to all LOAN PRICING loans, and not just non-prime loans. The form of written dis- Ameriquest must use a pricing model for loans that is designed closure contains information similar to that which Ameriquest to produce (before application of any price exception) the same is required to provide in the oral disclosures for non-prime interest rate and number of discount points for all potential loans. Household was also required by the regulators to imple- borrowers with the same credit risk characteristics and who are ment a one page summary of key loan terms. the same with respect to any other material characteristics (e.g., A clear, concise, written disclosure of key loan terms is loan-to-value ratio, type of property, etc). This part of the settle- another tool that can help protect lenders from deceptive sales ment commits Ameriquest to maintaining a policy that it vol- claims. Disclosures required by RESPA and TILA have been in untarily instituted in 2003 as part of a “best practices” initiative. effect for many years now, but are often insufficient to protect A “price exception” is defined as the offering of a rate that is a lender from misrepresentation claims even when properly lower than the rate for which the borrower otherwise qualifies given. In fact, there is a wide consensus among both lenders under the pricing model. To make sure that the use of price and consumer advocates that the current federal disclosures are exceptions is not undermining the pricing model, the settle- unnecessarily confusing to consumers. Of course, any lender ment provides that if in any ninety day period the number of considering a simplified summary disclosure must ensure that borrowers receiving a price exception exceeds thirty percent of it is consistent with the disclosures required by state and federal the loans originated during that period, there will be a rebuttable law. presumption that Ameriquest has violated this part of the settle- ment agreement. However, the term “price exception” does not REDISCLOSURE include a price reduction that is necessary to keep a loan below Another key component of the settlement is a requirement to federal and state “high cost” loan triggers or price reductions in give a new written summary disclosure if there is a “material certain other limited circumstances. Thus, loans where pricing is change” in the loan terms. The new disclosure must be mailed reduced in such cases do not count against the 30 percent cap. no less than six days before closing or otherwise delivered or This part of the settlement, along with restrictions on employee made available to the consumer at least three days before clos- compensation discussed below, would seem to eliminate the use ing for a non-prime refinance loan or one day before closing of overage pricing by Ameriquest. This is just the latest sign that for all other loans. overage compensation programs are receiving increased scru- A change is “material” if there is an increase in the interest tiny from regulators and the secondary market. New York, for rate of 30 basis points or more, or any increase in discount example, has for the past few years required lenders to describe points other than as a result of the trading of discount points their policy on overages.2 The secondary market has also gotten for an interest rate reduction that is affirmatively requested by more active in regulating the amount of points that can be the borrower; any increase in the repayment term of the loan; charged in a transaction For instance, Fannie Mae and Freddie 2 REAL ESTATE FINANCE FEBRUARY 2007 Subprime Lending Lessons from the Ameriquest Settlement Mac generally limit the total points and fees to 5 percent of financial interest in the loan being closed other than payment the loan amount. Many private investors impose similar restric- of standard settlement fees. tions. The public scrutiny of pricing data now captured by Each independent loan closer must be given written instruc- HMDA has further highlighted the potential fair lending risk. tions on the closing and must provide a written report to Lenders engaged in discretionary pricing need to seriously Ameriquest senior management if the loan closer discovers consider the benefits and risks of continuing to do so, and, at any unfair, deceptive, misleading or unlawful behavior by any a minimum, should put policies in place (such as back-end Ameriquest employee in connection with the loan. Further, closed loan reviews and front-end listening) to minimize the Ameriquest employees are only permitted to attend non-prime risk that pricing is creating a fair lending issue.