Mortgage Banking LawMichigan State University College of LawSummer 2008Professior Eliot Spoon

His background: was securities lawyer.

Residential housing finance. Residential mortgage loans.Where does all the money come from to make all these loans? How did the subprimemortgage crisis develop and how to we solve it?

Single biggest transaction a consumer makes in their lifetime.In the economy, the amount of mortgages by dollar amount that are made every year hasbeen over $1 trillion.

What is Residential Mortgage Banking? (Single Family Mortgages)1-4 family. Anything beyond this is "multi-family."

THE PRIMARY MARKET!Consumer goes to Mortgage Broker (ABC Mortgages), usually a private corporation withvery little capital. In Michigan, you only need a whopping $25,000. Barriers to entry areVERY low. Mortgage Broker goes to Mortgage Banker / Lender with the Consumer'sinformation, asking what kind of deal they can get. The Banker gives the money to theConsumer. Consumer pays Mortgage Broker a fee. Consumer wants a $100k, 30 year fixedrate mortgage. Consumer puts $10k down.

Lets assume that the Mortgage Banker is NOT a depository institution. A depositoryinstitution is one that people can go into and deposit money. They don't accept deposits.This is the case in half of the mortgage loans. Where do they get their money? Themortgage lender BORROWS the money from another BANK! Regular commerical banklending to a mortgage bank is called: Warehouse Lending. The commercial bank is calledthe Warehouse Bank in this transaction. How much money will the warehouse bank lend thelender? They never lend them 100%. Something less than 100%. This amount that is lessthan 100% is: the Haircut. The mortgage banker always gets a haircut. So warehouselender will provide $85k of the 90k the consumer wants. What they get depends on whatkind of loan it is. When the mortgage banker receives the warehouse loan from thewarehouse bank, the warehouse bank does not lend to them on an unsecured basis. Thesecurity is the SAME MORTGAGE LOAN. The loan to the consumer is pledged to thewarehouse bank.

The warehouse lender says this is great, but I am not in the business of collecting thismoney for 30 years. The mortgage banker then has to deal with the Secondary MortgageMarket.

THE SECONDARY MARKETA series of financial related institutions that deal with the mortgage banker. Essentiallybuying the mortgage loans from the mortgage banks.

The mortgage bank takes the loan and sells it to any one of a number of SecondaryMarket Participants. Who are they? Fannie Mae, Freddie Mac, and [Ginnie Mae], orprivate companies. Buying it at par means they pay 100% of the loan price for the loan.One of these secondary market participants and sends $85k to the warehouse banker, and

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$5k to the mortgage banker, effectively buying the entire loan.

Mortgage banker makes money from fees, gain on sales, and by servicing the loan.Servicing the loan is that they collect the money from the Consumer. The whole secondarymarket is invisible to the consumer. In most loans, you make a payment called an EscrowPayment, 1/12th of real estate taxes that you own on the property and 1/12th of theinsurance premiums to the Mortgage Banker. Holds this money until taxes and insuranceare due. For doing all this, the Mortgage Banker has to make sure the Consumer pays. Ifthey don't pay, the Mortgage Banker is responsible for suing the Consumer for nonpayment.Typical remedy is foreclosure to take title to the house for resale, to pay off the loan. Themortgage bank doesn't own the loan anymore! They are just servicing! Servicing is theprocess that the mortgage banker is responsible for collecting and distributing payments.They get a fee called a Service Fee, calculated on an annual basis. It's a percentage of theprinciple amount of the loan. Generally computed in Basis Points. 1/100th of a percent.0.01%. 100 basis points = 1%. The typical servicing fee is 25 basis point. 1/4 of 1% for theentire loan. $100k loan, is $250 a year. So that makes it more profitable to have as manyloans as possible.

The Consumer is making the payments to the mortgage banker.

Where do the Secondary Market Players get the money? They take these loans that theyhold, massage and twist them and turn them, and bundle them. They then sell them on theCapital Market. Pensions, hedge funds, anyone that has to invest large sums of money arethe ULTIMATE PROVIDERS of the funds. Mortgage rates that the consumer gets are for themost part what the investors in the capital markets are willing to buy, and what interestrates are attracted to them. Interest rates flow backwards. The amount of outstandingmortgage loans is over $11 trillion. There is no other part of the economy that there is thislevel. So if something goes haywire in the system, on the very macro level, how it caneffect everything else. THERE IS SO MUCH FRIGGING MONEY INVOLVED.

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Conventional loan is NOT a government loan.Government Loan: two principle types.

FHA insured loan. It's a loan that you pay an insurance premium to the government,and the government insures the lender that they will get their money even if youdefault. Lets lenders lend to people they otherwise would be skittish of lending to.VA Guaranteed Loan: guaranteed to a veteran and his family. Similar to FHA, but adifferent guarantee. Makes it easy for them to get loans.

Conforming Loan: essentially a loan that conforms to the requirements of Fannie Mae andFreddie Mac. If they will buy it, it is deemed to be a conforming loan. Whether or not it is aconforming loan has a LARGE impact on how the capital market will react. In general, aconforming loan is one that is no greater than $417k. Conforms to the underwritingrequirements. The credit of the underlying consumer has to be good enough. This is calledcredit underlay. Also a property underlay. Have to meet all three to be conforming.Jumbo Loan: a loan that is greater than $417k. Historically, with good credit, Jumbo Loanshave been 1/4% higher than conforming loans. More recently, they have been 1% higherthan conforming loans.Subprime Loan: A loan made to an individual with credit difficulties. For some purposesdefined in relationship to a person's credit score. Significantly higher interest rates.

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5/14/08

TABLE FUNDING - WHOLESALERSAnother typical scenario is that the first person the consumer comes in contract with is notthe Mortgage Broker, but is a Mortgage Banker #1. When the loan is made and theconsumer signs the primary documents:1. Mortgage Note - they promise to repay the money loaned to them2. Mortgage Document - creates the lien in favor of the mortgage banker on the propertyIn this scenario, the note and mortgage are payable to Mortgage Banker #1. This isdifferent than using a Broker because the Broker's name is never on anything. There aredifferent responsibilities and liabilities depending on WHOSE name is on these documents.Who acts or operates as a Mortgage Broker or Mortgage Banker.

If Mortgage Banker #1 closes the mortgage in their name, and immediately assigns it toMortgage Banker #2, #1 gets the money to make the loan from #2. #2 gets the moneyfrom the Warehouse Bank. This process is called Table Funding. Mortgage Banker #1 isfully funded at the table at the time of the closing.

CountryWide's description of their business describes this as their "Wholesale Division."They Table Fund mortgage bankers. Mortgage Bank #2 is the Wholesaler.

DEPOSITORY INSTITUTIONSAnother typical scenario: When we're dealing with a depository institution. They havespecial charters. You can be a state chartered bank, credit/loan, credit union... or you canbe a federally chartered one.

Consumer is dealing with ABC Bank. What changes? The source of money that the lenderuses to make loans.Sources for ABC Bank:

• Capital - very specific requirements for reserve.• Deposits - deposits that the bank receives from customers. (a key source that

mortgage banks don't have)

In 1982, mortgage rates were extremely high because they had to give high deposit ratesout. Banks thought that Adjustable Rates would be good for mortgages too, so they couldtrack deposit rates.

Another idea was that they should sell mortgages to the secondary market. They got theincome immediately, but if they didn't match their income with their expenses this is calledInterest Rate Risk. If the rates moved in the wrong direction, the banks that kept theloans had this risk. e.g. they have a 7% mortgage but have to pay out 12% on depositaccounts. Also, they have Credit Risk, if the customer didn't pay the mortgage. A largepart of the depository institutions were burned in the 80's by holding onto these loans. Sothe Depository Banks thought they should act like the Mortgage Banks and sell these thingsoff.

The Federal Home Loan Banks, provide there is liquidity for the banks to make the loans.They operate as a form of a Warehouse Bank for the depository institutions. The amount ofmoney here stands at $1 trillion.

SECONDARY MARKETS

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Fannie Mae and Freddie Mac: Specially chartered financial institutions. GovernmentSponsored Enterprises (GSE's). They get their charter from Congress. Buy and sell stockon the public stock exchange. 18 board members. 13 are appointed by shareholders. 5 areappointed by the president. Both are directly regulated by the government. They both haveas one of their regulators Federal Housing Enterprise Oversight (OFHEO), created in 1992.Mission is to regulate them in terms of their safety and soundness.

Their purposes (all of these are linked though):• Stability in the secondary market• Increase liquidity to make mortgage investments• Promose access to mortgage credit (consumer oriented)

Strangeness• Exempt from all state and local taxes, except real estate taxes. They do have to pay

Federal taxes.• Can conduct business in any jurisdiction without complying with licensing or other

such things locally.• Any securities they issue are deemed to be Government Securities for certain

purposes. Excempt from registration with the SEC (saves them a whole bunch ofmoney.) Treated like Government Securities in funds and such.

• Have a line of credit with the US Treasury of $2.25 billion, however, the Charter Actmakes clear that the obligations are NOT BACKED BY THE FULL FAITH AND CREDITOF THE GOVERNMENT! The government has no legal responsibility.

Fannie Mae and Freddie Mac - How do they work?

METHOD #1, dealing with Mortgage BankersThis is only for conforming loans!

Consumer and ABC Mortgage Bank, as Mortgage Bank. They originate loans and have to sellthem. Fannie Mae and Freddie Mac buy the loan from ABC Mortgage, and then ABCMortgage Bank pays off the Wholesale Lender.

Fannie and Freddie get the money to buy these loans from the Capital Markets. They sellBONDS that are backed by the mortgages. Meaning that investers buy the bonds, FannieMae gets the cash. Borrows make their payments, Fannie Mae and Freddie Mac pay theinvestors that bought the bonds, and FM and FM get the difference. So they buy a 7% loan,and sell a 5% bond. They make 2%. Bonds are essentially a fancy loan.

The government insists that it does not guarantee these bonds, even though you can treatthem that way in certain ways. The investment community doesn't believe the government.Fannie Mae and Freddie Mac are "too big to fail." This phenomenon is called the ImpliedGuarantee. But their total debt is $1.5 trillion. And they only have a $2.25 billion line ofcredit from the government! So its a mere pittance.

The implied guarantee means that FM can get a bond rate that is very close to thegovernment rate. It is a very low rate in comparison. So if you have a Jumbo Loan, the rateis higher because the PRIVATE secondary players cannot get the same rate as FM.

METHOD #2, Mortgage Backed Securities

Mortgage Company has loans. FM says that they have Credit Risk and Interest Rate Risk,and we don't want this all the time. FM set up a Trust, and take the loans and put theminto the Trust. Certificates of Beneficial Ownership come out of the Trust. This is similar

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to stock in a company. So the entire trust consists of Mortgages. They are then calledMortgage-Backed Securities: evidence of ownership of the trust that owns hundreds ofmillions of dollars of mortgages.

So ABC Bank holds onto the Mortgage-Backed Securities. It's a paper transaction. ABC Bankgives loans, FM gives bank certificates of ownership. But ABC needs the money, they haveto sell all the loans. So they sell the MBS into the capital markets. But who would buy amortgage backed security? Investors don't want to worry what's in these certificates. So,what they did was, with respect to these MBS, Freddie Mae and Freddie Mac guaranteepayment back on the mortgage backed securities. The investors have to way to invest: buythe bonds from FM, or buy the MBS from FM. Either way FM is on the hook. FM doesn'thave the interest rate risk now. Only the credit risk. FM charges a guarantee fee tomake money. In the MBS interests, they make money based on fees. In the Bond interests,they make money from the interest differential. FM own $1.4 trillion in mortgages, andguarantee another $3.3 trillion in the form of MBS.

FM buys loans and in fact guarantees loans.

Critics:• Too much exposure concentrated in these institutions!• Anti-Competitive• Is it a government subsidy? Ideological.

Derivitives to hedge these risks. There are other investments they make that may makethings worse rather than better.

Everything in the FM system and flow worked FINE during and after subprime crisis becauseit works!

OFHEO is lifting some restrictions because no one else is lending to jumbos and subprimes!

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05/19/08

Spread between FM bonds and government bonds is usually 30 basis points. Over last fewmonths, this differential went from 30 basis points to 190 basis points.

Why are people on FM's back for the last 8 years? 1. Too much exposure that thegovernemnt may have to bail out. 2. The idea is that the special status of being a GSE,ultimately transalates into allowing them to give bonds at lower interest rates. Pushescompetition out because it's not a level playing field. Also, being a GSE allows FM to borrowat a lower rate: cheaper about 20 basis points. They don't even pass all of this on to theconsumer! FM takes about 14 of those points for themselves and give the consumer the 6left. 3. Ideological argument.

GINNIE MAENOT a GSE. It is a government agency. Primary function is to facilitate the issuance ofmortgage backed securities. Issued first one in 1970. beat private sector by 5 years, beatFannie Mae and Freddie Mac by ~15 years.

Mortgage Banker, when dealing with Ginnie Mae, we're only talking about governmentloans. Mortgage Banker makes a FHA, VA, Public of Indian Housing (PIH), Rural HousingService (RHS), government loans to consumer. On an individual loan basis, the lender will

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be made whole if there is a default or foreclosure. The government wants to emphasizethese loans. Lenders will make them because the gov will guarantee them, but they needcapital! Ginnie Mae gets the government loans, puts them into a trust, issue a MBS whichgoes back to the mortgage banker, and the MBS is sold onto the capital market. What'sdifferent about this? The MBS has a Ginnie Mae guarantee. GM does not buy the loans forcash and sell bonds. They only do one thing: they put a guarantee on the mortgage backedsecurities.

The primary (historical) program of GM was that they would take loans, (assuming) all thesame interest rate at 7%, the MBS would be 6.5%. The MBS will have a interest rate that isa half a percentage below what the underlying loans are at. So what happens? Consumermakes payment at 7%. 6.5% gets sent to the investor, and the other half gets split into 50basis points. Ginnie Mae gets 6 basis points. The other 44 basis points goes to the MortgageBanker as a Servicing Fee.

How do you get into Ginnie Mae? Lenders have to apply, and get approval from GM or FM. Ifyou are approved to do business with GM, you are an Approved Ginnie Mae Issuer, itmeans they can engage in these transactions.

Ginnie Mae has a special status as well. When the mortgage banker becomes a ginnie mayissuer, they sign a contract that they will be a Servicer. Ginnie Mae watches this verycarefully. If the borrower doesn't make the payments, and we have an MBS either FannieMae or Ginnie Mae, the Servicer MUST ADVANCE THE MONEY ANYWAY. The investor in thecapital market wants their 6.5%, and doesn't care where it comes from. If you don'tadvance, as a Servicer, FM and GM will SWOOP IN IN THE MIDDLE OF THE NIGHT ANDTAKE ALL OF YOUR FILES. It's their money on the line, and they guarantee it, so they arevery diligent. A strategy for a mortgage company is to file Chapter 11 bankrupty. Do itbefore they terminate you! Because then the company gets a stay. The mortgagecompany OWNS the "right to service" which are valuable contract rights. Worthabout 1% of the outstanding principle value. The mortgage company can have a "Pre-packaged" bankrupty, when they won't be able to advance and they don't want GM/FM toremove their issuer status, they may declare bankrupcy and immediately sell their assets toa new company that is a FM/GM issuer. GINNIE MAE IS NOT SUBJECT TO THE AUTOMATICSTAY FOR BANKRUPCY! THEY WILL TAKE THEIR FUNDS, and you will be stuck with contractrights that used to be worth millions, and now they are worth nothing.

FEDERAL HOMELOAN BANKS (GSE's)When we don't have a state chartered mortgage banker, when we have a DepositoryInstitution instead. Their warehouse bank is the Federal Homeloan Banks. Providing asource of cash to depository institutions. A major source of funding for mortgages. Createdin 1933. 12 Banks were created. Divided geographically, based on population in 1930s. Canonly be owned by Depository Institutions in the jurisdiction of the respective FHB.FederalHousing Finance Board will appoint directors. Appointed directors unlike FM. Majority areelected, minority are appointed.

They go out into the capital markets and issue bonds. They then take those funds and thenloan the money on more or less a warehouse basis to the depository institutions so thebanks, S&L's, and Credit Unions have a low-cost source of funds.

Not the same functions as FM.

Each bank issues its own debt, but the banks are jointly and severally liable for the debtsunder the Federal act! They have about $1 trillion in total debt.

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NON-GOVERNMENT, NON-CONFORMING LOANSExample: Loans where the credit of the underlying borrow is solid, but the loan is in excessof $417k. Loan is $500k, (jumbo loan). How does a Jumbo Loan work? Consumer goes tomortgage banker, who needs a warehouse bank. And there needs to be an entity in thesecondary market, without FM and GM. Needs to work the same way though to funnelmoney down the system!

The secondary-market company says they will buy the loan, put it into an MBS and give itback to the mortgage bank. But the guarantee on the MBS means nothing! Or, thesecondary-market company will sell bonds to Capital Market, at a rate worse than FM andGM. The loans HAVE TO HAVE a higher interest rate to the consumer!

With an underlying MBS, Two different "certificates": a Series A and a Series Bcertificate. The difference is that if we have default in the underlying mortgages, the seriesB certificates will bear those defaults. So the first 20% or so defaults in the portfolio will beborne by the B certificates. So the Capital Market players that buy Series A will buy them(almost) like they are GM or FM securities. Creates a buffer, a heirarchy, to make most ofthe MBS more valuable.

First aspect: This WORKS for Jumbo Loans! Where it didn't work, was for subprime loans!What happened was (oversimplifying) they experienced losses so much greater thanhistorical figures and assumptions that were made, that all of the security holdersexperienced losses. The two or three tier setup that was designed to protect securityholders didn't work. The losses were too great.

Second aspect: The Series B certificate, which bore the losses first, it's nickname was "ToxicWaste." So the interest rate was very high.

So the Capital Markets STOPPED BUYING CERTIFICATES! Secondary Market companieswent out of business, warehouse lender said I'm not giving mortgage banker moneybecause there's no one in the secondary market to buy your loan, mortgage banker says Ican't give consumer loans because i don't have any money!

What made it worse? The system shut down. Anything that wasn't government, becamerisky IN THE MINDS of the investors, which sent the FM loans higher. There were about$1.2 trillion of subprime loans. Under the worst scenario, they expect maybe $400 billion inlosses. Yet, the amount of losses that have been reported, on all the people withcertificates, IS DOUBLE THAT AT LEAST! How are the losses more than the actual losses onthe underyling mortgages? Because they're holding them in securities, that no one will buy!So they became worthless without value. Accounting rules say that unless you are holdingsecurities that cannot be sold, you have to change the value to the fair value, whichhappened to be NOTHING.

So banks that held these securities were having real losses (without people paying), theyhad losses doubled because accounting rules sayif you can't value it, you have to treat it as if it was worth nothing.

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05/21/2008

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American Bankers Mortgage Corp v. FHLMC (Freddie Mac) - the mortgage soldmortgages to FM, and they were servicing the mortgages. They did a couple things badly.1. In its portfolio of mortgages it sold to FM, it under reported the amount of delinquenciesthat were occurring in that portfolio. They were still advancing money to FM. Why wouldthey deliberately misrepresent the status of the mortgages? They want to keep servicing it.The issue really is: when these mortgage companies originate the mortgages, theyrepresent to FM that they have originated them in accordance with all of the criteria the FMrequires. So when FM finds out that you have originated a loan not in accordance, FM forcesthe mortgage company to BUY BACK THE MORTGAGE. The mortgage companies don't haveany capital! So if they are asked to buy these loans back, they don't have the capital to dothis.2. They were co-mingling funds. Taking money that were paid by the borrowers on the FMmortgages, and putting it into their own corporate account. Some of this may be permitted,but it is tightly regulated and there are clear rules how you set it up. Once FM realizedsomething was happening, FM swooped in and took all the files and accounts. Some ofthose funds were not FM's. So the mortgage company lost the servicing rights, and moremoney that they owed FM. The court says, ok, some of that money wasn't FM's, but we'lljust set it off against what you own FM anyways. So the claims that were made that wasthat it was taking without compensation, etc. For this purpose, FM are NOTgovernmental actors, and what they did was NOT state action. State law claimsabout conversion. What did they convert? A valuable servicing contract. The short answeris: FM terminated the agreement, which they had a right to do. Once it was terminated,there was nothing left to service, so it was FM's.

Paslowski v. Standard Mortgage Corporation of Georgia - dispute over the escrowaccount. An account where the mortgage borrow paid in addition to the principle interest,pays the lender roughly 1/12 of the tax and insurance premiums. Then the servicer pays thepremiums when they are due. Capitalization Method - when a borrow makes a payment,the amount of principle of the mortgage is reduced. When the mortgage company pays thetaxes/insurance, the principle increases. Generally not done this way anymore. In this case,the borrower said they screwed it all up. For purposes of vicarious liability, we DOconsider FM a governmental actor, protecting the government from an outside agent.

For purposes of 5th Amendment, they are not a government actor.For purposes of vicarious liability, they ARE a government actor.So Fannie Mae and Freddie Mac receive the maximum protection.

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NOTEIt is a multistate note. Uniform note. For every fixed rate mortgage that FM buy, the notethat is used (evidences the loan that the mortgage lender has made to consumer), is in thisdocument. This document is the same essentially nationwide.

1. Built into this document, is the fact that whoever the lender is, expect that it betransferred!

2. Fixed interest rate. The rate does not change if the borrower goes into default. The rateis also expressed on a yearly basis (in a nod to the plain language folks).

3. Payments will be made monthly, usually on the first date of the month. Until the balanaceis zero. The borrower pays the interest first, it is calculated first. This means 1) that we payinterest in arrears, not in advance. So if we have a payment due June 1, you pay interestthat has accured for the month of May. 2) Does it matter if you may your payment on June

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1st, or June 12th? No, it doesn't matter. Because the language says, "will be applied as ofits scheduled due date." They will treat the payment as if it was applied on the 1st, even if itarrives on the 12th. So in theory, you want to may your payment as late as possible beforethey will charge you a late charge.

Example: $100k loan, 6.5% closed today on May 21st. When would the first payment bedue? July 1st. Payment amount is the SAME amount per month. 30 year loan, you will make360 monthly payments. 15 year loan, 180 monthly payments. At closing, you make a pre-paid interest, for the interest from May 21 to May 31st. From closing date to the end of themonth. Why is payment due on July 1 then? You are paying June's interest!

Amortization Schedule - For a 30 year loan, you don't pay half the principal off until 21years! "not unconscionable, just horrific"

4. Borrower's Right to Prepay -Prepaid in full: 1) you've sold the house. Your lender is going to require before it will releasethe lien, that you take the proceeds and pay off the loan. 2) when you refinance. In non-conforming loans, some may require a prepayment fee. Not so with conforming loans. Youhave to let the lender know that you are making a prepayment! Otherwise, they will apply itas a payment in advance for your next payment.

Your payment does NOT change if you pay off a substantial part of the loan through aprepayment! What happens, when you have a lower balance, you will pay off the balancewell before 30 years.

Where are the escrow payments? There is no mention of them in the note. This is dealt within detail in the mortgage documents, not the note.

5. Loan Charges - Dealing with "Usury" - charging more interest than permitted by statelaw. If the lender does this, the lender must remedy this by taking the excess interest thatthey have collected and refund it to the borrower or treat it as a prepayment. In moststates, these limits have been preempted by Federal law.

6. Failure to Pay As Required -(A) late charge of, in our example, 5%. But when is it late? It's due on the first of themonth. If you pay by the 16th of the month, you will avoid the late charge.(B) Default - it says you'll be in default on the 2nd of the month if you don't pay,technically! What happens? The lender must send you a notice, and give you at least 30days to make the payment. If you don't pay within 30 days, they have the right to"accelerate" and say the entire loan is due. They can say that you own ALL the principalNOW along with all the accrued interest at that time. As a practical matter, the servicersdon't do this if you don't pay on the 2nd. Generally, the servicer won't take any action for 3months.(C) Notice of Default

7. Giving of Notices -

10. VERY IMPORTANT - Incorporates by reference, a provision from the mortgage. Theprovision is called a "Due on Sale" Clause. It says is that if you sell the property, and thelender hasn't given their okay, you MUST pay off the mortgage. You can't go to a buyer andsay, you should just assume the mortgage, because if you do this and the lender has notapproved, it is a DEFAULT according to this document. It will be treated as if you didn'tmake a payment, in effect.

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BALLOON NOTEGenerally fixed term, and at the end of the period, the loan matures. They are amortizedover 30 years, and not for the fixed term of the period. You make the payments as if it wasa 30 year loan, not a 5 year loan for example. Why do people do this? Because you gamblewith interest rates. You don't have to worry about it if you move... various motivations andassumptions that can be wrong.

What's the difference between a fixed rate ballon note and a fixed rate regular note? Onlyone difference in terms of the form itself: THE LEDGER ON THE TOP OF THE PAGE!Everything else is fill in the blanks. The originating lender wants to document the fact thatthe consumer must understand that the loan will come due in 5 years and that there is aBIG amount that will be due. Lender is under no obligation to refinance the loan.

----05/28/08Continue discussion on the Uniform Documents.

ADJUSTABLE RATE NOTEKey issue - how the first blank is filled in, in Section 2 as the initial rate.The interest rate has a number of components. Interest Rate = Index + Margin. TheIndex for this particular note is (paragraph 4b) "weekly average yield on US Treasurysecurities adjusted to a constant maturity of one year, as made available by the FederalReserve Board." The Margin is simply a number that the lender chooses to add to theIndex. Usually it is between 2-4%. Historically, banks take a rate that is artificially lowerthan the real Index. This is what is meant by the term, Teaser Rate. That is, it's low, but itis not the sum of the index + the margin, and therefore is artificially low. So if the teaserrate is 5%, and the real rate should be 7%, how does this change? Paragraph 4a tells usthat the interest rate may change on the first day of (blank), so the lender has the ability tosay that the teaser rate can only last a short period. The first change doesn't have to be ayear, because of this blank. After the first time the rate changes, it changes once every 12months. That is set in this note.

So what happens a year later with this 5% teaser rate if the note says that it will changeevery June 1st? The change date is the date that the rate changes. If the rate changes onJune 1, the payment changes a month later. Lags by 30 days. Why? Because you payinterest as it accrues. With a June 1st change date, when do we look at the index?Paragraph 4b says that you look at the index on the day 45 days before the change date.So on April 15th, we look at the index, and we add the margin to get the new interest rate.Limitations in this document on to how much this rate can change in a single change isoutlined in Paragraph 4c. Fill in the blank for limitation on the first change, and then thenote says that it can only go up or down 1.0%. Why does this matter? Because when aborrower comes in, thei rcredit is evaluated in their ability to pay the 5% rate, the artificiallylow rate! The borrowers ability to pay the rate after the first changed rate, may besignificantly impaired. Once we have the rate, then you have to recompute the payment.You know what the unpaid principal balance is, so you take the unpaid principal balance atthe new rate, with however much time is left from the original loan. Then the customer isassigned a new amoritization schedule. The customer will then get a notice that on June 1their rate changes, and on July 1 their payment will go up.

Why would lenders make this kind of loan? What's in it for them? Cuts down on the interestrate risk. But in fact, they probably increase their risk if interest rates go up, becausepeople will not be able to pay the loans!

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The right to prepay under a variable rate note: works the same way! No prepaymentfee under FM loan. But in contrast to a fixed-rate note, your monthly payment *has* tochange because when you get to the next rate change date, you get the new interest ratebut the new payments are computed on the actual unpaid principal balance and come upwith a new amortization schedule. So your payment will change at the new rate changedate, not immediately after prepaying.

Due-On Sale Clauses under a variable rate note: paragraph 11. Concept in fixed rateloans: if you sell without the lender's consent, the entire loan is due and payable. Thelender may accelerate the balance. Concept in variable: if the transferee (buyer) submits tothe lender credit information that will indicate to the lender that the buyer will qualify, thenthe lender MAY NOT accelerate the loan. The buyer can assume the mortgage if they submitcredit information! Operates very differently than the fixed rate loan!

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Mortgage DocumentNo uniform document. Every state has very technical requirements. All states are essentiallythe same, except for minor technical differences.A "security instrument" for this purpose is the document that creates the lien. In Michigan,its called the "mortgage." Other names are "Deed of Trust," or "Mortgage," and they allmean "Security Instrument." Mortgage has a Mortgagor who is the borrower. Mortgageeis the lender. Deed of Trust is a slightly different form, and has a Trustor who is theborrower, and Beneficiary who is the lender, and a Trustee who is really an escrow agent.The fiction is that the trustee holds the deed in escrow pending the payment of the amountby the borrower.

The function of the instrument. What does it do? It secures, meaning that the lender canlook to the property to satisfy certain obligations if the borrower doesn't satisfy them. Whatdoes it secure? What are the obligations? Page 2 of mortgage: 1. Secures the payment ofthe loan. 2. the performance of the Borrower's covenants and agreements under thisdocument and the Note. So the idea is that they have to pay and perform agreements.

Most people make their mortgage payment by check. Paragraph 1: if you pay by check andit bounces, even just once, then the lender can force you to pay in a way they want.Mailbox rule does not apply! Payments are deemed received when they are received by thelender! Lender can accept any amount, and it will not be deemed a waiver of amounts pastdue. They can accept partial payments!

Paragraph 2: apply amounts to interest, principal, then escrow items, then late charges,then any other amounts due, then unpaid principal. So when you send in payment,principal, interest, and "escrow" are combined. There is a heirarchy of how payments areapplied!

What are Escrow Payments? Two primary ones: Property Taxes, and Homeowner'sInsurance. The lender/servicers collect for this because they want to make sure they arepaid! If taxes aren't paid, it may jeopardize their lien! Worry about insurance because theywant to protect their security! It is critical to the maintenaince of their security. So theytake the yearly payments, divide by 12, and add it to your monthly payment.

Federal law: RESPA - the Real Estate Settlement Procedure Act - one of its many provisionsgoverns escrow accounts and how they may compute and operate them. Allows the lenderto have a "Cushion" of 2 months of the escrow payments, in case their estimates are wrong.What happens if the Servicer doesn't have enough money and you've made your payments

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diligently? They have to make your payment anyway and give you months to repay themback!

The escrow payments sit in bank accounts, maintained by the Servicer where they attemptto make money off of it. In most states, lenders are not required to pay interest to theborrower on those payments. At any one time, you can have a Shortage, Surplus, orDeficiency. Shortage and surplus are simply a projection that you will have enough or toolittle. A deficiency is when the lender screws up and there is literally not enough money inthe account and the lender has to go into their pocket and pay the amount.

The presumption is, there is an escrow account unless the lender says IN WRITING thatthere isn't one.

Paragraph 4: if there is a lien that has priority over the mortgage, the borrower must takecare of it!

Paragraph 5: Property Insurance - must have "extended coverage", coverage that covers allrisk of physical loss. So something like hurricane insurance or flood insurance in certainareas that wouldn't be in a standard extended coverage policy, the lender has the right torequire that you get this special policies. Lender cannot dictate who the insurer can be, butthey do have the right to disapprove of substandard lenders with subpar ratings. Borrowermust name the lender in a Mortgagee Clause. This is in effect, a separate contractbetween lender and insurance company. You need this because the insurer may denycoverage, if for example, the borrower starts a fire and the house burns down. The Clauselets the lender still get paid for what the borrower would be denied coverage.

What happens if the borrower didn't get insurance? The lender will get coveragethemselves, because having the property insured is so important to them. We call this:Forced Placed Insurance. It costs a lot more! The insurance is generally then only for thebenefit of the lender and not the homeowner. But the lender will push the cost to theborrower, and they aren't even covered!

What happens with the money when a claim is given? Repair to the house, unless therepairs are not economically feasible.

Paragraph 6: Occupancy - borrower has to occupy the house as their primary residencewithin 60 days for at least one year! The idea is, that if it is owner occupied, then they willgive a high priority to making those mortgage payments. As the mortgage moves down thechain, interest rates are lower for owner-occupied residences than investment properties.There is less risk!

Paragraph 7: General obligation to pay, not destroy the property, or allow it to deteriorate.Repair obligation. Paragraph 9 says the lender can spend the money to do this if borrowerdoesn't do this. Lender usually doesn't do this for minor things. Extreme situations are whenthe house has been abandoned and the value of the lender's collateral (the property) isgoing down quickly.

Paragraph 8 and 9: Lender can go in if borrower doesn't maintain the property, and the costcan be added to the principal balance essentially.

----Mortgage Insurance - for the benefit of the lender paid by the borrower that in effectgives the lender the protection of having the equivalent where the mortgage where the loanto value is 80%. Example: Assume the the property that borrower buys costs $100k.

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Borrower put $10k down. Loan to value ratio will be 90%. The idea of mortgage insurance isto provide a benefit to the lender so that if there is a default and foreclosure, and theproperty sells for $85k the lender would have a $5k loss. The purpose of mortgageinsurance under this example would be to pay the lender $5k so that they would have noloss as a result of this mortgage.

If the lender can only sell it for $75k, therefore the loss would be $15k. Mortgage Insurancewould pay only $10k, so that the loss here would be $5k. They only pay $10k in thiscircumstance because the mortgage insurance will cover you as if you made a loan for$80k. In fact, they made a loan for $90k, so they will only cover the loss the lender wouldincur had it been $80k.

It covers the loss, but no more than if the house loses 20% of it's value. So if you go to alender and offer to pay 20% downpayment, you don't have to pay for mortgage insurance!

Premiums are paid to the lender, who then pays them when they are due.

There is a provision within paragraph 10, that mortgage insurance is unavailable (like ifinsurance companies will not insure because values are fluctuating too much), then thelender can collect money like the premiums as a cushion. But the consumer will not get thismoney back! So it's essentially a payment to the lender

Paragraph 10: Mortgage insurance -

The mortgage insurance companies can send part of the premium to another entity and thatentity will agree to share the risk. So that if there is a risk, both companies will bare the riskof the loss. In the mortgage contract, there is a provision that the 2nd party could be thelender or an affiliate of the lender! In this form of mortgage, there is a disclosure that thismight happen. So the lender can really take part of the risk on the loss on foreclosure, bypocketing some of the insurance premiums. This is called a captive reinsurance, when itis the same lender.

The Homeowners Protection Act of 1998 - referenced in (b) - owners would continue topay insurance long past the loan to value was past 80%, after the person had paid for along time. Once the property gets to 80% based on the original value of the property, theborrower as long as they are current in their payments, may request the lender to drop themortgage insurance. When it reaches 78%, it's automatically gone, and if you keep payingit, you are making prepayments!----

Paragraph 11: condemnation proceedings.

paragraph 12: waiver of one payment terms is not really a waiver for the whole time.

paragraph 13: signing. Instances when there is more than one borrower, where someonesigns the mortgage but doesn't sign the note. e.g. The loan is in the wife's name, but thehusband has to sign the mortgage for the joint marital property. Or, if two owners ofproperty, one can be on the note, but with joint owners, they both have to sign themortgage in order for the lien to be enforceable. Comes up in context of the Equal CreditOpportunity Act. Also, Joint and Several Liability. If you don't sign the note, you are notresponsible for the debt. You'll lose the property, but can't get sued.

paragraph 14: Loan Charges: new provision in this form. Some lenders would challenge that

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they didn't have the authority to charge these fees.

paragraph 15: Notices provision: deemed given when MAILED when from lender toconsumer! not the mailbox rule. When consumer to lender, it is when it is RECEIVED!

paragraph 16: what law governs? Federal law, and the law of the state where the propertyis located. Fundamentally, it is a state law issue. But we will see, is that over the last 25years or so, Federal law has imposed a number of limitations on state law in this area.

Silence on a particular issue doesn't mean NEGATE! This is a non-provision provision.Doesn't need to be there!

paragraph 18: the due on sale clause! In the note they were simply quoting from themortgage. Here it is. Federal preemption of state limitations of due on sale clauses.

paragraph 19: tells us that a borrower who is 1, 2, 3, months late and the borrower sendsnotice, then says the consumer has to pay the accelerated loan, then go through the wholeforeclosure provisions, IF THE BORROWER at least 5 days before the foreclosure sale comesup with the money to bring the loan current as if no acceleration had occurred (you mustpay anything that is due), the acceleration is wiped out, the foreclosure is wiped out, it's asif nothing happened. The one place this doesn't apply (that acceleration really isn'tacceleration) is when acceleration is invoked due to the due on sale clause.

If I was representing the lender in a nonconforming loan, then WE WOULD NOT PUT THISPROVISION IN THE MORTGAGE FOR THE NONCONFORMING LOAN!

paragraph 20: Attempt to impose limitations on class actions. It says that neither party canbring a class action unless they had individually notify the other, the borrower may notbring a class action unless it has notified the lender and given the lender the opportunity tocure. Parallel to lender and borrower. It effectively destroys the ability to do a class action!

paragraph 21: hazardous substances - shifts the risk to the borrower.

paragraph 22: acceleration remedies - basically, can't accelerate without notice.

In this form of mortgage, there are witnesses and each state requires as differentrequirements in terms of witnesses, and often notaries are required as well. Why do wehave these requirements? These are provided for in statutes dealing with RECORDING.Needed for Registrar of Deeds to accept the mortgage deed.

FEDERAL PREEMPTION

The mortgage market was crazy in late 70's and early 80's. Rates went really high. Had anumber of consequences. From the lenders standpoint, put them in jeopardy. Becauselenders made loans at a certain rate and then the cost of funds rose over the 10,15,30years of the mortgage loan. Management problem! But also because historical laws on thebooks in many states, put limitations on the way the lenders could operate. Specifically, inall 50 states, Usury Statutes existed. In many states, lenders could not charge interest ratesthat were anywhere close to where the market rates were. And for many, couldn't chargerates to cover the cost of their funds! The response of many lenders was that they couldn'tmake mortgages. They would have had a loss from day 1.

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In 1980, Congress passed the Depository Institutions Deregulation andMonetary Control Act (DIDMCA). If the loan meets certain conditions, then anystate law which sought to impose limitations on interest rates WAS PREEMPTED! What werethe conditions? 1. Had to be secured by 1st lien on residental property. 2. Had to be"federally-related loan." 3.

"Federally Related Loan" - property had to be a 1-4 family property. had to conform toone of these: made by depository institution, or by HUD approved lender, or FHA or VAloan, or made by lender where the loan was eligible for Fannie Mae or Freddie Macpurchase, or it had to be made by a lender who regularly makes loans and makes at least$1 million of loans per year, OR Loan in arrangement in connection of the sale of theprinciple residence. The first 5 are regarding the lenders, the last was an individual.

So if you wanted to sell your house, the buyer couldn't qualify to get a loan! One of theways you could sell your house was through a land contract. Where you do not transferlegal title until the party has paid all the amount. You charge interest! It's much less thanwhat the lenders would normally charge. But even this amount would be higher than thestate usury limits! So the individuals needed the protections of DIDMCA too.

States could opt out of the law during the first three years. Some states did. States hadability to regulate other aspects of the transaction, but the bulk of the states, even today,there are NO USURY LIMITS for "federally related loans."

Wolfert v. Transamerica Home First, Inc. - reverse mortgage. The lender disperses someamount to the borrower, and the borrower doesn't have to pay it back until they sell theproperty or until they are dead. Many there is not a big dispersement up front, there is adispersement every month. Covers living expenses. In this case, there was a lump sum andthen some minor distributions. As part of the arrangement, the amount had to be paid onthe sale of the property and there was a Contingent Interest Feature. That at the time ofthe pay back event (sale or death or whatever) you measure the increase in value of theproperty from the time the loan was made to the time of the termination event, and in thiscase, half of the appreciation was to be paid to the lender as additional interest. In addition,there was a separate fee called a Maturity Fee.

She said, this violates the State Usury law! the court says, if this is interest, then it ispreempted and YOU LOSE! Because DIDMCA preempts. If you claim this is not usury, thenthe court can look at it. But essentially it doesn't violate any other provision.

Garn - St. Germaine Act (sp?) - 1982When lenders had made loans at low interest rates in the 70's, and the high interest rates ofthe 80's, people wanted to assume the loans at the low rate! But there were many statesthat limited or disallowed due-on-sale provisions. Lenders couldn't enforce their contractsbecause of the state limitations! If the banks were force to accept these low interest ratesassumptions, they would go broke. Right or wrong, Congress responded with this law.

One component said that state laws that limited due on sale clauses, were preempted. Thedefault rule was that if you have a provision in the mortgage document, you may enforce it.

States may opt out, but very few did.

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Took the opportunity to define a "due-on-sale". This law tells us when and when you maynot exercise the due on sale clause, as referenced in the mortgage!

Example: if borrower gets a second mortgage, due on sale provision cannot be triggered onthat event. On the death of the borrower when there are joint tenants or a will, otherwisetransferred to someone else, due on sale cannot be triggered! If you have a leasearrangement, as long as it is for 3 years or less, and doesn't contain an option to purchase,then you may not trigger the due on sale clause. Transfer to children or result of divorce...Very practical circumstances.

If you exercise due-on-sale, you CANNOT collect a prepayment fee!

Levine v. First National Bank of Commerce - Levine got a mortgage. Got married, decided tomove. Found people to buy the property, "on the advice of the agent selling the property,"said the buyer could assume the mortgage. A "bond for deed" situation, which is nothingmore than a land contract. In the list of what counts and what doesn't count for due on sale,land contracts ARE a due on sale trigger! That is the essence of a land contract! Clearly is atransfer of some part of the interest. Recognized from day 1 that the purpose is a sale. SoLevine and his buyer always made their payments to First National. But at some point,someone at the bank realized the payments were coming from the new buyers. Madeinquiries and figured it out. Pursuant to the mortgage, said they are accelerating thebalance and demanded full payment. Levine and buyer didn't, so bank foreclosed. Levinewas pissed, sued bank for wrongful foreclosure. Buyer sued Levine for disturbing theirpeaceful possession.

Jury awards Levine $300,000 for wrongful foreclosure. Awards Buyers $25,000 each fordisturbance. Bank is responsible for about $350,000! The bank then appeals, hopingsomeone will read the Federal law and everybody isn't as crazy as the trial court! Appealscourt says trial court was right. Get all the way up to Supreme Court of Lousiana andsomeone reads the Federal Preemption Law. Says that they have a land contract!

Mortgage was made in 1997. Look at paragraph 18 of our mortgage. Uses the damnlanguage of "bond for deed", intent to transfer legal rights at a future date. Supreme Courtof Lousiana finally got to the obvious result, that this was an event that allowed due on saleclause to be triggered, and any state laws are pre-empted. Therefore, there is no wrongfulforeclosure and disturbance of enjoyment.

You may have to spend a lot of money to actually get someone to read and understand thelaw!

----

06/04/2008

Land Contracts - typical borrower and lender. Mortgage is $100k. A year later, somethingcomes up, borrower wants to sell the property. The borrower may not want to pay off themortgage, for example, because interest rates have risen and the mortgage rate is good, orthe new purchaser is not credit worthy and couldn't get a mortgage themself. Land Contract- principle provisions: purchaser will pay payments over some period of time to seller. Sopurchaser promises to pay original borrower $125k. When the full amount is paid, and onlyat that time, will seller be obligated to deliver the deed to the purchaser. The Borrower iscalled the Vendor. The Purchaser is called the Vendee. Looking at this from the point ofview from Vendee and Vendor, when the contract is executed and vendee starts makingpayments, in effect the vendee owes the vendor the money and this is secured with the

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property. But it is the equivalent of a second mortgage. Because notwithstanding thistransaction, the original lender has a first mortgage that will always take priority. So if theVendee defaults, and the Vendor in effects wipes out Vendee's equitable interest (withoutlegal title) through a court procedure, throughout all of this, the original mortgage is stillthere! So the Vendor will get it back subject to the mortgage. On the same token, if thevendee makes all the payments to the vendor but the vendor doesn't pay the mortgage off,then the vendee will get the land still with the mortgage on it! Often the arrangement isthat there will be an escrow to pay part to the mortgage payment to the lendor. Or, thearrangement is that the vendee pays the lendor directly and the excess goes to the vendor.Often times the lendor will get tipped off when they receive checks from a third party.

This is also called Seller Financing. In the DIDMCA, one of the categories is when theseller sells his primary residence. Normally, this is referring to the above transaction. Ifthere was no mortgage on the property, and seller sold to purchaser with a land contracttransaction, then the individual would have to worry about the state laws. But the seller cantake advantage of the Federal law under DIDMCA. From a remedy standpoint, many sellersuse a land contract standpoint because of state laws that are more flexible for the seller.

The Alternative Mortgage Transaction Parity Law (AMTPA)The concern was that in the circumstance of the early 1980's, interest rates were so high,so many people could not get traditional financing because they couldn't afford it, lendersconcerned because they couldn't do business, lots of attempts at creative financing.Example: Assume market rate was 12%. If the loan was at 8%, the payment would besignificantly lower. Lenders said, is there a way that we can make the loan only requirepayments at effectively 12%? The stated interest rate is 8%, we'll qualify you as if it was8%, and we'll set your payments at 8%. If you sell/refinance/maturity, we want thetraditional interest payment. This additional payment will be equal to some percentage ofthe appreciation in the property from the time of loan origination to the triggering paymentevent. Typically was 1/3 of the appreciation.

There wasn't a problem with being able to pay it, because if you sold or refinanced you hadthe money from the sale! You would just hand them 1/3 of the appreciation. This was calledContingent Interest. Lenders knew their effective yield would be around what the marketrate would be.

One of the problems was, there were many state laws that limited or potentially causedissues with this arrangement. So lenders and borrowers wanted to do this, but there were alot of legal issues in the way!

The same thing is true with respect to balloon loans. Many state laws could be read tolimit the ability of lenders to do this.

Remember that these were not normal economic conditions. There were ways to be creativewith financing, but state laws stood in the way of the enforceability of some of thesearrangements.

Other issue: mortgage institutions, state chartered institutions, realized that they couldn'tmake these loans but federally chartered institutions (banks, savings and loans, and creditunions) could do it! By the nature of being federally chartered depository institutions, theyhad preemption over these laws that prohibited these arrangements. The state institutionswanted parity with the Federal institutions with respect to these types of transactions.

How do we get parity though? It says that state chartered banks can do whatever the

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comptroller.... ????

State chartered institutions could follow the regulations of what is now called the Office ofThrift Supervision. Basically said they could make any of these alternative mortgagetransactions. Could make any of these loans essentially as long as they providedadequate...

Alternative Mortgage Transaction1. Interest rate can be adjusted or negotiatied. e.g. a variable rate mortgage2. Ballon Loans. payments are amortized on long term basis, but loan matures in muchshorter period.3. "other variations not common to traditional fixed rate, fixed term transactions" what doesthis mean? "sharing of equity or appreciation"

Which Federal regulations do the state institutions have to follow?• Late charges and prepayment fees. They can charge anything, just like a Federally

chartered institution. (Maybe the OTS didn't realize what they did! Took the industry~5 years to figure it out. 4 years ago, the OTS rescinded state based lenders rightto preempt state regulation of late charges and prepayment fees.)

State statutes are preempted as long as the state chartered institutions follows the specificregulations of the OTS. 560.35 - 560.210. Not difficult requirements for state charteredinstitutions to meet.

* The OTS also says that AMTPA applies not only to first lien loans, but also tosubordinate liens (2nd mortgages), the state chartered lender will get the samepreemption benefits.

Case at the end of handout 4: If you have interest only for the first 5 years, then you beginamortizing, that will be an alternative mortgage and fall under this law. Why? It containsterms that are not common to traditional fixed rate, fixed term mortgage. So it's a prettyeasy criteria to meet!

The second mortgage type that the OTS considered, this is a one time rate reduction fixedmortgage. If you make the first 2 years of payments on time, your rate will drop. So it's nota traditional adjustable rate, not a balloon loan, does it fall under category 3? The OTS saysit's not normal and therefore does meet category 3!

Michigan case in packet 4: Balloon loan made. It had a conditional right to refinance.Mistake number one! If you're the lender, you've done a lousy job. They'll argue whetherthe conditions are met or not. One condition was that borrower had to pay the property tax.Also had to give notice that they have a theoretical right to refiance. The individual lenderdidn't give this notice. Dispute whether they had the right to refinance or not. Exactly whatyou don't want. Agreed to a modification of the loan: converted it from balloon to adjustablerate loan. The court said, this isn't permitted! The Michigan law is clear that you cannothave an adjustable rate loan that doesn't change in accordance with the index. They set itout in the mortgage itself! The lender said, what about the federal preemption statutes? Thecourt said that it doesn't apply to modifications. But the loan at origination fell under thepreemption because it was a balloon loan! Why a modification doesn't apply, isn't clear. Thestate courts are VERY HOSTILE to a law that preempts state law.

When these statutes get in front of state courts, nobody knows what's going to happen.

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----

TRUTH IN LENDINGBeen around for about 40 years. Applies to all sorts of consumer credit transactions. Only

focusing on the application to residental mortgage transaction. The Truth in Lending Act,15 USC 1601 et seq and a very comprehensive regulation Regulation Z, 12 CFR 226 etseq. The Federal Reserve promulgates Regulation Z. The regulations are more specific, andthe official staff commentary is the most specific of all. They attempt to come up withcommentary and change it every year. The commentary has the force of regulation.

Closed End Credit - Where there is one dispersement, and that's the maximum amountthat the lender will loan. Typical mortgage loan: they just give you $100k at the beginningand that's it. Lien is secured by the house.Open End Credit - Where you borrow, repay, and reborrow. Typical equity line of credit.There are different regulations depending on whether it is closed or open end credit. We aregoing to focus on closed end credit.

Purpose: assure a meaningful disclosure of credit terms so that the consumer will be able tocompare more readily the various credit terms available to him and avoid the uninformeduse of credit! Effectively a disclosure statute. But it has now gone in some respect, to effectsome of the substantive terms of the mortgage transaction. Essentially a statute thatattempts to give the consumer information about the cost of the credit that they are aboutto obtain.

What transactions are subject to this statute? Exemption: where the extention of credit(making of the loan) is primarily for business, commerical, or agricultural purposes. The actwill not apply if one of these is the primary purpose for the loan. [If we're representing thelender, never take the risk. If I'm not sure, just act like it applies.] Example: a guy rentshouses out. When he buys them, he needs a loan. Commentary says this is for business,truth in lending doesn't need to apply. But the lender will pretend it does, just to cover itsass.

The act tries to create a concept called Finance Charge to inform the consumer of the costof the credit. Defined as: Simply the cost of credit expressed as a dollar amount. So, a$100k loan, at 6.5% over 30 years, the finance charge is the total interest charged:$127,545. That's the cost of credit. What else should be a cost of credit in addition to theinterest? Any fee "an incident to or as a condition to the extention of credit."

Goal: find out the cost of credit. Subpart: find the components on whether something is inthe cost of credit.

APR - Annual Percentage Rate - That is the cost of credit expressed as a percentage!(expressed as a percentage of the principal) The flip side of finance charge. So the statedrate is 6.5%, and we know that there are other fees, then the APR has to be greater than6.5%! The APR is always (unless there are zero fees) greater than the stated interest on thenote. Defined as: The interest rate plus fees.

The theory is, that we figure out what's in the cost of credit, and we tell the consumer theAPR is this, the APR from this lender is this, then they don't have to look at anything else!Sounds good. Doesn't work.

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Finance Charges - defined: 12 CFR 226.4. Why the hell did they do this? Conceptualrationales: They want the APR to be as low as possible, so they want to get as many thingsout of it as possible. Even if the fees are paid to the lender, it's not part of the APR. 12 CFR226.4(c)(7) is the list of fees in a real estate transaction that are not finance charges. The"(c)(7) charges"

----06/09/08Trott & Trott - largest firm in Metro Detroit area. 13 on Crains. Real estate and finance law.

Ultimate purpose of Truth in Lending: allow consumer to compare cost of credit.(c)(7) - fees related to residential type transactions which are NOT CONSIDERED FINANCECHARGES, so are not part of the APR calculation and the cost of credit!

Determination of the Finance Charge and therefore the APR:

226.4 - (a)(1) charges by third party - general rule (charges by someone other than thecreditor, are going to be included if the lender requires the use of the third party as acondition of giving the loan, OR the lender retains a portion of the third party charge).Example, mortgage insurance. If lender has nothing to do with it, other than requiring theuse of it, then it meets the first element and DOES need to be included as a finance charge.

Special rule for closing agent charges. Closing agent generally is a third party, and oftentimes it is the title insurer or the title insurance agent. Many lenders want to use the titleinsurance agent as the closing agent because the lender.... BLAH... in each of these, thereis a special charge by the closing agent: a closing charge. Charge for conducting the closingand everything that needs to be done to close the loan transaction. Is the closing fee afinance charge? 226.4(a)(2) says that they are finance charges if (i) the lender requires theservice; (ii) the lender requires the charge; (iii) lender retains a part of the fee.

The closing fee is going to be a finance charge unless, the Fed follows when addressing thatif the closing part is merely incidental and a small part of the fee, then it isn't included. If itis more substantial, then it must be broken out and given as a finance charge.

Mortgage broker fees. 226.4(3) - even though they are a third party, the mortgage brokerfees are ALWAYS included. Cannot apply the general rule of third parties that are in226.4(1).

Other special rules: 226.4(7)(d) - insurance that you can buy, and if you die, they will payoff the mortgage. NEVER BUY THIS! the premiums are too high, just buy life insuranceoutside of the mortgage process. The regulation is written knowing that they are highpremium instruments. Can be excluded only if the lender doesn't require it, and it'sdisclosed in the writing.

226.4(7)(d)(ii) - when premiums will be included in the finance charge. Excluded if: 1. maybe obtained by person of consumer's choice, and may opt out. This is consistent with theFannie/Freddie mortgage. The lender MAY exclude the premium from the finance charge. Ifthe lender is involved, it has to be disclosed.

226.4(7)(e) - (1) recording fees/taxes may be excluded. If you're paying governmental feein order to gain the lien status for the mortgage, it may be excluded. Fees that are conditionprecedents for recording, in Florida for example, the 11th Circuit said that they HAVE to bedisclosed. (3) deals with this circumstance.

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What does the lender do? Gives the consumer a Truth in Lending Statement. Every aspectof this is traced to 226.18. The Federal Reserve also publishes a sample form. 226.17 tellsus that "finance charge" and "annual percentage rate" must be more conspicuous than anyother.

The "Amount Financed" is the Loan Amount minus the Prepaid Finance Charges. Theamount they are financing will be less than the total loan amount if there are prepaidfinance charges (because they will be taken out first). Prepaid Finance Charges are paid atthe closing, paid out of the lender's loan immediately.

Loan origination fee: fee paid to the broker or lender. Calculated as percentage of the loanamount. So when you have a 7% loan and 1 point. At closing, as a prepaid loan fee, you'regoing to pay 1% of the total loan amount.Redraw Fee: they charge money to remake the documents with a new date.

How do we determine if a fee should be noted as a finance charge fee? 1. Look to see if it'spart of the (c)(7) fee! If it's one of them, it's not a finance charge. 2. Then look at specialrules. Third party, closing or mortgage broker fee. If it doesn't fit into one of the categorieshere, then it IS A FINANCE CHARGE!

Flood Cert Fee: it's a (c)(7) fee! not a finance charge!Funding Fee: not categorized, it's a finance chargeDoc Prep Fee: Special rules, this is NOT a finance charge!

This lender has no idea what it's doing. Settlement or Closing fee is a finance charge. Whyis there a Recording charge that is financed and one that is not? The one that is theassignment of the mortgage. The one that isn't regards the recording of the mortgage! Withtable funding, you're going to have an assignment that is going to be recorded at theclosing.

All of these disclosures are as a result of 228.18. It directs the disclosure on this form.

Now that we have the form, what would we do with it?226.19 tells us essentially that in certain transactions this statement must be given ormailed within 3 days of receipt of the application. The three day window applies to:Residential Mortgage Transactions - a defined term under Truth In Lending. Does notinclude all the transactions we've been talking about. 226.2 defines: finance acquisition orinitial construction of the dwelling. This does NOT include the typical transactions of SecondMortgages, Reverse Mortgages, REFINANCINGS! What does this mean? Technicallyspeaking, if you're not subject to the requirement of 3 days after you receive theapplication, it tells us that if you're not a residential mortgage transaction, you only have togive the statement prior to closing! As a technical matter, the lender doesn't have to giveyou the disclosure 3 days after you apply if you're refinancing. If you go to a lender todayfor refinance, they don't treat the situations any differently! Why, when the law gives themability to treat them differently? Because you never give people who are responsible forgenerating these notices the discretion! They will screw it up! Just have one rule, stick to it.

At this stage, the mortgage is in its infancy. Terms can change! As a matter of course,lenders will deliver as part of the closing package, a revised Truth in Lending Statement.

226.36 - ability to deliver electronically with consumer's consent.

----Advertising - 226.24

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Simply geared to make sure that the terms are expressed clearly with emphasis in makingsure the APR is stated properly. If you state a simple rate you give loans out, you muststate the APR making certain assumptions. The APR must be as conspicious as the simplerate, so that it is not permissible to have an advertisement that says 6% mortgages andAPR 8.2% in small print. If you even state the amount of finance charge or amount ofpayment, you must then also disclose the APR.

----PREDATORY LENDING!

Defining it is difficult. When you charge a rate that is higher than is commonly available.Consumer takes out a mortgage loan that they cannot afford to repay.

What to do about lenders that are misbehaving, entering into transactions that are not intheir best interests? Government does not want to penalize borrowers.

The primary Federal response has been for years was through Regulation Z. In Section 32loans. 226.32. Define these loans in terms of their interest rate and fees charge. The ideawas that the one aspect of predatory lending is that people are being overcharged. Thenthey could limit the substantive elements of the loan.

Once they could characterize them, regulate them by means of disclosure and directly intheir substantive terms. Much of the argument now has been that they defined them toonarrowly! How did they define them?

This does NOT apply to Residential Mortgage Transactions! (financed for acquisition orconstruction of residence). Applies to refinances and 2nd mortgages. Look first at the APR...if the APR is more than 8% if it's a first loan or 10% more if subordinate loan, the yield onTreasury securities having comparable maturities. Or, can apply if the points and fees arelarger than 8% of the total loan amount. These are called "high cost loans."

If you're in one of these loans, there has to be an additional disclosure given at least 3 daysprior to the closing. Certain provisions are not permitted in these loans. 1. If you have aterm for less than 5 years, the loans cannot be balloon loans. 2. There cannot be negativeamortization (when your payment doesn't cover accrued interest and even though youpay, your principal still goes up!). Limitations on prepayment penalties. Can only beimposed during the first 5 years; if the lender themselves does the refinancing, the lendercannot charge them. At closing, if consumer's debts are greater than 50% of their income,then they cannot charge a prepayment fee at all (because the borrower will likely have torefinance).

Other prohibitions: you cannot make these loans without regard to the consumer's ability torepay. They cannot make a "pattern of practice" not checking the consumer's income anddetermine that they can repay. This used to be called Asset-Based Lending. You didn'tcare what their income was, because if they didn't, you just foreclosed. You just made surethe loan to value rate stayed high.

People who bought Section 32 loans had liability for things that the original lender did.Secondary buyers had more exposure. All the legitimate funders said that they didn't wantto touch them. So the primary lenders in the market here were the predatory lenders thatthe regulation was designed to protect against!

Subprime means loans to people that have credit issues! We want many of those people to

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be able to get loans!

Many states passed laws that broadened the criteria for being included in Section 32 (highcost loans). Deliberate decision to say that they think these consumers are worthprotecting. Proposal in the Federal provision is to create a new category, a higher cost loan!Instead of 8% and 10%, it would be 3% and 5%. And apply to all mortgage transactions.Would apply the same type of prohibitions in not making loans without regard to income.

----06/11/2008

In proposed amendments to Regulation Z, there is a proposal to create "higher price" loans,somewhere inbetween normal and "high cost" loans. The trigger will be 3% and 5% insteadof 8% and 10%. Similar restrictions, including the idea of cannot engage in pattern orpractice of making loans without regard to the borrower's ability to repay. No prohibition tonegative amortization. The proposal for a higher price loan proposes that a lender would berequired to start an escrow account. The FM form gives the lender discretion.

The Right of RescissionSpelled out in 226.23. Concept: Under certain circumstances, the Act directs the lender andthe borrower, that even though they are ready to close, once they close, the borrower mustbe given a time that they can say, "I don't want to do this!" They've already signed thedocuments, but nothing has been dispersed. Not every transaction. Primary transactionwhich is NOT subject to this right is the Residential Mortgage Transaction. Meaning, loansfor the purpose of the acquisition or the construction of the dwelling on the property. So theright is available in refinanacing, subordinate liens, or if there is no mortgage on theproperty.

How does it work? Applies to anyone in the transaction who has an interest in the property.So that if one spouse is not a borrower but does have an interest in the property, they areentitled to a notice of rescission and they may rescind! They clearly have an interest in thetransaction. Two owners, typically husband and wife, either one may rescind!

Mechanically, the lender must give a notice (essentially at closing) that there is a right torescind. The right of rescission lasts until midnight of the third business day after the last tooccur of closing, delivery of material disclosures (APR, total payments, etc), and delivery ofnotice of the right to rescind. So if we close a transaction on Monday, and give them noticeof rescission and all material disclosures, the right to rescind would be terminated onThursday night at midnight, between Thursday and Friday. During this period, the lendercannot make any dispersements, including dispersements to the consumer. A cash-outrefinance, when you refinance and you get some cash out of it. No-cash refinance iswhen you refinance for your balance. If you do it right, and you have no closing costs, oryour closing costs are built into your rate, you would have a ... to your balance. Yourbalance would just go down! You've done nothing but sign a paper. What happens is thatyou reset the time you have to pay!

For some people, this 3 day waiting period isn't fast enough. The consumer says they willsign anything if they can get the money right then. This was anticipated in the statute.Basically, the statute and regulations say, you can't do it! Except in very unique and specialcircumstances. The regulation tells us that the circumstances say the consumer must have abona fide personal emergency. Courts tend not to recognize unique personal emergencies.The lender may care, because 2 years later, the consumer may not be making theirpayments, and at risk of foreclosure, and the consumer may say, "you shouldn't have given

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me the money before the 3 days had elapsed." Courts have said the consumer was right.The provision is there to protect the consumer, and it doesn't matter wha the consumersays or signs earlier. About the only personal emergency that the lender can feel safe that 3years later the consumer can't come back and ask the court: when the consumer is inforeclosure and the right of redemption has not expired. Basically, it's a bona-fide personalemergency if the consumer won't be able to hold onto the property because the mortgage isin foreclosure and the redemption period will expire in less than 3 days!

Exception #2 (#1 is Residential Mortgage Loan): If there is a refinance by the samecreditor that made the first loan, and it is effectively a no cash out refinance. Amount ofrefinance cannot be greater than unpaid principle balance plus accrued interest, plus anycosts then there is no right of recission (note that in TiL, they talk about creditor, notlender. Creditor if the loan is closed in their name. The broker doesn't close a loan in theirown name, so the broker is not a Creditor. The mortgage bank is a Creditor. )

What happens if a consumer rescinds? The regulation provides for the following mechanics.If the lender has dispersed anything, the lender has to get it back! The real issue comeswith the right of rescission is where the consumer claims, "the notice you gave me wasdefective" or "you didn't give me all material disclosures", so the 3 day period never startsrunning. So 2 years later, the consumer says, "by the way... I'm in default and about to beforeclosed... I didn't get the notice, so I rescind right now." Then the lender is required, ifthere is an effective rescission at that point, to within 20 days of the rescission, to get backall the money that they've paid (to insurance, blah...), and then the consumer has to giveback the money they received! It's a huge mess. The consumer MUST bring the suit within 3years of closing. The right of rescission terminates completely 3 years after the closing.

CIVIL LIABILITYFor basic errors in Truth in Lending can be significant. In consumer credit generally, theviolation is twice the finance charge. For mortgages, it is twice the finance charge, and noless that $200 but no more than $2000 per violation. A typical violation is the lendermischaracterizing what is and what isn't a finance charge, and getting the APR wrong. Ingeneral, lenders can be off by 1/8% tolerance. Also, if the APR is off more than 1/8% butit's off because a finance charge has been mischaracterizing, they will allow more than1/8% if the finance charge has been understated by no more than $100.

If it is a violation, it is actual damages plus twice the amount of the finance charge (>$200but <$2000) plus costs, plus attorneys fees.

Different tolerance when a loan is subject to right of rescission, and the person says theydidn't get the initial disclosures, because the APR was off, so the 3 day window hasn'tstarted to run and I rescind now! So the tolerances are slightly different for these types ofclaims. Lender has more leeway. Lender can be off by 1/2% or $100, whichever is greater.If you have a no cash out refinance, it's 1% or $100, whichever is greater.

When the rescission is made after foreclosure has been initiated, the lender gets the leastamount of tolerance. Gets $35 cushion. So the borrower has to go in the tank within 3years, and foreclosure has to have happened.

Policy rationale is that under circumstances be more protective of the lender, and others,more protective of the consumer.

This stuff isn't in Regulation Z. They're all in the statute.

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For class actions, things are slightly different. Actual damages plus amount discretionary bythe court up to a maximum of, the lesser of $500k or 1% of the creditor's net worth.Statute of limitations is 1 year from the date of the violations, except for Section 32 loans,where it is 3 years.

The Right of Rescission cases are continually, so Statute of Limitations doesn't apply. Butthere's the 3 year cut off.

Difference in liability with respect to broker and funding bank. Broker is creditor everywhereoutside of TiL. Liability of assignee is liable for only anything that is apparent on the face ofthe document. If something is omitted that should be there, they;re not responsible. That'swhy some lenders say, broker, close in your own name. As a practical matter, it maymatter, but particularly if the violation is not on the face of the documents but the mortgagelender

example: broker screws up TiL, lender can sue usually on contractual basis.

One safety valve for the whole process is if you err on the side of characterizing somethingas a finance charge, and the APR is larger than it really is, then there is no violation! Sowhen in doubt, it's a finance charge! (except not on the exam)

Smith v. Highland BankLender gave the notice, and plaintiff said later on that the notice was defective, therefore hestill has the ability to rescind. Certificate of Confirmation, means that you are electing to notrescind. Some lenders want the consumer to affirmatively say they are not rescinding. Theycan't sign this ahead of time though. Lenders say they can't rely on receiving nothing,because if consumer put rescission in the mail, they won't get it til past the 3 days. In thiscase, the consumer says, he saw this but he thinks he has to tell them now that he's notrescinding. The notice was confusing, therefore it was defective, and he has 3 more days (oressentially 3 more years).

The court cites Rodash, but this was different, because it only had one signature block atthe bottom. This did confuse the consumer. Because he had to sign the one signature block,thinking that they're signing that they got the notice. This one in this case is different. Thisis not confusing. Your rescission rights terminated 3 days after you got this form.

Wiggins v. AVCOThis one is easier to read than previous case. But the court says this is defective! One of theproblems is, that the homeowner got screwed by a contractor who stole all the money. Theborrower owes all this money, and has no property behind it. This affected the court's view.The court ultimately was deciding, who was going to bear the risk of the crooked contractor.The basis was, this was a confusing notice.

Moore v. Flagstar BankMoore's got a loan. Couple of players: Crossstate Mortgage (purely a broker), Flagstar(closed the loan in their own name), foreclosure companies. What happened was, at closing,Crossstate was purely a broker. At closing, Flagstar gave the borrower the wrong truth inlending statement. It was a prior draft. They screwed up. Couple years later, Mooredefaulted and they foreclosed. Moore's claim was that he didn't get all the materialdisclosures, the CORRECT material disclosures, because they admitted it when they sent thecorrect one. Once they sent the correct one, the borrower, who was in foreclosure, said IRESCIND. Did the borrower have the right to rescind? Was there a violation of the Truth inLending statement?

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1. Moore sued Crossstate. They're not liable because they're not a creditor!2. Moore sued Flagstar, the creditor. Did they violate TiL? They gave an incorrect disclosure,but the error was that they were getting a loan at a lower rate than what they orginallywere disclosed. Court says can't rescind or a claim for damages! The original disclosure wasfor a higher APR! Also, the difference between the two was characterizing the mortgagebroker fee. At that time, it was not a finance charge because it was subject to the straightthird party rule of not being a finance charge. They had to create a special rule to make it afinance charge.

Veale, Beach, MacKey... court says that there are certain types of errors that are sotechnical they they won't call them errors for damages.Veale - they didn't have "in monthly..." blah... there was a typo in the note.Beach - Supreme Court case. Deals with 3 year termination of right of rescission. Borrowerattempted to raise it as a defense after 4 years. Court says hell no. 3 years is 3 years,however you use it or raise it.MacKey -

Parker v. PotterMoney Consultants assigned the loan to Mr. Potter (instead of the capital markets).Mortgage on marital home, it was the refinance, and the husband refinanced the housewithout telling his wife. So she didn't sign the mortgage. At that point, it would beunenforceable. The lender went back and got Mrs. Parker's signature somehow after theclosing. Then, did not provide a notice of right to rescind. She has this right, even thoughshe's not a borrower! Parkers went into foreclosure, Mrs. Parker says I want to rescind!Potter says, can't do that, I'm an assignee and I'm only laible for defects on the face of thedocument, and that he wasn't aware of her absence. Court took opportunity to say that theassignee defence of only being liable for things on the face of the document does NOT applyregarding the right of rescission. But this doesn't make sense, because the defect could be alack of a material disclosure and the assignee may not know. But the Court says,notwithstanding this, assignee cannot use this regarding the right of rescission.

REAL ESTATE SETTLEMENT PROCEDURES ACT OF 1974(RESPA) 12 USC 2601, and Reg X: 24 CFR 3500. Unlike Regulation Z, these are regulations

from the department of housing and urban development (HUD), not the Federal Reserve

Board. Only two organizations regulating a very central part of mortgages. Different quality

levels.

RESPA covers the whole mortgage chart we discussed. Prior to mortgage, servicing the

loan, escrows in particular, but does not deal directly once loan is in the secondary market.

Purposes of RESPA:

1. Give more effective advanced disclosures to consumers regarding closing costs. RESPA

calls closing costs, "settlement costs".

2. Most controversial, maybe principle purpose: to address the following situation which was

rampant pre-1974: Go to a real estate broker and you want to buy a house. Consumer asks

real estate broker to suggest a lender. They would recommend a lender that would pay the

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real estate broker a fee for recommending them! Consumer would get a lender not based on

quality or a lender that would provide the best rate or service. Lenders would then add the

cost of the kickback into the cost of the loan. Solutions, one could be just simple disclosure.

They didn't do this. HUD prohibited it, actually criminalized it. This provision dealing with

kickbacks has made a huge body of law to be made unnecessarily. People have been

prosecuted under this. Not only is it criminal, violation is akin to anti-trust, so it's treble

damages. Major effect on the industry.

3. Address and simplify escrows. They have attempted to do this.

4. Reform a modernization of land title registrations. But they haven't done this. Mostly

state law.

Types of transactions it covers: preorigination through postorigination through servicing of

the loan. Applies to Federally Related Mortgage Loans, defined before in the context of

usury preemption.

Exemptions from RESPA (But usually the lender will give the disclosures anyway):

• Loans where the property is 25 or more acres, RESPA doesn't apply.

• Loans for business, commercial, or agricultural purposes. usually follows the

interpretation of Regulation Z.

• Temporary financing, eg a construction loan that has a maturity of less than 2

years.• A pure bridge-loan will not be considered subject to RESPA. It is considered to be

temporary financing. When you have to sell your whole house to have the downpayment for the new one, but you have to close on the new one anyway, so thelender will make you a loan for the downpayment of the new house. Temporaryloan, not for construction, that is really a bridge loan.

• If you have vacant land, it typically will be exempt unless you plan to have a homeon it within 2 years.

• Assumption exemption - when the mortgage is assumed by the borrower. If thelender does not have the right to approve the assumption, so in effect there is not adue on sale clause, then the assumption of the loan by the purchaser from thelender's original borrower, the loan is not subject to RESPA. Logically, the lendermay not even know of the assumption because they have no right to approve it.

• If the original document says that the terms of the agreement will change, then thenew transaction is not a separate transaction and RESPA doesn't apply. The termschange but they have been contemplated by the original instrument.

◦ If you have a loan and put a new note in there, it IS a new transaction andIS subject to RESPA.

• For a bona fide transfer of a loan in the secondary market. That is, a transfer fromone lender to another. When is this considered a bona-fide transfer? In theregulation, HUD says they consider the real source of the funding and the realinterest of the funding lender to determine if this transfer is a bona fide transfer of aloan in the secondary market. They're concerned whether or not RESPA applies tothis transaction is because HUD is concerned and lenders are concerned that if

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RESPA applies, the consequence to the two lenders is that the anti-kickback rulesapply.

◦ Table Funding Scenario - When lender 1 closes loan in their own name,mortgage lender 2 has provided the funds through table funding (onelender provides the funds to the other lender, which the first uses to closethe loan, and there is an assignment at closing from lender 1 to lender 2).HUD's position is that this is NOT a bona fide transfer of a loan in thesecondary market. They're concerned because anti-kickback rules will applybetween these two entities if RESPA applies. The real funding comes fromlender 2, and lender 2 has funded it all along.

◦ Warehouse Bank Scenario - Lender 1 gets a warehouse line of credit fromBank 1. Lender 1 closes loan in their own name after borrowing money fromthe bank, and Lender 1 would then sell the mortgage to Lender 2 after thefact. Is this a bona fide transfer in the secondary market? Moreno v.Summit Mortgage Corp., Moreno is consumer. Summit Mortgage is Lender1, Bank 1 is Bank United, the loan is eventually sold to First Nationwide.There was payment from First Nationwide to Summit Mortgage. Essentiallythe consumer was saying that that payment violated the anti-kickbackprovisions of RESPA, so Moreno is entitled to a lot of damages. Issue ofwhether the payment of money from First Nationwide to Summit wassubject to RESPA. The court said this was not table funding. In 2004, whenthis was decided, most lawyers would recommend that if you had a bona-fide warehouse line, then this transaction would not be subject to RESPA. ---- You have to figure out the real source of the funds. In most circumstances,the 2nd lender has made a commitment to buy these mortgages. Whywould a commitment generally be necessary? Because the warehouse bankwon't lend money unless it is there! The Court rejects the argument thatLender 2 is the real source of the funds. Summit is liable to Bank United.This is not an artificial transaction, and First Nationwide is or may be thesource of the funds, but Summit is really the one on the hook.

▪ HYPO: First Nationwide has an affiliate that supplies warehouseloans. So what happens if they are the warehouse lender and Lender2? Question of whether the warehouse bank is a bona fidewarehouser? Is the money ONLY for that transaction withNationwide? Or, Is the money for anything, as long as they have acommitment? Then it's pretty hard to argue that this is a shamwhen most of the loans aren't sold to Nationwide, they're sold tosomeone else.

Disclosure Obligations under RESPA (only for fees that are charged in connection with thesettlement/closing of the loan!):

• Obligation of lender to deliver to the consumer the Special Information Booklet.Provided by HUD. Something in plain English, describing what RESPA is all about.Must be mailed within 3 days of the application.

• Statement about servicing. Must be given within 3 days after application.Information whether servicing is going to be transferred, or its likelihood, (if Summitwas being table funded, they would indicate up front that they won't be servicing it.)The lender is required to give statistics about how often they transfer the service.

• The Good Faith Estimate - 3 business days after application. Estimate of what theclosing costs (term RESPA uses is Settlement Costs). Examples: origination fee,credit report, various fees... Must be given up front, but it's an estimate. Thestandard is pretty loose. Talks about the fact that it must be in good faith andreasonably related to the charge the borrower is likely to pay. No private right ofaction for a violation under this provision: 2500.7. Doesn't mean there isn't a claim

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to the consumer, because the consumer may be able to make a claim under thestate's consumer protection law.

◦ What happens if the borrower is getting a refinace loan and it is a no-costrefinance. The borrower isn't paying any closing costs. The lender takestheir costs, and builds it into the interest rate. HUD recognizes that this mayoccur, but the consumer really is paying for the costs. You STILL have to fillout the Good Faith Estimate if you have a no-cost refinance. Label thecharges "POC", paid outside the closing.

◦ Special section of the Good Faith Estimate - "THIS SECTION IS COMPLETEDONLY IF A PARTICULAR PROVIDER OF SERVICE IS REQUIRED" - Generally,you can require the borrower to use a certain settlement servicer, even ifthey are AFFILIATED and if they are an attorney, credit bureau.... this justsays "here is our relationship with these companies." Lender does not haveto provide this information if they maintain a list of providers, if they have 5or more providers, and they inform the client that they have the list, theycan see it if they want, and the lender will pick off a provider off the list. Youwill find out who it is at the closing.

◦ Proposal from HUD that when the lender gives the Good Faith Estimate,they will be bound by the amounts on the list. Lenders may not be able toget a fixed price from their vendors! Other proposal, expicitly disallowdiscounts from the vendor and the lender.

• HUD-1 Settlement Statement - Allocation of cost between lender and borrower. 2ndpage - what we care about. the lender's charges to the buyer. It is the same of theGood Faith Estimate, except, this is the one that counts. HUD-1A is for refinances.Just the 2nd page of the HUD-1. The borrower has to see that 1 day before ... LOOKTHIS UP...

Bloom v. Martin, the lender did not disclose either in the GFE or the HUD-1 the existenceof 2 fees. Demand Fee, when buyer requests a payoff letter, and they had to pay a fee atthe time to pay off the loan in order to pay for the recording of the discharge of themortgage. Question of whether this violated RESPA. No question that the lender didn'tdisclose these fees. What's wrong with the plaintiff's claim? HUD-1 and GFE only apply tofees at the time of settlement. These fees are after settlement, so they are not needed tobe disclosed.

THE ANTI-KICKBACK PROVISIONS OF RESPA12 USC 2607. aka "Section 8".

Elements of a kickback. Section (a). "no person shall give" - it's personal so that anybodycan violate this provision, regardless of whether they are in the business or not. The payerand receiver are equally culpable: violation to give and accept. Any "fee, kickback, or thingof value" aka just about anything you can think of. "thing of value" is in 3500.14(d) inregulation X, tells us that it can be anything essentially. If someone is doing something toget someone to make a referral, it's not allowed. If there is this agreement, that wherethere is something exchanged for a referral of business from one person to another, it's aviolation. Agreement between real estate broker and mortgage lender is a traditionalexample of something that violates this paragraph. The number one violator of Section 8were the Title Companies for title insurance! It's a commodity, it doesn't matter where youget title insurance. So they try to find ways for lenders to use their title companies.

Section 8 (B) is a form of a kickback, but it's about two vendors splitting fees.

Section 8 (C) tells us what is NOT a violation of (A) and (B).GOODS OR FACILITIES ACTUALLY FURNISHED OR FOR SERVICES PERFORMED. (What this

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means has been the subject of a lot of dispute.)

Culpepper is consumer. He pays 1 point closing fee. Lender 1 is Premier Mortgage. Lender 2is Inland Mortgage. InLand table funds Premier. InLand mortgage pays a premium of 1.65%to Premier, in addition to the loan amount. Why would they do that? They paid that becausethe interest rate was above market (market was 7.25%, the loan was for 7.5%). Thatobligation, at a higher than market rate, is worth more than the amount of the loan.Culpepper's claim is that Inland paid, Premier received, a thing of value (the $101,600) forthe loan itself to be given to Inland. ***Whether the payment of a premium in a tablefunded transaction (because a warehouse bank, the transaction would not be subject toRESPA) is a kickback?

---- 06/18/2008

Culpepper case... The amount InLand paid to Premier is called a Yield Spread Premium.Referred to as YSP. A payment for a loan that is above market rate. In the case, the Plaintiffborrowers were in default, and asserted a defence that this transation between Inland andPremier violated Section 8(a).

• Does RESPA apply? Yes.◦ Inland would argue that the transaction was a bona fide transfer in the

secondary market, so we never get to the question of whether it violatesSection 8(a). This argument fails, because HUD says, in interpreting thestatute, that you look to the real source of the funds. If you are tablefunded, any transaction between the two banks is not considered a bona-fide transaction.

• Is the transfer of the loan and the payment a violation of Section 8(a)?◦ From Culpepper's standpoint, this is a referral fee because Inland is paying

Premier for the right to fund the loan, it's a settlement service, by payingthe 1.625% from Inland to Premier, they are paying to refer the loan tothem. The defence is Section 8(c)(2), the payment of any person for goodsactually furnished or for services actually performed. Inland will argue thatthe exception applies because what Inland paid for, is the loan itself. Andthis is a good, a tangible good. Paid the premium because the loan wasvaluable. Initial District Court decision said this is correct. This was not asurprise to the mortgage industry, because this happened all the time.Yield-spread premiums was a common part of the industry. 1998, 11thCircuit Court of Appeals says, that they were concerned with the fact thatthis was a table funded transaction. That Premier had used Inland's funds toclose the loans. How can this really be a payment for a good (the loan)when really the substance is, Inland owned it all along because it was theirmoney! This was not a payment for goods, because the real ownership ofthe loan was always with Inland from the beginning. This payment was forthe referral of the loan! This sent shockwaves throughout the industry,because the industry had millions of loans that had been structured in thisfashion.

◦ The Court gave a rehearing, said that this is not a per se rule where a yieldspread is always a violation. You can introduce evidence that the paymentwas for facilities actually performed. Left it clear by implication that theyweren't clear what evidence would suffice. There were then hundreds ofclass actions suits filed against lenders like Inland and brokers, because ifthis was a payment in violation of Section 8(a), then both payee and payorare liable! The payor's were bigger companies with more money. Theargument by plainitiff's council was that every one of these loans is thesame, and that they couldn't have paid for facilities or services because we

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all know that the amount wasn't determined to what services they provided.It was simply provided and calculated by the difference of the interest rates.So it was purely calculated on the difference of interest rates, so plaintiff'ssaid we still have a good class. This argument was a pretty powerfulargument. Essentially says there are no facts to talk about here.

◦ Who is going to bail out the lenders from this potential liability? Violation ofthe section is treble damages! Treble the amount of the illegal fee. Thegovernment will bail them out. HUD! HUD Statement of Policy of 1999-1,and clarification 2001-1. If this was clearly illegal, why did HUD instructlenders how to disclose it in 1992? Because they didn't even think about it.This liability wasn't contemplated. They said they believe there is a 2 partanalysis that has to be made.

▪ TWO PART TEST!▪ Whether there were, with respect to payments made to the lender,

goods provided or service provided? - We know the broker hasdone something. Payments made and services and facilities.

▪ Reasonableness in the aggregrate of the payment to the broker interms of what they did.

◦ Lenders rejoiced because this is case by case, and doesn't allow classactions! Look at what they did, and what they got paid in specific instances.There still may be claims though, if the payments to a broker from a lenderwere excessive what they did, but the litigation would take place on a caseby case basis.

◦ 11th Circuit, interpreting the HUD statement, If there is no relation betweenYSP and the services that were provided, then we won't look at thereasonableness of the payment. Essentially, don't goto 2nd step if there isno relation between YSP and services. 11th Circuit says that calculation ofYSP isn't done with relation to the services provided! HUD issues clarification2 years later saying explicitly that the 11th Circuit has read the policyincorrectly, and finally in Heimmermann (other circuits...) the courts figuredout that there are not common quesitons of fact with respect to these loansAND THEY WILL NOT CERTIFY THE CLASS.

◦ Should HUD outlaw YSP? It has the effect of incentiveizing brokers to offerhigher rates to their customers.

Section 8(b) - Splitting ChargesEchevarria v. Chicago Title - title company charged the borrowers $ and $54 to recordthe mortgage. The Cook County recorder costs $14 less. So Chicago Title marked up thecost of recording the title by $14. The Echevarria's said that they violated Section 8(b)! Themarkup, which Chicago Title retained, is a violation of Section 8. 7th Circuit says that themarkup may be a bad thing, but the question is whether it violates 8(b), "can't accept aportion of a charge other than for services performed." Cook county received exactly whatthey wanted. so the transaction between Cook county and Chicago Title did not violateSection 8(b) because the splitting of the charge was for the services rendered. Theargument by Echevarria's was that they're looking at the transaction between Chicago Titleand Cook county. The third party is the consumer! Between consumer and Chicago Title,this was an unlawful payment because it was $14 more than it should have been and thiswas the unlawful payment. This is wrong, because it would mean the consumer would be inviolation because they paid it! 7th Circuit rejects P's arguments.

In Kruse v. Wells Fargo, identical situation but in the 2nd Circuit. The court says that theyread Section 8(b) saying that it doesn't require both the payee and the payor liable. So theycould say Chicago Title violated Section 8(b), a fee other than for services rendered or pure

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markup, and not say the consumer was liable. In a pure overcharge situation, where thereis no markup (but this was a markup because there was an actual charge for a service) egwhen there is a fee for something like document preparation, then there is NOT a violation.The money doesn't go to anyone but the lender.

One way around markup is by saying, I performed these services. The courts will acceptthat. When you ask for a credit report, you charge the consumer for its costs. If the reportcosts $250, and you charge $300, then you may run into trouble. But you could say, thereport costs $250 but the extra $50 is our internal costs for reviewing the documents. Thatwould be a better argument.

Section 8(c)(4) - another exemption. We have a real estate broker, who then gives them toa lender who makes money on them. Broker wants a piece of the action. We know that theycouldn't require the lender to give them a kickback, but some real estate brokers decided toform their own mortgage lender and make it a subsidiary. They will send their customers tothe mortgage lender that they own, and they mortgage lender can then send profits up tothe mortgage broker in the form of dividends. The concern was that there may be a claimthat the ownership by the real estate broker, or the payment of the dividends was in fact apayment for the referral of the customer from the broker to the lender. This is called anAffiliated Business Arrangements, and is exempted by HUD under certain conditions.This is a vehicle around the prohibitions in 8(a). An Affiliated Business Arrangement isformally defined as requiring 2 parties. 1) a person in a position to refer settlementservices. 2) a settlement service provider. (anything we can think of relating to themortgage) 3500.15 is where they define the regulation regarding this. The person in aposition to refer settlement services is defined in 3500.15(c)(9). Affiliated BusinessArrangement is when the real estate broker refers to the mortgage lender, but it could beany sort of combination. Where the person in a position to refer, at least has anownership interest of 1% in the settlement service provider or in other ways hasan affiliate membership (some measure of control over the settlement serviceprovider. Control, contract, etc.). == Affiliated Business Relationship. So in the originalhypo at the top of this paragraph, the answer is yes. So if you meet certain conditions, youcan transfer money from lender to broker and not violate Section 8.

What is required for this relationship? (so that Section 8(a) doesn't apply to them)• (A) "The Affiliated Business Arrangement Disclosure" - there has to be a disclosure

made to the consumer at the time of the referral from the broker to the lender.Must say the nature of their relationship. Must talk about the range of charges thatthe settlement service provider is going to charge.

• (B) "The Required Use Prohibition" - the consumer is not required to use anyparticular provider of settlement services. So real estate broker cannot say, "youmust use this lender!" exceptions: if provider is an attorney, appraiser, or creditreporting agency. The lender can require the user to use specific settlement serviceproviders in those circumstances. What if broker says, "you can use any lender youwant, but if you use my lender, i'll waive your closing costs" so that there is apowerful incentive to use the affiliated business arrangement. Does this fail to meet(B)? Up until 1992: yes. In 1992, HUD issued a revision of Regulation X. (rightbefore clinton administration, regulation x was completely revamped). Priorinterpretations about required use are no longer! So a real estate broker may givean incentive to the consumer and NOT be in violation of the Required UseProhibition.

• (C) The only thing of value that is received is a return on the ownership interest. Ifyou are paying dividends, and they are legal dividends based on the ownershipinterest, then you meet this condition. However, (usually doesn't apply in wholly

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owned. usually applies in partially owned.) if the broker requests an interest in thecompany in exchange for all this business, for example requests 10% of thecompany, the lender will say that this isn't tied to the amount of business the brokergives. So lender will adjust at the end of the year based on how many referrals. Thisdoesn't work and its a stupid idea. RESPA WAS DESIGNED TO PREVENT REFERRALFEES! No matter how complicated you make it, all of the customers of the broker(all the other lenders) are going to be pissed and search for some kind ofkickback.*** Cannot alter the amount of ownership interest based on the amount ofreferrals! How the broker gets ownership of the company matters too. Theownership interest must be gotten by paying a fair value for the stock or share ofthe company.

Title Company and Mortgage Lender form a Title Agency with 50/50% ownership. Socustomer will pay premiums to title agency. Then the money will be distributed to each. Thisis an Affiliated Business Arrangement. So Lender will get profits and it's not a kickback.Meet the three above requirements. The problem was, from HUD's standpoint, when theTitle Agency is set up, it's run by the Title Company. Some were sham companies to ineffect, provide a kickback to the Lender! The settlement service provider really isn't onebecause it isn't doing anything. It's just a dummy corporation. What does it have to do tobe considered a bona fide settlement service provider? HUD Statement of Policy1996-2. It attempted to lay out guidelines. If you don't follow them, this structure whichtechnically works, will be deemed a sham and the payments from the title agency to thelender will be in violation of Section 8. But the guidelines weren't specific enough. From alawyers standpoint, what level of comfort can you give your client? Conservative and followall guidelines. Aggressive and only follow a few. It's a quesiton of how much business riskthe client from the lender's standpoint wants to take. If it was structured wrong and it wasdeemed a sham a, a class action could be formed and then sued for treble damages. Easyto prove once the court decides its a sham. Fee * transactions * 3 + attorneys fees. Done.Everything is tainted if it's deemed a sham.

-----06/23/08

RESPA -

Affiliated Business Arrangements (review) - Important because they are an exception to theprohibition on kickbacks under so-called Section 8 regulations. None of the paymentsbetween the entities will be deemed to be in violation of Section 8. People in the industryhave seized onto this exception to do exactly what Section 8 tries to stop: kickbacks.Person in Position (real estate broker for example) refers service to Settlement ServiceProvider (mortgage broker). Greater than 1% ownership interest. Three conditions so therelationship is legal.

• There is a disclosure at the time to the consumer. At the time of the referral to themortgage broker. Affiliated Arrangement Business Disclosure.

• Consumer is not required to use this settlement service provider, unless it is anappraiser, a credit reporting agency, or an attorney.

• Payments made are on based on the ownership interest.This is the simple case. It can get more complex.

There can be a number of parties involved. And it doesn't have to be a real estate broker

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and a mortgage broker.

Assume real estate broker has a number of employees, and the owner says to hisemployees, "if you have a customer, we really want to promote the use of our mortgagebroker, so if you refer our customer to our mortgage broker, i'll pay you a bonus." Does thisin some way violate the conditions for an affiliated business relationship? The answer is,today, is that it is perfectly permissible. An employer can pay an employee a referral fee.HUD tried to modify this. There are some limitations in the proposed rule. Real estatebrokers have been able to create an exception of who is actually an employee. Agents forreal estate brokers, are deemed to be independant contractors because the national realestate brokers have a lot of political power. Under every every test, they would beemployees. Positive, except that, for purposes of this rule, if they were to receive a referralfee by the owner of the real estate broker, THEY COULD NOT TAKE ADVATANGE OF THISEXEMPTION because they are not employees!

Back to previous hypo... we have a mortgage lender and a title insurance company(underwriter) and they each take a 50% interest in a Title Insurance Agency. We have aABA, because the ownership is equal or greater than 1%. Mortgage lender refers itscustomers to the Title Insurance Agency. Why do they set it up this way? The mortgagelender is going to benefit most here. The consumer is going to pay premiums to the Agency,and the Agency is giving half of its profits to the mortgage lender, even though the titleinsurance company is doing all the work. The title insurance company gets more business,because the lender has an economic incentive to refer its customers to the title insuranceagency. If they do everything right, it is legal. But it's costly. They have to set up a titleagency company from scratch. But they were so anxious to split the money, but it was asham and did nothing beyond receive money and send half to each party. The questionbecame, from HUD, How do we know a sham from a legitimate one? Policy Statement,"Sham control business arrangements" Number of factors. Doesn't tell us how much each isweighted, or how conclusive one is to another. Some include:

• Does this entity have enough capital to operate? One of the indicators of a sham iswhere the capitalization is too small. Over capitalize it then to prevent this violation.

• Does this agency have its own bona-fide employees? Hire from the job marketpeople to run it. Most conservative, find someone with no prior arrangements to thetitle insurance company. At the very least, make their people full time employees ofthe new agency!

• Where is the office? Most conservative, have an office that is not part of eitherparty's office.

• Who is making the decisions? Are the employees making the decisions? Or are the50% owners making the decisions?

• Where does the agency get its business? Do they attempt to find businessindependent from the mortgage lender.

Analyze each of these factors, stir them up, and see if it stinks. There is no per se rule.This example was never challenged by regulators or private plaintiffs. Who is likely tochallenge this? The consumers don't care. It's important to the competitors to the titleinsurance company! What actually ended up happening was that the agencies couldn't makeenough money! The cost to operate it, took away a good part of the profit. Didn't makeinsurance for title company because they were losing money.

Mortgage lenders owning real estate brokers. Tough to make economically. The real estatebrokers want to put their customers in places that close quickly!

Other aspects. All the factors are conservative. What they've done is say that the mortgagelender has 40% ownership with 0% asset contribution. The title insurance provides all thecapital for the agency. It seems to work, except that how they get paid percentages. HUD

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regulators say, if you give ownership interest in effect based on the referrals that one partywill give, then your structure is flawed. The thing of value that you have given is apercentage ownership. And they did nothing in effect to get that thing of value exceptprovide referrals.

Violations - the person is fined and put in prison. The essence of criminalizing businessconduct. Sec 2607(d) in RESPA statute. Amount is treble-damage of the amount charged forthe settlement service. The amount charged to the consumer, not just the kickback! Inaddition, government can get an injunction, or can be brought by private plaintiffs. Costs +Attorney Fees.

EQUAL CREDIT OPPORTUNITY ACT15 USC 1691. "Regulation B" promulgaged by the Federal Reserve. C.F.R. 202.1. This actwas passed 1976. Primarily to put women on the scene and put the playing field even interms of credit. Many married women were not able to take advantage of the credit theyhad generated with their husbands. Primary motivator was gender.

It essentially prohibits discrimination on a number of bases. Race, color, religion, nationalorigin, sex, marital status, age, applicant's receipt of income derived of any publicassistance program (can't discount income because it's public assistance), or applicant'sexercise of rights under the act.

Who is subject to the act? It's not only consumer credit. It's ANY extension of credit,including business credit. Applies to creditors (last saw this concept in Truth in Lending Act.Someone that is in the ordinary course of business an extension of credit AND note is intheir name.) CREDITOR in this context means a person who in the ordinary course ofbusiness regularly particpates in the in a credit decision. Our chart for the wholesemester... mortgage broker or lender, may be table funded or loan may be purchased daysor weeks later. This is not determinitve on whether they particiapte in a credit decision. Atable funder often times makes the decision and doesn't let the mortgage broker make anydecision. The "creditor" may not be the mortgage broker because they are not participating.Also includes people who regularly refers people to lenders. In most cases, the mortagebroker AND the mortgage lender will be "creditors" therefore.

Once you have a creditor, the Act and Regulation B says there are certain rules that mustbe abided by as you go through the process.

• What are the rules applying to gathering information?◦ Regulation B 202.5 - can't merely discriminate, can't discourage people

either. Can ask about marital status when applying for a loan, but may notask any information about spouse. Cannot ask if income is from alimony,child support, or ... unless you say to the consumer that you don't want theincome counted. Cannot ask about gender. May not ask about child bearingintentions, but can ask about dependents. Cannot ask about race, color,religion or national origin, but may ask about permanent residence andimmigration status.

• Evaluating the information◦ Can't take into account applicant's age, unless its used to favor the elderly

applicant (age 62). 2 ways in which creditors can evaluate. Credit scoringsystem, has to be empirically derived and statistically sound. Permissible aslong as old person doesn't get a negative factor. Judgmental system is not ascoring system. In those, a person can't consider age as such, but can take

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into account how long person would work and get income in order to payback the loan.

◦ In evaluating the rules of extensions of credit, the rule of spouses isrelevant. If you have spouse who is not an applicant, you cannot force thenonapplicant to sign the note. Not applying for the loan, so they shouldn'tbe personally liable. However, you may depending on state law require thenonapplicant spouse to sign the mortgage, or security instrument, to makethe security valid and enforceable.

◦ The credior must advise withing 30 days of receiveing a completedapplication, completed means: appraisals of property, full credit report, etc.Must notify applicant that you APPROVE or DISAPPROVE (adverse action,is the term used here). Or, may make a counteroffer! Must give statementexplaining reasons why they took the adverse action or telling consumerthey have a right to request the reasons. Must include specific informationto be sufficient. "cannot verify income" is ok. "don't meet our standards" isnot ok.

How do you prove someone violated the antidiscrimination aspect of this law? Couple ofways.

• "Discriminatory Treatment" -◦ Overt - treat people differently based on the protected categories. If you

have a loan program that says you make loans on these terms, but youhave to be over 25, that will violate equal credit opportunity act.

◦ Comparative - you cannot tell, by simply looking at the loan application orresult, that someone has discrimiated someone based on a category. Whenyou compare them, you see they have been treated differently. Examplebased on race, the white couple with a certain income with marginal credit,and there is an identical minority couple, you see with the white couple, theloan officer would really work to help them. With the minority file, the officerwould just say, "sorry, you don't qualify."

▪ Disparate Impact - essentially means that there is no overt oreven comparative discriminatory treatment, but you have a criteriafor ranking credit. You only make loans of $400k or more. They findthat in fact, people who take advantage are 98% in a non-protectedcategory. Facially neutral criteria, but has a greater impact on aprotected class. Sometimes called the effects test. If a businesspractice has a disparate impact, burden shifts to lender to provethat it's a business necessity and that there is no other way toaccomplish their goals that would have less of a discriminatoryimpact. Very difficult to prove.

Litigation involving these aspects.

McDonald Douglas Burden Shifting Test. Plaintiff says they applied, they qualified, thenthey didn't get it. The burden shifts to lender to give nondiscriminatory reason for the creditresult. If they do this, then the plaintiff has to prove that this is a sham.

African American Woman. She applied for $51k loan, bank's appraisers says its worth $47k.Plaintiff complained. Plaintiff got loan from another bank for $46k, appraised at muchhigher. Judge Posner got the case. Argues that the McDonald Douglas burden shifting testdoesn't apply in the lending context. There isn't ONE loan that the bank is going to give.There isn't a vying for a specific loan or job. Makes sense in employment context, but not inlending. Plaintiff can still show this, but they don't get the benefit of burden shifting. Haveto show by a preponderance of the evidence that there was discriminatory impact. But this

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was the only Circuit to rule this way. As a practical matter, there isn't much difference. Thelender has to give a non-discriminatory reason under the burden shifting, and then theplaintiff says that was mere pretext. In the context of summary judgment motion, whenactual facts are considered, the plaintiff is going to have to come up with some evidence ofdiscriminatory treatment.

Important to know what stage of litigation we're at. If motion to dismiss, very difficult fordefendant to win as long as complaint has basic provisions. Court assumes everything infavor of non-moving party. Zmudeo case in 7th circuit. The reason I got turned down for aloan, the lender says it's because it didn't appraise out, but plaintiff says the credit scoringsystem has a disparate impact. But in a motion to dismiss, it will survive. When liklihood ofhim proving the scoring system as bad was very unlikly, but they had to litigate.

Mattis case, 10th circuit, so thye have mcdonald-douglas. P says he qualifies, didn't get it,but other people outside the class did get the loan. Court says you can't show you werequalified, because Bank One just used the fannie mae and freddie mac underwritingstandards. And so with that in place, you're not even able to make the prima facie case.Even using mcdonald-douglas standard, plaintiff LOST the summary judgment motion.

Rosa v. Park West - Rosa (male) went into bank dressed as a female. Said he wanted aloan. Loan officer wasn't comfortable with that situation, told patron to go home and getdressed properly and then come back. What's the violation? Is it race, color, religion,national origin, sex, marital status, age, income derived from public assistance? Onlypossible one could be sex. What is it that plaintiff would have to show? That a womandressed like a man would be treated differently. A woman in comparable circumstanceswould be treated better. In a motion to dismiss, the court just has to cobble together atheory even if the plaintiff doesn't know the theory exists.

LIABILITY: assuming there is a violation of the act, creditor is liable for actual damages. Itmay be the inability to get the loan because they were discriminated against, and whatdamages may flow from that. But there is also punitive damages. Available in individualactions, cannot be greater than $10,000, and in class actions, cannot be greater than thelesser of $500,000 or 1% of the lender's net worth (like Truth in Lending). Also costs andattorneys fees. Unlike Truth in Lending (1 year statute), there is a 2 year statute oflimitations here, starting the day of the occurrence of the violation.

Lopez v. Platinum Home Mortgage - borrower applied for loan, and appraised value of thehouse came out lower than was expected. So when borrower, at the closing, the terms ofthe loan had changed. The court found as a matter of fact, that the application wascompleted on February 15th, and the borrower was in effect notified of the decision onMarch 25th (the date of the closing). So the question is, was there a violation? Borrowercame to closing, saw the different terms, and said he'd take it. So the loan was based onthe different terms. Borrower then sued under the Act, saying they didn't receive a notice ofadverse action. The Court said, if we look at the definition of adverse action, it says thatunder the ECOA, if there is a counteroffer by the creditor and the borrower accepts, there isno adverse action. So here, the creditor counteroffered and the borrower accepted, and didnot need a notice of adverse action. Is there still a violation? The court thought thisdisposed of the case.

• But remember there is an obligation on the lender to make a decision within 30days! On the facts, the borrower never received communication. So even if therewasn't adverse action, there wasn't an acceptance or counteroffer! The courtdoesn't address this. If they had argued and won that, what are the damages? Theviolation is not receiving notification within 30 days. Damages under equal credit arenot as bad as Truth in Lending.

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Tease v. First Union Home Equity Bank - P alleges she was not an applicant that wasrequired to sign the note and loan. The bank says they had the application and it was the Pwho applied! Motion to dismiss was not granted, because all inferences had to be made inP's favor.

FAIR HOUSING ACT42 USC 3601. Series of catergories where discrimination is prohibited. Applies to all aspectsof residental real estate transactions. Different list of classes. Race, color, national origin,religion, sex, familial status (essentially when families have children under 18) andhandicapped.

----STATE REGULATION

Today, virtually every jurisdiction regulates mortgages. Primary tool of regulation for statesis through a licensing process. So you would need a license in order to engage in thebusiness of making residential mortgages. Distinction between state chartered mortgagebankers and state chartered depository institutions. Depository institutions are regulated allover the place, if nothing else by the FDIC. State chartered mortgage bankers who docommercial loans are essentially not regulated.

Substantive provisions in terms of what types of loans they can make, what provisions canbe in the loan documents, or other acts the lenders cannot do. Regulation is more sweepingthan simply: you need a license.

In the new bill that is in front of the Senate... the next step is Federal Regulation of thesebankers. Provisions that mandate to the states to make sure they are regulating. Potentialmovement toward federal regulation of state chartered mortgage bankers. Many mortgagebankers would welcome a federal licensing requirement. This would preempt state law, socurrently they need to be licenced in every state.

Many states were dissatisfied with Regulation Z. They wanted stricter regulations, coveringmore loans. The definition of a "high cost loan" was too narrow.

Michigan's regulatory scheme. There is no uniform act that every state has to follow. Eachstate is different.No licensing act til 1987. we have the Michigan Mortgage Brokers, Lenders andServicers Act (MCLA Sect 445.1651-1684)

• Brokers are essentially defined as someone who doesn't close the loan in their ownname.

• Essentially institutions only.Effective January 1, 2009, Michigan expanded the group of people that need to be licensedto include individual Loan Officers. Many times the loan officers were processing bad loansbecause they want the commission. They don't care what's wrong with them. Loan officersare now required to take a class. Annual renewals will be necessary. Can't have themlicensed before they start. But generally these are small businesses, like small law firms.Built into the law, it says when you hire someone, they must be licensed within 90 days.

Mortgage Brokers, Lenders, and Servicers• Key requirements is that they must have a certain amount of net worth. In

Michigan, Brokers and Lenders have to have $25,000. Great, there are no barriers

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to entry. Problem: there are no barriers to entry. Servicer has to have $100,000.Why the difference? Servicer takes the customer's funds, and the state is worriedabout the company taking the payments and doing bad things. Surety (sp?) Bondsare also needed.

Traditional licensing requirement with full blown investigationRegistration - streamlined licencing process. For people/institutions that have beenapproved by someone else. So if you are Fannie Mae / Freddie Mac / Ginnie Mae registeredand approved, then you don't have to go through the whole process again.

The states cannot regulate depository institutions, because they are regulated by someoneelse.

Once you get a license, you are subject to auditing by the state. Not done annually becausethey don't have the staff. There are literally thousands of licensed or registered in the state.The state, once they do get in there, can audit for compliance of all the state laws BUTALSO all the federal laws we have been talking about.

What if you sell your registered, licensed company? If you sell more than 25% of thecompany (voting control) to someone else, you cannot do so until the state approves it.Because the state licensed and approved you based on a specific management andstructure.

In the real world, what often happened, was that people would start companies, advertise,and then someone would call them out on them needing a license. The state said, if youhold yourslef out as a broker or lender to the public, then you need a license.

The state has been aggressive or not depending on the time on various aspects of thelicense and licensing process. It's difficult because it's an inconsistent regulatoryenvironment.----Another aspect reflected in the Michigan Consumer Mortgage Protection Act, around2002. Provides some regulatory assistance to the borrowers. Provides that the borrowershave to get a bill of rights, counciling before entering into the loan, prohibits balloon loansof less than 5 years unless it is a bridge loan less than 1 year (like the federal laws). Doesnot apply to loans for the acquisition of a dwelling. Many provisions of Truth in Lending don'tapply to the acquisiton of first liens. Applies to refinances, second mortgages, etc. just liketruth in lending.

In 2002, the legislature did not choose to expand the scope of Predatory Lending laws thatwe have studied in reference to Truth in lending. Michigan legislature now rethinking that.

Mortgage banks that were licensed entered into arrangements with out of state companiesthat wanted to use their licenses. This is called Net Branching. So a branch in GrandRapids. HQ in Detroit. Grand Rapids should be scrutinized just like the Detroit one.Michigan OFIS Bulletin No. 2003-09-CF. If these people are really operatingindependantly, then they need their own license. Illustritive of what state regulators have todeal with. When the barriers of entry are so low, problems like this occur. If you have alicensing scheme and someone can escape the umbrella of investigations and such, they areusually doing it for a reason! They don't want to be subject to investigations because theyare doing shady stuff.

The question is, given the changes in Michigan licensing law, are the questions involving NetBranching still relevant? One reason why we shouldn't care so much: the individuals in

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Grand Rapids would have to be licensed themselves as individual loan officers!

-----------------------

REVIEW

2 hours long. 4 questions. Closed book. All subjects are fair game. RESPA, Truth in Lending.Information emphasized in class is what he wants.

1.Memo from client. Prepare Adjustible Rate Note based on terms client has given. Had toknow what was in it. Paragraph by paragraph.

1. Options to structure relationship:

We have a mortgage lender and 3 real estate brokers. How can we structure this? Someform of an affiliated business relationship. Various ways to do this. One course is to create astructure where all three real estate brokers own shares of one big mortgage broker. Oneentity is problematic because they can't switch their ownership shares depending on thecontribution each does. If they did this, they woul dhave to give affiliated businessarrangement notice. This is not an attractive alternative. Another possibility, is to have eachof them form their own mortgage broker, avoiding the ownership locking share, and eachwould do business with the mortgage lender. Cannot be a sham, have to be a bona-fideentity performing actual services. If they don't and the mortgage lender pays a fee to themortgage broker that is really a payment to the real estate broker, then it is illegal. Yetanother way to do this is to not form any mortgage brokers, and go directly to the mortgagelenders. Get paid for services rendered. This is a defence to the claim that it's a kickback.Issues: no affiliated business arrangement, licensing issue. Real estate broker may need alicense as a mortgage broker. Also, the very real problem of proving the difference betweenthe services the real estate broker would provide anyways and an added service they aregetting paid for. Without a separate entity, it's difficult to ascertain.

Charge closing processing fee:

Issues involved. One may be that if you don't perform any services for it, it may be deemedto be overcharging. HUD adopts the interpretation of RESPA that overcharging is prohibited.The courts, with Section 8(b), have not adopted it. But there's the possibility HUD will bringan enforcement action. Is the fee legal? If it's overcharging, it would not be.

How is it to be disclosed? 1. Where would you have to disclose it? The good faith estimate,the HUD-1, and the question is, Is it a finance charge? To analyze whether it is a financecharge, 1) is this a (c)(7) charge? if yes, then it's not a finance charge. done. if no, then: 2)is it a fee related to the obtainment of credit? loan processing fee based on mortgageamount, it is related to the loan. So yes, the processing fee is likely legal unless it isovercharging because you didn't perform services, and it DOES need to be disclosed andshould be disclosed as a finance charge.

So affiliated business arrangement, RESPA, and Truth in Lending.

----

2. (a) Real estate broker has an employee (Jeremy). The broker owns 5% of a mortgagebroker. It also owns 100% of a title insurance agency.

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Jeremy's job is to market. Take the customers of the real estate broker and attempt to"refer" business to the mortgage broker and to the title insurance broker. Every timeJeremy does this, he gets a bonus. Is this a problem? The payment is going from employerto the employee. This is NOT a violation of RESPA. But is Jeremy a bona-fide employee or ishe an independant contractor? (Individual brokers are generally independant contractors).Payments should come within the exemption.

Title insurance agency pays quarterly administrative fee to real estate broker. Is thispayment a violation of Section 8? One of the exemptions is for services actually rendered.However, you have to look at how is the fee calculated? If it's based on the amount ofbusiness referred, it's at least suspect. The amount of work they do as a parent reallyshouldn't have to do with the amount of money paid. It could be okay, but the way it iscalculated is suspect.

(b) Tests knowledge of Ginnie Mae. Major risks and benefits for becoming involved withGinnie Mae. When you are a GM servicer, you have to, even if you don't collect the moneyfrom the borrowers, you have to pay the investors anyway. That's why it's called a modifiedpass through. The capital markets get paid no matter what. So you have to have a lot ofcash that you can draw on if you are a GM servicer. Secondly, if you screw something up,GM can terminate immediately. And they are not subject to the automatic stay inbankruptcy. Other negative is that it costs more to service FHA and VA loans thanconventional loans. GM certificates are made up of FHA and VA loans. Benefits: it's a greatoutlet to sell your loans. You transfer loans to GM, they give them back as a MBS, then yousell the MBS. People will buy these MBS because it is a government backed security. It's asafe investment for investors. Thirdly, even though it costs more to service, it pays more toservice! Servicing rate is significantly higher thatn reglaur loans. 44 basis points GM, regularare 25 basis points.

3. Client has made a prepayment and lender won't change the payment, so she changed itfor them. Who's right? In an adjustible rate loan or even a fixed rate loan, the lender is notobligated to recompute the payments even though a prepayment has been made. With anadjustable rate loan, it will be recomputed AND take into account the prepayment in 2008,on schedule. On the change date, you refigure with the unpaid principle balance.

She also signed a standard loan that she warranted it would be her principle residence. Andit's not now. She moved to detroit. The lender can say she is in default. Couple things:they'll take into account change in circumstances. It's not a strict agreement to make ityour principle residence. And this absolute agreement would only be effective for a year,and this is beyond the year period.

She has the problem that she is renting the place. Does this trigger the due-on-sale clause?Critical for the next issue, because she is consulting us about her rights. Lender sent her aletter saying she is in default and they accellerated the balance.

With no due-on-sale notice, the lender has screwed up because they have to give her aright to cure, 30 days beyond the letter. Lender did not give a right to cure. They do nothave to do this if it is a due-on-sale violation. If it's 3 years or less, a lease is NOTconsidered an event that triggers due-on-sale.

Grading: goal is to give best curve he can give. for this class. 80% A and B's. 20% C+ andbelow.

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