New Jersey's Anti-Predatory Lending Act:

A Lender's Guidebook

Dateline: September, 2003

 

Overview:

On May 1, 2003, the New Jersey Legislature followed the lead of other states around the nation and enacted the “New Jersey Home Ownership Security Act of 2002” N.J.S.A. 46:10B-22 et seq. (the “Act”) and its implementing regulations, which will go into effect on November 28, 2003.  In enacting the Act, the Legislature found that abusive mortgage lending has become a growing problem in the State, leading to a loss of equity in homes along with a corresponding increase in the number of foreclosure actions instituted in this State.  In light of this perceived increase in abusive lending practices, the Legislature deemed the Act necessary to “encourage lending at reasonable rates with reasonable terms.”  The Act sets forth the basic framework while granting authority to the Commissioner of Banking and Insurance to promulgate regulations to further the Act’s objectives.

The within article will examine the provisions of the Act, discuss the loans covered by the Act as well as those exempt from its regulations, set forth the penalties imposed for violations of the Act, and explore some of the unanticipated consequences of the Act.  While not intended to be an exhaustive commentary and discussion on the Act, the within article seeks to provide the reader with a general understanding of its provisions.

 

Regulated Loans:

The Act seeks to regulate three categories of loans:  (1) home loans, (2) high-cost home loans, and (3) covered home loans.  Rather than implementing a universal set of regulations and prohibitions for all loans, the Act places restrictions on each separate class of loan.  Such regulations and prohibitions are only applicable to loans made or entered into after November 28, 2003. 

It is anticipated that the Act will be pre-empted by federal law, thereby preventing the Act from regulating nationally chartered banking institutions or their subsidiaries.  The Office of the Comptroller of the Currency and the Office of Thrift Supervision have previously stated that federal law pre-empts similar state anti-predatory lending laws and that those statutes do not apply to nationally chartered banks.  Those offices have noted that federal law, not state law, provides national banks with the authority to engage in real estate lending.  In addition, the Office of the Comptroller of the Currency has proposed a regulation which would definitively hold that such state laws are pre-empted.  Specifically, the proposed regulation would provide that state licensing laws and laws that address the terms of credit, permissible rates of interest, escrow accounts, and disclosure and advertising would be pre-empted by federal law.  However, federal law would not pre-empt state laws that generally pertain to contracts, debt collection, acquisition and transfer of property, taxation, zoning, crimes, torts, and homestead rights. 

 

1. Home Loans

The first class of loans covered by the Act are “home loans.”  The Act defines “home loans” as “an extension of credit primarily for personal, family, or household purposes” secured by a mortgage on a “one to six family dwelling which is or will be occupied by a borrower as the borrower’s principal dwelling.”  This definition includes security interests in manufactured homes but does not cover reverse mortgages.  That definition, which does not contain a limitation as to the amount of the loan, is broad enough to encompass the majority of loan transactions in New Jersey not included within the definition of the other two covered classes.  The largest class of loans not defined as home loans are rental and investment properties.  However, caution must be exercised as the borrower may be able to resort to the protections of the Act by subsequently residing in the mortgaged premises.

The Act places six restrictions on home loans:

  1. Creditors are prohibited from financing any credit insurance premiums, debt cancellation, or suspension agreement or contract, except those fees calculated and paid on a monthly basis.

  2. Creditors are prohibited from engaging in the practice of “flipping” a home loan.  This practice, as defined by the Act, will be discussed in greater detail later in this article. 

  3. Creditors may not encourage a debtor to default on an existing loan if the home loan is to refinance all or any portion of the existing loan. 

  4. Limitations are placed on the amount, and assessment, of late fees. 

  5. Creditors shall not accelerate a loan unless, in good faith, the borrower has defaulted in a material term of the loan. 

  6. Creditors have an obligation to provide payoff figures within seven business days, while prohibiting them from charging a fee for such requests. 

 

2.  High-Cost Home Loans.

The second class of loans regulated by the Act are high-cost home loans.  The Act defines high-cost home loans as loans with a principal amount $350,000 or less, which amount shall be adjusted yearly, which either: 1) have an annual interest rate which would qualify the loan as a “mortgage” under the Federal Home Ownership Equity Protection Act, currently 8 percentage points above the comparable Treasury yield for first mortgages and 10 percentage points for subordinate lien loans, or 2) includes total points and fees payable by the borrower at the time of closing, excluding either a conventional prepayment penalty or up to two bona fide discount points, exceeding: a) 5% of the total loan amount if the loan exceeds $40,000, b) the lesser of 6% or $1,000 if the total loan amount is less than $20,000, or c) 6% if the total loan amount is between $20,000 and $39,999.

For purposes of the Act, bona fide discount points are defined as loan discount points which: (1) are knowingly paid by the borrower, (2) are paid for the purpose of reducing the interest rate and achieve that purpose, and (3) reduce the interest rate on a home loan secured by a first lien by more than two percentage points provided that the original rate does not exceed the conventional mortgage rate or reduces the interest rate on a home loan secured by a junior lien by more than three and one-half percentage points. 

The Act defines points and fees to include: 

  1. Any amount payable under a point, discount, or other system of additional charges

  2. Service or carrying charge

  3. Loan fee, finder's fee, or similar charge

  4. Fees for preparation of loan-related documents

  5. Charges for maintaining an escrow account for future payments of taxes and insurance

  6. All compensation paid to a mortgage broker

  7. Cost of premiums for financing any credit insurance premiums, debt cancellation, or suspension agreement or contract, except those fees calculated and paid on a monthly basis

  8. The maximum prepayment fees and penalties that may be charged or collected under the loan, and

  9. Prepayment fees and penalties incurred if the loan refinances another loan held by the same creditor or an affiliate. 

However, points and fees do not include:

  1. Title insurance premiums and examination fees

  2. Taxes

  3. Escrows for future payments of taxes and insurance

  4. Filing fees

  5. Recording fees

  6. Tax payment fees

  7. Flood certification fees

  8. Pest infestation inspection fees

  9. Home inspection fees

  10. Appraisal fees

  11. Credit report fees

  12. Survey fees

  13. Attorney’s fees

  14. Notary fees

  15. Fire and flood insurance premiums. 

Lenders should be warned that the definition of points and fees contains many ambiguities and references definitions contained in other statutes.  As such, the definition is subject to change at any time by revisions to the referenced statutes or clarifications by the Department of Banking and Insurance (the “Department”), which has already acknowledged the confusions caused by the language of the Act.

Once a loan has been classified as a high-cost home loan, it is subject to the numerous restrictions by the Act.  Specifically, the Act prohibits:

  1. Balloon payments

  2. Negative amortization

  3. Charging a default rate of interest

  4. Payment of more than two periodic loan payments out of the proceeds of a loan

  5. Forum selection clauses if that forum is less convenient, more costly, or more dilatory for resolution of the dispute

  6. Payment of a contractor for services performed under a home improvement contract directly from the loan proceeds

  7. Charging a fee to modify, renew, extend or amend the loan or to defer a payment

  8. Charging points and fees in connection with the loan if the proceeds are used to refinance another high-cost home loan held by the same creditor

  9. Financing points and fees in excess of 2% of the total loan amount. 

Additionally, the Act imposes the following obligations on the creditor: 

  1. The creditor must give to the borrower a written notice that the loan is considered a high-cost home loan and advise the borrower that he may be able to obtain a loan on more favorable terms from another lender

  2. The borrower shall receive counseling prior to entering into the transaction; and

  3. A creditor must use the judicial foreclosure proceedings of this state in foreclosing on the loan and mortgage. 

 

3.  Covered Home Loans.

The final class of loans regulated by the Act are covered home loans.  The Act defines “covered home loans” as: 1) loans where the total points and fees to be paid, excluding a conventional prepayment penalty or not more than two bona fide discount points, exceeds 4% of the total loan amount or 4.5% of the total loan amount if the loan is $40,000 or less or if the loan is insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs or 2) a loan falling under the definition of a high-cost home loan. 

Unlike home loans or high-cost home loans, the Act does not impose restrictions upon covered home loans but, rather, limits the situations in which a covered home loan may be issued.  The Act prohibits the practice of “flipping,” or refinancing, a home loan entered into in the prior five years into a covered home loan unless the new loan has a “reasonable, tangible net benefit to the borrower.”  Despite the Act’s inclusion of definitions for common terms such as “conventional prepayment penalty” and “conventional mortgage rate,” a definition of “reasonable, tangible net benefit to the borrower” is noticeably absent.  The only guidance provided by the Act is that all surrounding circumstances should be considered, including the terms of the new and refinanced loans, both economic and non-economic circumstances surrounding the transaction, the purpose of the loan, the cost of the new loan, and other circumstances of the borrower.  It is likely that this term will ultimately obtain its definition from the Courts.

Notwithstanding, the Act does set forth two situations where flipping will be presumed: 1) where the primary tangible benefit to the borrower is a lower interest rate but it takes more than four years for the borrower to recoup the costs of the points, fees, and other closing costs through savings in the reduced interest rate and 2) where the existing loan is a special mortgage originated, subsidized, or guaranteed by or through a state, tribal or local government, or nonprofit organization which includes one or more special benefits, such as a reduced interest rate, which benefit will be lost by refinancing.

Although not providing a form for evaluating a refinanced loan, the Department has encouraged lenders to maintain records demonstrating that an analysis of the benefits to the borrower was conducted and obtain an explanation from the borrower as to non-economic benefits of a transaction.

 

Liability and Exposure for Violations:

The Act implements a dual system for enforcement by permitting the borrower to assert affirmative claims or defenses for violations as well as authorizing the Department to issue civil penalties and impose additional penalties. 

A borrower may assert claims or defenses against a lender for claims that they may have against those selling manufactured homes or home improvement contractors if that entity made, arranged, or assigned the home loan.  However, any recovery by the borrower is limited to the amount necessary to extinguish the borrower’s liability under the home loan, plus costs incurred by the borrower, including reasonable attorney’s fees.

Additionally, the Act affords borrowers the right to assert claims or defenses against creditors for violations with respect to covered home loans and high-cost home loans.  However, such recovery is also limited to the amount necessary to extinguish the borrower’s liability under the home loan, plus costs incurred by the borrower, including reasonable attorney’s fees.  Additionally, while claims or defenses may be raised at any time during the term of a high-cost loan, a six-year statute of limitations, commencing at the date of closing, is imposed for covered loans.

The Act also provides that a person found to have violated the Act shall be liable to the borrower for the following:  1) for material violations, statutory damages equal to the finance charges agreed to in the home loan agreement, plus up to 10% of the amount financed, 2) punitive damages if the violation was malicious or reckless, and 3) costs, including reasonable attorney’s fees.  However, a creditor can avoid liability if they establish either: 1) that the creditor made appropriate restitution to the borrower and the appropriate adjustments to the loan within 45 days of the loan closing or 2) the borrower is notified of the violation, restitution is made to the borrower and appropriate adjustments are made to the loan within 90 days of the loan closing, before given notice of the violation by the borrower, if the violation was not intentional, and if it was a bona fide error, such as a clerical, calculation, computer malfunction and programming, or printing error.

The Act clarifies that the remedies contained therein are not exclusive remedies but rather cumulative.  Despite the fact that such violations may invoke the protections of the New Jersey Consumer Fraud Act and potential treble damages, the Department has clarified that if a borrower seeks recovery under the Consumer Fraud Act that such recovery shall be capped by the Act. Additionally, they have clarified that the Act will not permit a double recovery for the same loss. Although not addressed in the Act, it appears that the burden of establishing a violation with lie with the borrower and that a presumption of compliance will exist. 

The Act’s provisions applies to creditors, defined by the Act as “a person who extends consumer credit that is subject to a finance charge or is payable by written agreement in more than four installments, and to whom the obligation is payable at any time.”  That definition includes brokers while excluding attorneys and title insurance companies assisting in the closing. 

Additionally, the Act imposes assignee liability on high-cost loans.  The Act limits the exposure of an assignee or purchaser of any high-cost home loan if, as proven by a preponderance of the evidence: 1) there are in place at the time of the purchase or assignment of the loan, policies that expressly prohibit its purchase or acceptance of assignment of any high-cost home loan, 2) there is a requirement by contract that a seller or assignor of home loans to the purchaser or assignee represents and warrants to the purchaser or assignee that either (a) it will not sell or assign any high-cost home loan to the purchaser or assignee or (b) that the seller or assignor is a beneficiary of a representation and warranty from a previous seller or assignor to that effect and 3) the assignee or purchaser exercises reasonable due diligence at the time of purchase or assignment of home loans or within a reasonable period of time thereafter intended by the purchaser or assignee to prevent the purchaser or assignee from purchasing or taking assignment of any high-cost home loan.  The Department has provided guidance as to the safe-harbor provisions by noting that an assignee need not review each and every loan to meet the “reasonable due diligence” requirement.  However, if the loan pool is very small or if the initial review discloses a high cost loan, a more extensive review would be required to meet the “reasonable due diligence” requirement.

In addition to providing affirmative claims and defenses to borrowers, the Act sets forth a regulatory scheme enabling the Department to issue civil penalties and impose additional penalties.  The Department may impose the following sanctions if it determines that a person has violated the Act:  1) impose a civil penalty of up to $10,000 for each offense, 2) suspend, revoke, or refuse to renew a license issued by the Department, 3) prohibit or permanently remove the person violating the Act from their current position or other activities regulated by the Department, 4) issue a cease and desist order and require restitution, or 5) issue temporary restraints.  To facilitate the Department in their investigations, the Act requires that lenders maintain records concerning regulated loans and provide access to those records for examination by the Department. 

Unintended Consequences:

Despite its goal of protecting subprime borrowers, the Act threatens the existence of the subprime market.  The Act may drive subprime lenders from New Jersey given the ambiguities contained therein and the potential for unlimited assignee liability.  While it is conceded that there exist lenders seeking to take advantage of uneducated and unsophisticated borrowers, the majority of subprime lenders do not engage in such practices and fulfill the necessary role of providing funding to those who cannot obtain credit on more favorable terms.  It is feared that the benefits to be obtained from the Act will not outweigh the costs associated with lost financing opportunities for those in New Jersey who need such financing the most.

In addition to the risk of default typically associated with such borrowers, there is the added risk of the penalties imposed by the Act.  These risks taken together, and the corresponding reactions by the market, may influence lenders to invest their assets in states with more favorable lending regulations, thereby depriving borrowers in New Jersey of a potential source of financing.  The Act restrains non-predatory lending in four ways: 

  1. The Act restricts the ability of lenders to sell their loans in the secondary market,

  2. The Act increases the costs of the foreclosure process,

  3. The Act increases the risks to lenders, and

  4. The Act increases the costs of lending.

The availability of funding is dependant upon the existence of the secondary mortgage market.  The Act has the potential to eliminate the secondary mortgage market for many loans originated in New Jersey, thereby depriving lenders of an outlet to sell their loans and acquire additional funds to be lent.  Fitch and Standard & Poors, two agencies that rate loans sold on the secondary mortgage market, have already announced that they will not rate bonds backed by most loans in New Jersey.  Standard & Poors has justified this position by noting that they cannot rate those bonds without being able to quantify the risk.  It is anticipated that Moody’s, another rating agency, will follow their lead and refuse to rate similar bonds.  Moody’s has already taken that position in Georgia, whose anti-predatory lending laws are similar to the Act.  Additionally, Freddie Mac and Fannie Mae have imposed limitations on the loans that they will acquire in Georgia and New York as a result of their anti-predatory lending acts.  Given their position in these states, it is likely that they will impose similar limitations and refuse to purchase, at a minimum, high-cost home loans originated in the state.  If, however, they determine that the Act contains too many ambiguities, they may not purchase any loans originated in New Jersey, as they had done in Georgia prior to revisions to Georgia’s anti-predatory lending statutes.  The loss of this funding will result in reduced capital available for financing in New Jersey, thereby depriving borrowers of funding sources.  This unintended consequence could have far reaching effects and it is likely that remedial revisions will need to be made to the Act, just as revisions were necessary in Georgia.

The Act will also have a chilling impact on non-predatory lending in that it increases the cost of collection.  Despite its stated purpose of eliminating predatory lending, the Act also imposes the potential for additional expenses upon non-predatory lenders.  In addition to the risks set forth in the statute, there will also be increased costs to lenders in seeking recourse to their collateral.  The implementation of the Act and the surrounding publicity will encourage mortgagors in default to assert that their loan contains predatory terms in violation of the Act, even when such violations do not exist.  Such assertions may result in the filing of frivolous contesting answers in foreclosure actions.  Such answers will remove the case from the expeditious procedures of the Foreclosure Unit to the local courts which provide protracted discovery and management.  Lenders will see increased expenses in using this extended process as well as having counsel file motions for summary judgment to dispose of these claims.  In light of the fact that the counsel fees permitted to be recovered are limited by statute without consideration of the actual costs incurred, lenders will be exposed to these additional costs without the possibility of recovery from the borrower or at sheriff’s sale.  Even if these increased costs do not drive lenders from New Jersey, it is inevitable that these costs will be passed onto the consumer in the form of higher mortgage rates.

The Act also increases the risk to lenders.  As noted earlier, the Act contains ambiguities which make it difficult, if not impossible, to ascertain if a certain loan is compliant.  The Department has recognized these ambiguities and has attempted to eliminate the confusion.  However, their responses to date have not clarified the Act and, to some extent, have added additional complexity and ambiguity.   A key example is the definition of “points and fees.”  The Act defines this term by relying upon federal statutes and regulations in addition to a listing of items covered in the definition.  Each of those regulations and statutes are open to change, thereby changing the definition contained in the Act.  Additionally, there appears to be some items which are set forth in the Act as included and also excluded.  In light of the ambiguities and complexities of the Act, a lender may violate the Act despite their attempts to comply with its provisions if it is later determined that a charge should have been included in the definition of “points and fees.”  This risk is further compounded by the lack of a good faith defense in the Act.  Purchasers of loan pools are confronted with this risk on a larger scale.  In addition to the possibility that a lender attempted to comply with Act but failed due to confusion over its language, the purchaser must also assume the risk that their review of the pool may not uncover such violations or meet the “reasonable due diligence” requirements in the Act.  This increased risk has the potential of chasing lenders from New Jersey to states with more favorable lending laws. 

Compliance with the Act will result in increased costs of lending.  The Act requires that lenders establish procedures to determine if loans are covered by the Act and to insure that they do not violate the Act.  For example, lenders must analyze each refinancing transaction to determine if that loan qualifies as a covered home loan and, if it does, establish a “reasonable, tangible net benefit to the borrower.”  To require such an analysis for each loan will require that lenders increase their workforce as it will take longer to process each loan.  The Act will also require these lenders to store records of that analysis to protect themselves in the event that a violation is alleged.  Those increased costs will also be present at the secondary mortgage market level as assignees will be required to perform the same analysis on purchased loans to insure compliance by the original lender and to afford them the protections of the safe harbor provisions.  These increased costs will not be borne by the lenders but will be passed onto the consumers.

In addition to being over-inclusive and threatening to reduce the source of sub-prime funding in the state, the Act is under-inclusive in that it does not target all forms of predatory lending.  Rather than investigating the true character of a loan and determining if it contains predatory terms, the Act targets individual characteristics, not necessarily predatory in nature, which are common in predatory loans.  For example, borrowers may use a balloon payment or a negative amortization schedule to obtain a loan with the intention of refinancing once their credit rating improves.  In addition to providing credit with oppressive terms, predatory lending also encompasses those situations where a borrower who would otherwise qualify for credit on more favorable terms is targeted for higher cost loans.  The Act does not address these situations and does not provide recourse in those situations.  The inability of the Act to distinguish between truly predatory loans and those loans offered to high-risk borrowers creates uncertainty which threatens the New Jersey sub-prime market.

Finally, the Act places state chartered lending institutions at a competitive disadvantage with nationally chartered banks.  If the Act is pre-empted, as anticipated, state chartered banks will be unable to offer loans on the same terms and at the same cost as other banks.  As a result, these banks will likely lose their market share in the subprime market to nationally chartered banks.  If that occurs, the Act will not reduce predatory lending but, rather, change the characteristics of the institutions providing such loans. 

Conclusion:

The Act seeks to protect the residents of New Jersey from lenders engaging in predatory practices.  Although the Act has a noble purpose, it is questionable whether the desired goals will be achieved.  Rather, it appears that the Act may be more harmful than beneficial in that it restrains legitimate lending to those without access to prime funding.  Additionally, the Act creates a system which puts state chartered banks at a competitive disadvantage to federally chartered banking institutions.  For those lenders subject to the provisions of the Act, the ambiguities contained therein create a procedural minefield which must be navigated before they can lend money to borrowers.

In light of the ambiguities contained in the Act and the potential liability imposed therein, it is recommended that all lenders transacting business in New Jersey or investors acquiring loans originated in New Jersey consult with an attorney to insure that procedures are implemented to identify covered loans, insure compliance with the Act, and implement procedures to obtain protection under the Act’s safe harbor provisions.

 

This Article is a service of the Creditors’ Rights Department and Litigation Department of Fein, Such, Kahn & Shepard, P.C., 7 Century Drive, Suite 201, Parsippany, NJ 07960.  Phone: 973-538-4700. Website: www.feinsuch.com.  It does not constitute legal advice nor create an attorney-client relationship.  For more information contact Shareholder Alan F. Such at afs@feinsuch.com.

 

© 2003, Fein, Such, Kahn & Shepard, P.C., all rights reserved.  Permission is granted to reproduce and redistribute this article so long as (i) the entire article, including all headings and the copyright notice are included in the reproduction, and (ii) no fee or other charge is imposed.