Massachusetts v. Fremont: Predatory Lending and the Creation of an Extraordinary Ex Post Facto Suitability Standard
| Author | Wayne van Rooyen |
| Position | Junior staff member of the school’s Journal of Gender, Social Policy & the Law |
| Pages | 13 |
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Wayne van Rooyen is a 2010 J.D. candidate at American University Washington College of Law. He is also a junior staff member of the school’s Journal of Gender, Social Policy & the Law.
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On October 4, 2007, Martha Coakley, Attorney General for the Commonwealth of Massachusetts, filed suit against subprime mortgage lender Fremont Investment & Loan and its parent company Fremont General Corporation (“Fremont”).1 The suit alleged that subprime loans Fremont originated violated Massachusetts’ consumer protection statute and the spirit of Massachusetts’ Predatory Home Loan Practices Act because the lender ignored the homeowners’ inability to repay their mortgages.2 The Massachusetts Superior Court agreed and ordered Fremont to discontinue foreclosure on any loans that were “presumptively unfair” and ordered the lender to renegotiate the loan terms with struggling borrowers thereby creating an extraordinary ex post facto suitability standard.
A suitability standard can be defined as an appropriateness test wherein a lender assesses the borrower’s ability to repay the loan the borrower is offered. Suitability standards were not used in the mortgage industry until after the enactment of the Home Ownership and Equity Protection Act of 1994 (“HOEPA”), which amended the Truth in Lending Act to protect borrowers of high-cost subprime loans.3 HOEPA, however, was largely ineffective at preventing predatory lending because very few sub-prime loans triggered its provisions.4 In an effort to close these gaps, individual states began enacting their own anti-predatory lending laws that included suitability standards, but most of these state laws would later be preempted by federal banking laws.5 In the wake of the subprime crisis, there has been resurgence in anti-predatory lending laws and related suitability standards.
Both the federal government and state governments have responded to the subprime crisis with legislation incorporating suitability tests. The federal government’s response includes a number of legislative proposals that create additional guidelines for mortgage loan underwriting, most of which require lenders to assess the borrower’s ability to make his/her mortgage repayments.6 States have also responded by creating new lending laws or amending their predatory lending laws to include some type of suitability standard.7 For example, Minnesota’s new mortgage originator statute requires a suitability test and prohibits providing loans that have no tangible net benefit to the borrower.8 While Massachusetts’ consumer protection law did not previously include a suitability standard, new amendments created a defined suitability standard for all loans and not just the high-cost loans that the Predatory Lending Home Practices Act regulates.9
Suitability standards were not used in the mortgage industry until after the enactment of the Home Ownership and Equity Protection Act of 1994 (“HOEPA”), which amended the Truth in Lending Act to protect borrowers of high-cost subprime loans.
Another consequence of the subprime mortgage crisis has been an increase in subprime suits in which the plaintiffs argue for bench-made appropriateness tests.10 In June 2008, Illinois challenged the lending practices of Countrywide Mortgage Corporation (“Countrywide”) as violating its unfair and deceptive practices laws.11 The Illinois Attorney General argued thatPage 60 Countrywide’s expansion in its effort to securitize mortgages forced the lender to lower its underwriting standards which resulted in borrowers obtaining loans for which they were not qualified. The State of California and the City of San Diego have also independently filed suit against Countrywide making suitability claims that the lender was deceptive in originating loans that it knew its borrowers could not afford.12
The Massachusetts Superior Court held that Fremont’s loans were “presumptively unfair” if they met all four of the following conditions: 1) the loan included a two or three-year adjustable rate; 2) the introductory rate was more than three percentage points lower than the fully indexed rate to be paid after the introductory rate expired; 3) the borrower’s debt-to-income ratio exceeded fifty-per-cent at the time of the loan if the debt was measured by the fully indexed rate; and 4) if the loan-to-value ratio was 100 percent, or if the loan carried a substantial prepayment penalty or a prepayment penalty that extended beyond the usual prepayment period.13 Because it used specific provisions as a threshold, the Massachusetts court has fashioned a standard more closely analogous to the requirements of a state, high-cost mortgage law.
High-cost mortgage laws were introduced to prevent predatory lending by triggering a suitability test if the thresholds were met or exceeded. In Fremont, once the requirements were met, the court then correctly shifted the burden to Fremont to show that the loans the company originated were not unsuitable for the individual borrowers.14 The Fremonttest, however, is dissimilar to general mortgage suitability standards, which are more akin to Minnesota’s recently enacted requirement that a lender make a specific inquiry into a borrower’s ability to repay their loans.15 Usually suitability tests are a one-step test in which the lender evaluates a borrower’s ability to repay a loan, whereas the Fremont test is a multipart test that first looks to the terms of the loan and then the borrower’s ability to repay.
The first, second, and fourth prongs of the Fremonttest share some similarities with various threshold tests established in high-cost loan statutes.16 A loan is classified as presumptively unfair if, under the first prong, the loan is an ARM with an introductory period of three years or less.17 Under the Massachusetts Predatory Lending Home Practices Act, an ARM that has an interest rate eight percent above the yield on United States Treasury securities with comparable maturity period as the mortgage is designated a high-cost loan.18 Only after this threshold is met is the lender required to make a suitability determination. North Carolina uses a similar calculation to regulate its rate-spread mortgages but only allows a three percent difference between the loan rate and the U.S. Treasury yield. Rate-spread mortgages also trigger North Carolina’s suitability test, which requires a reasonable presumption of the borrower’s ability to pay.19
The second prong labels a loan as presumptively unfair when the introductory interest rate is at least three percent lower than the fully indexed rate.20 The Predatory Home Loan Practices Act does not include a similar provision. Like North Carolina’s predatory lending statute, Massachusetts’ law provides that the lender must use the rate after the introductory rate has expired to measure if the loan qualifies as a high-cost loan.21
The fourth prong of the Fremonttest classifies a loan as presumptively unfair, when the loan-to-value ratio is 100 percent, or the loan carries a substantial prepayment penalty or a prepayment penalty extends beyond the introductory period.22 The Predatory Home Loan Practices Act does not reference loan-to-value calculations, but like North Carolina’s rate-spread loan law, bars all prepayment penalties for high-cost loans.23 Illinois uses a novel approach that requires, for any type of mortgage, a borrower must first decline a loan without a prepayment penalty before accepting a loan with a prepayment penalty.24 Illinois further sets a sliding scale for prepayment penalties that is capped at three percent of the total loan amount.
Prong three of the test articulated in Fremontis a true suitability test that is nearly identical to Massachusetts’ own high-cost lending laws, as well as other states’ predatory lending laws.25 This is the only prong that could stand alone as a suitability test, but here it is used as another threshold test.26 Together with the other tests, the third prong creates a line that if crossed, requires the loan to be ruled as unsuitable.27 This provision is phrased similarly to Massachusetts’ Predatory Home Loan Practices Act suitability test, which also uses fifty-percent as the limit for an acceptable debt-to-income ratio. Both North Carolina and Illinois set a fifty-percent threshold for affordability of high-cost loans as well.28 The Fremontdecision/holding is unusual because all three states’ high-cost loan statutes require this affordability test to be applied only after determining that a loan is high-cost while Fremont applies the tests simultaneously.29
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While Fremont’s mortgages were legal at the time of their respective originations, it is evident that the lenders engaged in a clearly orchestrated plan to originate loans it knew borrowers could not repay.
It was necessary for the court in Massachusetts v. Fremont to apply a retroactive suitability standard because it was the best possible method to find that Fremont’s loans were unfair...
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