Legislative Update -- General Assembly Continues to Address Issues of Residential Lending & Mortgage-Related Fraud
Article Date: Tuesday, February 15, 2011
Written By: Donald C. Lampe & Meredith J. McKee
Residential lending and mortgage-related fraud continued to be high-priority issues for North Carolina’s General Assembly during the 2010 short session. Responding to the historically high incidence of foreclosures, lawmakers extended 2008’s emergency foreclosure-prevention act for 30 months, expanded its reach beyond just “subprime” mortgages, and adopted additional anti-foreclosure protections for members of the United States military. The General Assembly also enacted a host of new regulations to stem mortgage- and foreclosure-related fraud, revised existing regulations for “high-cost home loans,” and increased fees for registrants under the S.A.F.E. Act.
Emergency Act Extended
For residential mortgage lenders and servicers, the most significant legislation adopted this year related to 2008’s emergency foreclosure-prevention act, which had been set to expire this year. Through Session Law 2010-168, the General Assembly extended the Act and expanded its requirements.
The Emergency Program to Reduce Home Foreclosures Act, which took effect on Oct. 1, 2008, originally was targeted to provide short-term foreclosure relief for so-called “subprime” borrowers. The Act, then, was aimed at borrowers who had received mortgages below Fannie Mae’s conforming loan size limit that exceeded certain interest rate thresholds. The Act required loan servicers to send a qualifying borrower a pre-foreclosure notice, at least 45 days before filing a notice of hearing in a foreclosure proceeding, to advise the borrower of available foreclosure-prevention resources. The notice had to list all past-due amounts and any other payments required to bring the loan current.
The 2008 Act also required foreclosing lenders to report information about the borrower, loan and pre-foreclosure notice to the Administrative Office of the Courts. The Commissioner of Banks was instructed to use this information in its “State Home Foreclosure Prevention Project” to identify borrowers with a “reasonable prospect to avoid foreclosure,” and to facilitate loan modifications and workouts.
As the title suggests, however, the 2008 law was an “emergency” act and therefore was limited in duration. The Act was set to last just two years, by which time, everyone hoped, most “bad” loans would have worked their way out of the system and foreclosures would be tapering off.
Unfortunately, that is not what happened. Based on data maintained by the Administrative Office of the Courts, in 2009 there were 63,282 foreclosure “starts” in North Carolina. In 2010, instead of declining, that number increased to 67,854.
Confronted this year with an increased incidence of foreclosures, the General Assembly decided to extend the Emergency Program to Reduce Home Foreclosures Act for an additional two-and-a-half-year period (until May 31, 2013).
The General Assembly also decided to expand its reach, removing the original limitations that restricted the pre-foreclosure notice and reporting requirements to so-called “subprime” home loans. Now mortgage servicers are required to send the same notice before pursuing a foreclosure on any residential mortgage, regardless of what interest rate the loan carries. By the same token, servicers are required to file information regarding each contemplated foreclosure with the Administrative Office of the Courts, regardless of whether the loan would have qualified as a “subprime” mortgage under the prior version of the Act.
The mandate for the State Home Foreclosure Prevention Project has been expanded as well. The Project now has a legislative mandate to “seek solutions to avoid foreclosures for home loans,” as opposed to just those meeting the “subprime” criteria.
A requirement that servicers pay a $75 fee each time they make the required pre-foreclosure filing with the Administrative Office of the Courts is new. These fees are being used to create a “State Home Foreclosure Prevention Trust Fund” to pay for various foreclosure-prevention efforts.
The Fund is being divvied up as follows: First, $2.2 million per year or 30 percent of the Fund (whichever is greater) must be used to pay for the Foreclosure Prevention Project itself. Second, $3.4 million per year or 40 percent (whichever is greater) must be used to fund foreclosure-prevention counseling provided by nonprofit agencies. The remaining 30 percent of Fund assets will be used to compensate nonprofit legal service providers for services supplied to homeowners in default or in danger of defaulting.
Servicemembers on Active Duty Protected From Foreclosures
During the 2010 short session, the General Assembly also supplemented the already broad federal protections against foreclosure that exist for members of the United States military. Lenders and trustees now are prohibited under state law from exercising any contractual “power of sale” provisions to effectuate a foreclosure during a borrower’s military service or within 90 days thereafter.
The impulse to protect servicemembers from civil litigation during times of active service can be traced back more than a century. Broad protections were adopted during periods of warfare, starting with the Civil War. Up until World War II, however, those protections had been permitted to lapse during peacetime. That changed when the federal Servicemembers Civil Relief Act (50 U.S.C. App. § 501, et seq.) was enacted in 1940 as the United States stood on the precipice of World War II. Although frequently amended over the years, it has never been permitted to expire.
As currently drafted, the Servicemembers Civil Relief Act (popularly known as “SCRA”) protects servicemembers against certain civil obligations, as well as collection proceedings, garnishments, attachments, evictions, judicial foreclosures, and certain civil judgments, during and for a brief period after times of active service. Most financial institutions are familiar with SCRA’s provisions and have designed their compliance procedures accordingly.
But due to the confluence of foreclosure rates in the United States and the increase in armed conflict, SCRA has received significant recent attention. The Act has been revised at the federal level numerous times in the last decade, and some states have enacted legislation to supplement its protections.
North Carolina’s Session Law 2010-190 (“An Act to Prohibit Foreclosures While Mortgagors or Trustors Are on Active Military Duty”) was adopted to complement SCRA’s provisions pertaining to non-judicial foreclosures. It relates specifically to foreclosures completed under the “power of sale” provisions that appear in most of North Carolina’s residential mortgages.
The new language, appearing in Article 2A (“Sales Under Power of Sale”) of Chapter 45 of the North Carolina General Statutes, expressly prohibits trustees and lenders from exercising any power of sale during a borrower’s period of military service, or within 90 days thereafter.
The definition of “servicemembers” to whom these protections apply might surprise those who are unfamiliar with SCRA. The prohibition extends not only to members of the Army, Navy, Marine Corps, Air Force, Coast Guard and National Guard, but also to the commissioned corps of the Public Health Service and National Oceanic and Atmospheric Administration.
Periods of “military service” are defined differently for separate braches of the armed forces. For members of the Army, Navy, Air Force, Marine Corps and Coast Guard, “military service” is the same as “active duty,” as that term is defined in 10 U.S.C. § 101(d)(1).
For the National Guard, “military service” includes any active service in excess of 30 consecutive days that is authorized by the President or Secretary of Defense pursuant to 32 U.S.C. § 502(f) for purposes of responding to a national emergency. For a servicemember from the Public Health Service or the
National Oceanic and Atmospheric Administration, “military service” is simply active service.
While the protections set forth in Session Law 2010-190 apply only to servicemembers, the effect of the law is to create new compliance requirements applicable to all foreclosures. The clerk of court is prohibited from conducting a foreclosure hearing pursuant unless the mortgagee or trustee has certified in writing that the hearing will not occur during the borrower’s military service or within 90 days thereafter.
Under existing procedures, a mortgagee or trustee attempting to exercise a power of sale was required to give interested parties notice of the foreclosure hearing. That notice now must include an advisory stating that the foreclosure may be prohibited by North Carolina law if the debtor is currently on military duty. This additional disclosure is intended to give servicemembers and their dependents notice of the new protections and an opportunity to invoke them.
These provisions took effect Jan. 1, 2011, and apply to foreclosures initiated on or after that date.
General Assembly Takes On Mortgage-Related Scams
After focusing its regulatory energy for the past several years on mortgage origination and foreclosure prevention, in 2010 the General Assembly also turned its attention to mortgage-related scams. The new Homeowner and Homebuyer Protection Act (Session Law 2010-164) targets three different types of transactions increasingly associated with fraud.
The first is a foreclosure-rescue scam, where a homeowner who has defaulted on his mortgage is told that he can prevent or postpone foreclosure by selling his home to a third party. That third party, the buyer, pays far less than market value but promises to allow the seller to continue living in the home. As a result of the transfer of title, however, the seller loses most (if not all) of the equity built up in his home and often finds himself in serious trouble with his lender.
Session Law 2010-164 tries to put a stop to such scams by making it unlawful under Chapter 75 of the North Carolina General Statutes to participate in a “foreclosure rescue transaction” unless the homeowner is paid at least 50 percent of the fair market value of the property. The law also requires that the agreement be reduced to a writing that includes certain specified information.
To qualify as a “foreclosure rescue transaction” subject to these regulations, the sale must meet four elements: (i) the sale must involve the seller’s principal residence; (ii) the seller must be in default (e.g., more than 60 days delinquent) or in a foreclosure proceeding; (iii) the buyer, his agent or others acting in concert with him must represent to the seller that the transaction will prevent or postpone foreclosure and allow him to remain in the residence; and (iv) the seller must retain some interest (usually a tenancy interest of some kind) in the property conveyed. Exceptions exist for transactions between immediate family members, and for sales to government agencies, mortgage lenders, and certain financial institutions.
The statute expressly states that the homeowner himself does not violate the statute by engaging in an illegal transaction. For all other participating parties, however, the transaction qualifies as an unfair trade practice pursuant to N.C. Gen. Stat. § 75-1.1 and can be voided (except against a bona fide purchaser for value).
The second practice targeted by lawmakers this year is one where a property owner leases a home to a renter and also sells the renter an “option” to purchase the property in the future. The renter pays a hefty “option” fee at the front-end of the transaction but later discovers, when he tries to exercise the option, that the property owner is unable to convey clear title. Or the renter may be evicted after being late with just one or two rental payments, forfeiting the option payment and the right to purchase the property.
The General Assembly has attempted to prevent abusive lease/option transactions by, among other regulations:
• requiring that the terms of any lease/option contract be put in writing and recorded;
• granting the purchaser of the option the right to cancel the contract within three business days of execution;
• granting the purchaser the right to cure a default once during every 12-month period throughout the lease agreement; and
• prohibiting forfeiture of the option to purchase until written notice of default and a right to cure has been given.
Any violation of these restrictions, which appear in Chapter 47G of the North Carolina General Statutes, constitutes an unfair trade practice in violation to N.C. Gen. Stat. § 75-1.1.
The third category of transaction addressed by the General Assembly are installment contracts for the purchase of real property. Problems arise where a purchaser agrees to pay for real property in installments but does not receive title until the last payment is made. Contracts for these types of sales are frequently short on details, and buyers who are late on even one payment may lose everything. Some buyers may also learn, upon paying the final installment, that the seller is unable to convey clear title to the property.
The new regulations apply only to contracts for the purchase of an interest in property involving five or more installment payments (exclusive of the down payment), where the seller retains title to the property as security for the buyer’s obligations. Qualifying installment contracts must, among other requirements:
• be reduced to writing and recorded;
• grant the purchaser the right to pre-pay the outstanding balance at any point;
• disclose to the buyer certain facts about the condition of the property, outstanding liens or deeds of trust, and pending orders or matters of public record that would adversely affect the property;
• grant the buyer a three-day right to cancel the contract; and
• give the buyer notice and a right to cure any default before the contract can be terminated.
Sellers also must provide periodic account statements and cannot charge excessive late fees.
Violations of these regulations, which appear in a new Chapter 47H, are actionable as unfair trade practices under North Carolina law.
Home Loans Subject to “High-Cost” Regulations Expanded
This year, the General Assembly also tweaked the standards used to define which loans may be regulated as so-called “high-cost home loans.” These changes took effect Sept. 1, 2010, and were enacted through Session Law 2010-168.
N.C. Gen. Stat. § 24-1.1E, which was created in 1999 as part of North Carolina’s predatory lending law, defines which loans are subject to special “high cost home loan” regulations. A loan qualifies as a “high cost home loan” if it meets any one of three tests. The first test is based the loan’s annual percentage rate, the second on the “points and fees” charged at closing, and the third on any pre-payment penalties included in the terms of the loan.
Session Law 2010-168 made two revisions to the second test. First, the General Assembly lowered the threshold at which the “points and fees” paid at closing will trigger the high-cost home loan regulations. While before the “points and fees” paid at closing had to exceed five percent of principal in order for a loan in excess of $20,000 to earn the “high cost” label, that threshold has been lowered to four percent.1 For a loan under $20,000, the threshold remains the lesser of $1,000 or eight percent. See N.C.G.S. § 24-1.1E(a)(6).
The General Assembly also modified the definition of “points and fees.” Now, up-front fees in excess of 1.25 percent of the loan amount that are paid to the Federal Housing Administration, the Veterans’ Administration, or the U.S. Department of Agriculture to insure or guarantee a loan can be excluded from the calculation. Up-front private mortgage insurance premiums that exceed 1.25 percent of the loan amount also can be excluded in certain cases. While the first change (reducing the “points and fees” trigger from five percent to four percent) will pull more loans into the “high cost” bucket, the second change should help prevent loans from being pushed into this category simply because the cost to guarantee repayment increased with the economic downturn.
Fee Increases for S.A.F.E. Act Registrants
Finally, Session Law 2010-168 included relatively minor revisions to the North Carolina Secure and Fair Enforcement (S.A.F.E.) Mortgage Licensing Act. Adopted in 2009, the S.A.F.E. Act brought North Carolina’s licensing of mortgage originators in line with a federal bill passed in 2008, which created a national registry for loan originators. The hope was that a standard national licensing process would reduce mortgage fraud, increase the qualifications of those making loans and protect consumers.
Pursuant to the 2008 S.A.F.E. Act, loan originators operating in North Carolina were required to register with the Nationwide Mortgage Licensing System (“NMLS”), submitting a credit report, criminal record, and information on any civil judgments entered against them. Originators also were required to submit fingerprints for a criminal background check and to pass a written exam (with state and federal components). Applicants who satisfy these requirements receive a unique identifier, which follows each licensee throughout his or her career.
The revisions to the S.A.F.E. Act made during the 2010 short session were relatively modest, aimed at increasing various fees assessed in connection with the licensing system. For example, the fee for mortgage brokers and loan branches has increased from $125to $300. The annual renewal fee for loan originators is now $125, instead of $67.50.
The General Assembly also empowered the Commissioner of Banks to begin collecting an “administrative processing fee” of up to $75 for changes made by North Carolina licensees in the National Mortgage Licensing System. Changing a licensee’s address, name, or other basic information may require payment of this fee.
1. Remember, however, that a loan exceeding any of the three thresholds set forth in N.C.G.S. § 24-1.1E(a)(6) is a “high-cost home loan.” For that reason, even when the “points and fees” paid at closing do not exceed this four-percent threshold, a loan could still qualify as “high cost” based on its annual percentage rate or pre-payment penalties.
Donald C. Lampe and Meredith J. McKee are members in the Charlotte office of Womble Carlyle Sandridge & Rice, PLLC. Mr. Lampe is a member of the Firm’s Regulatory Compliance and Consumer Credit Practice Team. Ms. McKee is a member of the firm’s Consumer Financial Services Litigation Team.
Views and opinions expressed in articles published herein are the authors' only and are not to be attributed to this newsletter, the section, or the NCBA unless expressly stated. Authors are responsible for the accuracy of all citations and quotations.