The case of Commonwealth of Massachusetts v. Fremont Loan and Fremont General Corporation is sending shock waves throughout the mortgage industry.
In what is apparently the first case of its kind, a Massachusetts court has ordered the California-based subprime lender Fremont Investment and Loan to halt all foreclosures in the state to give officials time to review each mortgage to determine whether the loan is “structurally unfair” under the state’s lending laws.
Fremont had been ordered by the Federal Deposit Insurance Corporation last March to cease and desist from making subprime loans. The FDIC determined that the Fremont had been operating without adequate subprime mortgage loan underwriting criteria, and that it was marketing and extending subprime mortgage loans in a way that substantially increased the likelihood of borrower default or other loss to the bank.
The Massachusetts lawsuit was filed in October 2007 by Attorney General Martha Coakley, alleging that Fremont had engaged in predatory and unfair lending when it made home loans to individuals who could not afford them. Coakley called on the court to order Fremont not to proceed with any foreclosures until her office had time to review the fairness of each mortgage.
In his 29-page decision, Suffolk County Judge Ralph D. Gants agreed with Coakley that a large share of Fremont’s mortgage loans could potentially be considered “structurally unfair” under the state’s lending laws and issued a 90 day preliminary injunction against any foreclosures by Fremont.
Under the terms of the injunction, Fremont must provide the Attorney General’s Office with at least a 30-day notice of all foreclosures it intends to initiate for the approximately 2,200 loans that Fremont still owns and services, and allow the Attorney General an opportunity to object to the foreclosure going forward. If Fremont has issued a loan that is considered “presumptively unfair,” and the borrower occupies the property as his or her principal dwelling, the Attorney General has 45-days to object to the foreclosure.
The judge ruled that a loan is “presumptively unfair” if (1) The loan is an adjustable rate mortgage with an introductory period of three years or less; (2) The loan has an introductory or “teaser” interest rate that is at least three percent lower than the fully-indexed rate (the relevant index at the time of origination plus the margin specified in the mortgage note); (3) The borrower has a debt-to-income ratio (the ratio between the borrower’s monthly debt payments, including the monthly mortgage payment, and the borrower’s monthly income) that would have exceeded 50% if Fremont had measured the debt, not by the debt due under the teaser rate, but by the debt due under the fully-indexed rate; and (4) Fremont extended 100% financing or the loan has a substantial prepayment penalty or penalty that lasts beyond the introductory period.
The court found that it was unfair under Massachusetts law for Fremont to make loans where Fremont reasonably expected borrowers to default on the loans after the initial introductory interest rates adjusted. In some instances, the court noted, Fremont also offered these same borrowers 100% financing, gravely increasing the risk of default if they were unable to obtain refinancing if the market value of their homes declined. The borrowers’ risk of default was further heightened by Fremont’s substantial prepayment penalties that required borrowers to immediately obtain refinancing after their introductory rates ended.
The judge acknowledged that “the fact that Fremont’s loans bearing these four characteristics were not generally recognized to be unfair at the time these loans originated is not irrelevant to this case” and said that he “will certainly take that factor into account in determining what preliminary injunctive remedy is appropriate to address the unfairness.”
The judge further stated that “this Court emphasizes that borrowers who have received presumptively unfair loans from Fremont should not interpret this preliminary injunction to mean that they have been released from their obligation to repay these loans. They have not been given any such release. The spirit of this decision is simply that Fremont, having helped borrowers get into this mess, now must take reasonable steps to help them get out of it.”
Attorney General Coakley praised the judge’s decision and said that the injunction would allow some borrowers to renegotiate their loans; and if they cannot afford their home, it gives them time to find alternative housing.
“This decision shows again that in many cases, irresponsible and unlawful lending practices caused this foreclosure crisis,” Coakley said. “We intend to hold accountable those who allegedly engage in unlawful lending conduct.”
The mortgage industry obviously does not share Coakley’s view. The case is now on appeal before the Massachusetts Appeals Court and both the American Financial Services Association and the Mortgage Bankers Association are among those who have filed briefs asking the higher court to overturn the injunction, calling it a “breathtaking usurpation of the legislative role.”