The waves of mortgage foreclosures rolling across the country have affected millions of homeowners, and have led to increased awareness of the risks of subprime lending. The current foreclosure crisis also has led to a rise in unscrupulous businesses attempting to prey upon distressed homeowners.
While many reputable businesses and organizations exist to help homeowners avoid foreclosure, many companies offering to save homeowners from foreclosure are nothing more than sharks. These would-be rescuers often use deceptive or deliberately coercive tactics in extending home equity loans or mortgage refinancing strategies.
That's why predatory lending is against the law. In fact, there are numerous federal statutes intended to protect distressed homeowners against it. In addition, many states, including Minnesota, have their own anti-fraud protections, and many also have particular prohibitions against equity stripping.
For these federal and state protections to apply, there must be a workable definition of what tactics are prohibited. So how are "predatory lending" and "equity stripping" defined in Minnesota?
Federal protections against predatory lending begin with a veritable alphabet soup of legislation, including TILA, HOEPA and RESPA.
Congress passed the Truth in Lending Act (TILA) in 1968 as part of a broader Consumer Protection Act. TILA gives a homeowner a right to rescind a loan secured by his or her primary residence. This can include home equity loans, home improvement loans, and refinances.
The Home Ownership and Equity Protection Act (HOEPA) is an amendment to TILA. It requires lenders to make additional disclosures to borrowers, such as the annual percentage rate (APR), at least three days before the loan closes.
Still another protection in federal law is the Real Estate Settlement Procedures Act (RESPA). This law requires lenders to fully disclose all costs and fees related to the loan. Borrowers are entitled to challenge any illegitimate or undisclosed fees, including kickbacks and dubious referral fees.
Violations of these statutes can allow the borrower to rescind the transaction in its entirety, if the transaction involved the borrower's primary residence.
In 2004, Minnesota passed one of the first laws in the country prohibiting "equity stripping" through foreclosure rescue schemes. Over a dozen states have followed the Minnesota model by passing similar legislation.
This legislation addresses the reality that a supposed foreclosure rescue can quickly turn into a nightmare. The rescue scheme may allow the homeowner to remain in the home temporarily, but only at the risk of losing the house entirely in the future. As an example, a common strategy is to buy out the existing mortgage (which allows a period for the homeowner to reinstate or redeem the mortgage and end foreclosure) with a contract for deed. The contract for deed provides little protection for the homeowner, who can end up losing all right to the house if any payments are missed. Also, the refinancing to pay off the existing mortgage serves to strip all (or virtually all) of the equity the homeowner had built up in the house. That equity is taken by the new lender (the company or individual providing the money to pay off the existing mortgage).
Minnesota's equity stripping laws are based on establishing the fundamentals of fair transactions: sufficient disclosure, no excessive fees, and ability to pay. These requirements are buttressed by other laws against fraud and deceptive trade practices, as well as by Truth in Housing requirements and other federal laws.
Two Recent Minnesota Cases
Two recent cases in Minnesota show the kind of conduct that the predatory lending and equity stripping laws are intended to prohibit, as well as how the protections can work.
On September 17, in Hartman v. Smith, the U.S. District Court in Minnesota reaffirmed the existence of equitable mortgages in Minnesota. An equitable mortgage is a transaction that purports to convey title to real estate (like an outright sale) but actually was intended by the parties as an alternative method of financing. The courts inquire into the real purpose of the transaction in recognizing an equitable mortgage in order to prevent one party from unfairly exploiting another in a complicated transaction.
The court ruled in Hartman that the transaction had been intended as a financing method, rather than as an outright sale or transfer of the property. As a result of the Court finding that the transaction had been an equitable mortgage, many of the statutory protections against predatory lending applied to the transaction, including the disclosures required by TILA and HOEPA.
However, in Hartman, the plaintiffs (a married couple) had conveyed the property to their daughter, which undercut their ability to make HOEPA claims, as the property was no longer their principal dwelling.
Two weeks after the federal court decided Hartman, an Anoka County jury decided that a woman had been the victim of a fraudulent or predatory mortgage foreclosure rescue scheme. Seeking to save her house from foreclosure, Sandra Gustafson had turned to a firm named Midwest Equity Consultants for a loan. In return for payment of the mortgage in foreclosure, Ms. Gustafson conveyed her house to Midwest Equity Consultants, who then re-conveyed it to her on a contract for deed. Midwest Equity Consultants stripped the house of the equity Ms. Gustafson had built. Ultimately, Ms. Gustafson failed to make a payment when due, and Midwest Equity Consultants sought to evict her from the house.
At trial, the jury found that the transaction had violated Minnesota's equity stripping laws, and that Gustafson was entitled to rescission of the transaction. Interestingly, Midwest Equity Consultants had been involved in both the Hartman and Gustafson cases.
The two recent cases discussed in this article help to clarify how prohibitions on predatory lending and equity stripping apply to foreclosures and mortgage refinancing strategies.
If you are involved in a real estate transaction and have legal questions, get the trusted advice you need. Contact an experienced real estate attorney.