PREDATORY LENDING AND BROKERING PRACTICES

PREDATORY LENDING AND BROKERING PRACTICES

Background

“Predatory Lending” is a general term used to describe abusive lending practices by some depository
institutions, licensed creditors/lenders, and by some MLBs viewed as “preying” on unsophisticated
consumers/borrowers. The U. S. Congress and the California legislature have each acted to address these
practices through the introduction of legislation that has added substantial new law regarding the making and
arranging of residential mortgage loans with the primary focus on owner occupied dwellings. In addition, new
federal regulations have been adopted as guidance for lenders and MLBs/MLOs when engaged in the making
and arranging of alternative mortgage instruments or non-traditional mortgage products. “Redlining” of certain
neighborhoods and communities was among the practices considered to be unacceptable.

In this section, the term “lender(s)” are the persons or entities that regularly make loans and whose names
appear on the promissory notes as the initial payee or that meet a defined status, when the mortgage loans are
subject to the Real Estate Settlement Procedures Act (RESPA) implemented through Regulation X, as well as
other applicable federal law. Regulation X is found in 24 CFR Section 3500 et seq. The term “creditor(s)” are
the persons or entities that, among other defined responsibilities and reporting obligations, extend credit to
consumers/borrowers in transactions subject to the Truth-In-Lending Act (TILA). Accordingly, the federal
definition is two-pronged, i.e., the “creditor(s)” for the purpose of making disclosures and delivering notices of
rights pursuant to TILA and “lender(s)” that regularly make loans and whose names appear on the promissory
notes as the initial payees and on the security devices/instruments as the beneficiaries/lenders/mortgagees.

California and Federal Legislation

The first effort to address predatory lending practices was accomplished by the California Legislature in 2001.
This legislation is now commonly known as the Predatory Lending Law and is found in Financial Code Section
4970 et seq. This law became operative on July 1, 2002. During the same period, the U.S. Congress and the

FRB pursued amendments to TILA found in 15 USC Section 1601 et seq. and in Regulation Z, 12 CFR Section
226 et seq. On December 20, 2001, the FRB issued final amendments to Section 226.32 of Regulation Z and to
the related “Commentary”. Creditors/lenders were required to comply with these amendments on October 1,
2002, commonly known as “Section 32” or the “High-Cost Loan Law”.

The aforementioned state law limited or controlled specific loan terms and added prohibited conducts by
creditors/lenders and MLBs in connection with consumer loans defined to be secured by the borrower’s
principal dwelling. The federal law amendments added disclosures to consumers/borrowers in loan transactions
where the security property is an owner occupied dwelling (as defined).

Federal Regulations

As previously mentioned, the Office of the Comptroller of the Currency (OCC); the Board of Governors of the
Federal Reserve System (Fed or FRB); the Federal Deposit Insurance Corporation (FDIC); the Office of Thrift
Supervision (OTS); and the National Credit Union Administration (NCUA); (collectively the Agencies)
published the, “Interagency Guidance on Non-Traditional Mortgage Product Risks,” November 7, 2006, which
became effective November 14, 2006. The same Agencies issued the, “Statement on Subprime Mortgage
Lending”, which became effective June 29, 2007.

The Guidance and the Statement were adopted by state regulators of banking (depository institutions), licensed
lenders, and of MLBs, including the Commissioner of the DRE (Business and Professions Code Section
10240.3). Accordingly, these documents/regulations had a sweeping affect on mortgage lending and brokering
(as well as severely limiting the secondary market for alternative mortgage instruments and non-traditional
mortgage products) throughout the entire country, including the terms available for residential loans.
Limitations and prohibitions on certain conducts by creditors/lenders and MLBs were imposed through these
documents/regulations.

Redlining

The aforementioned “redlining” practices by creditors/lenders and MLBs have been outlawed. The practices
defined as a violation of applicable law included creditors/lenders and MLBs drawing lines on maps around
areas within neighborhoods and communities in which lending and brokering activities did not occur (i.e.,
creditors/lenders and MLBs refused to make or arrange residential mortgage loans, as defined). This past and
unlawful practice of “redlining” was replaced by a much bigger problem of “reverse redlining”.

Reverse redlining involves targeting these previously underserved areas that were occupied by residents and
tenants who were often members of lower socio-economic classes or who were members of racial and ethnic
minorities (as well as recent immigrants). A catalyst for targeting these previously underserved areas was the
federal Community Reinvestment Act that was amended and expanded in 1999 by the Gramm-Leach-Bliley
Act.

The occupants of these geographic areas were generally less knowledgeable about loan programs and the
lending process and were typically uncertain or afraid to assert their legal rights, even in instances where it
appeared they were taken advantage of by creditors/lenders and MLBs (who failed to appropriately perform
their disclosure duties and related obligations, including the fiduciary duties owed to consumers/borrowers by
MLBs). Because of the reverse redlining, the individuals residing in these geographic areas became targets for
abusive lending and brokering practices.

Consumer/Borrower Abuses by Creditors/Lenders and MLBs

These practices involved unlawful tactics such as fraud, deceit, misrepresentation or deception, and unfair
business practices that may otherwise not be unlawful; but were unethical and, if pursued by MLBs, resulted in
breaches of fiduciary duties owed to consumers/borrowers. Inducing consumers/borrowers to repeatedly
refinance the mortgage loan secured by their principal residences and charging high rates and fees each time
(sometimes referred to as “churning”) is an example of the unfairness cited by the Federal Reserve System in
their background commentary for the Home Ownership and Equity Protection Act (HOEPA), the “High-Cost
Loan Law”. This “churning” practice is patently unfair and unethical, particularly when no demonstrable
benefit from the refinance inures to the consumer/borrower (such as improving the rate and terms as the
borrower’s credit worthiness and financial standing improves), i.e., the refinance was not in the interest of
consumers/borrowers.

As previously discussed in this section, federal and state legislation was enacted and regulations were adopted
in an effort to curb predatory practices. These regulations expanded regulatory oversight of what are described
as “High-Cost Loans” or “Higher-Cost or Priced Loans”. Until a California Supreme Court decision struck
down the City of Oakland’s Predatory Lending statute in favor of regulation at the state and federal level, some
cities and other local political subdivisions had adopted or considered adopting their own predatory lending
statutes. In the previously mentioned case, the court held California through its state legislation had occupied
the field and that any local ordinance was preempted thereby.

“High-Cost Loans” – An Overview of Sections 32 and 35

Federal legislation was enacted to regulate predatory lending practices pursuant to the aforementioned HOEPA
in Section 226.32 in Regulation Z where the regulations were promulgated to implement the amendments to
TILA (as mentioned, commonly known as Section 32). In addition, the Federal Higher Cost Mortgage Loan
Act, commonly referred to as Section 35, was adopted by Congress. Section 226.35 in Regulation Z of TILA is
where the regulations were promulgated implementing this law (15 USC Section 1601 and 12 CFR Sections
226.32 and 226.35).

In “High-Cost Loans” (Section 32), the interest rate threshold is determined by comparing the Annual
Percentage Rate (APR) with United States Treasury Securities of a comparable maturity. The APR is the
effective mortgage loan interest rate, which includes fees and charges considered prepaid finance charges, as
defined (12 CFR Section 226.4 (a)(b)). For first or senior deeds of trust or mortgages, if the difference in the
APR exceeds the rate of comparable Treasury Securities by 8% or more, then the APR has met one of the two
defined thresholds for a “High-Cost Loan”. For second or junior loans, the APR threshold is 10% over
Treasury Securities of comparable maturities.

The second of the two tests is whether the defined points and fees (including compensation paid to MLBs)
exceeds a threshold equivalent to 8% or more of the “net” loan amount (after deduction of the qualifying
prepaid finance charges, except for the prepaid interest represented by the initial partial month’s interest
proration imposed at the time of loan closing). If either the APR based test or the fee based test is met or
exceeded, then the mortgage loan is considered a “High-Cost Loan” for purposes of applying HOEPA.

“Higher-Cost/Priced Loans” (Section 35) are defined for federal purposes as a consumer credit transaction
secured by the consumer/borrower’s principal dwelling with an APR that exceeds the average prime offer rate
for a comparable transaction as of the date the interest rate is set on the subject mortgage loan. When the
subject mortgage loan is a first or senior encumbrance, the applicable APR that triggers Section 35 is set at
1.5% or more than the applicable prime offer rate. If the loan is a second or junior encumbrance, the applicable
APR that triggers Section 35 is set at 3.5% or more than the applicable prime offer rate. The applicable prime
offer rate is the average prime offer rate for conventional loans.

The average prime offer rate means an APR that is derived from average interest rates, points, and other loan
pricing terms currently offered to consumers by a representative sample of creditors/lenders for mortgage loan
transactions (including compensation paid to MLBs) that have low-risk pricing characteristics. The Federal
Reserve Board (FRB) publishes average prime offer rates for a broad range of types of transactions including
conventional mortgages in a table updated weekly known as the H15 Statistical Release
(http://www.federalreserve.gov/releases/h15/update/). Key issues included in Section 35 require
creditors/lenders to not extend credit solely based on the value of the consumer/borrower’s collateral without at
the same time considering the consumer/borrower’s ability to repay the mortgage loan debt service.

In addition, prepayment penalty fees are regulated and escrow (impound) accounts must be established by
creditors/lenders to provide for the monthly collection of sufficient sums for the future payment of property
taxes and property and casualty and other mortgage related insurance coverage when the property taxes and the
premiums for such coverage become due and payable. These escrow (impound) accounts are established by
creditors/lenders or by their servicing agents on behalf of consumers/borrowers in such loan transactions.

These federal and state laws to prevent creditors/lenders and MLBs from engaging in predatory practices will
be discussed further in this Chapter. MLBs/MLOs are well advised to familiarize themselves with each of these
laws, including implementing regulations, as the remedies include rescission of the mortgage loan, actual and
punitive damages, attorney’s fees and costs, license revocation or suspension, possible exclusion from the

mortgage and other real estate related industries for specified periods, and in some circumstances criminal
penalties. MLBs/MLOs should seek the advice of knowledgeable legal counsel prior to engaging in residential
mortgage loan transactions when the intended security property is the owner occupied dwelling of the
consumer/borrower.

California “High-Cost Loans” – “The Covered Loan Law”

Legislation was passed into law in 2001 that created California’s “Covered Loan Law” effective with
transactions originated on or after July 1, 2002. As previously discussed, this law provides that mortgage loans
(as defined) with annual percentage rates or points and fees that exceed certain levels must adhere to specific
restrictions and limitations.

The law is intended to protect consumers/borrowers of these “High-Cost Loans” from abusive lending and
brokering practices and is limited to consumer credit transactions that are secured by residential real property
located in California and used, or intended to be used, as the consumer’s/borrower’s principal residence and
improved by a 1 to 4 unit residential dwelling. For the purposes of this law, “consumer loans” exclude bridge
loans (defined as temporary loans having a maturity of one year or less that fund the acquisition or construction
of a dwelling intended to be the primary residence of the consumer/borrower) or a reverse mortgage (as
defined) (Regulation Z, 12 CFR Section 226.32 and Financial Code Section 4970(d)).

The state’s “High-Cost Loan” legislation was codified in the California Financial Code, commencing with
Section 4970. This Predatory Lending Law is more restrictive than federal law regarding the application of the
APR tests. The first test to be applied under state law is whether the amount of the original principal balance
qualifies the mortgage loan as a “Covered Loan”, defined to mean a loan secured by real property located in
this state used or intended to be used or occupied as the principal dwelling of the consumer/borrower and which
is improved by a 1 to 4 dwelling unit. To establish “Covered Loan” status, the original principal balance of the
loan is not to exceed the most current conforming loan limit for a single-family first mortgage loan, as
established by FNMA for the community in which the security property is located. Applicable federal law does
not apply a “Covered Loan” original principal balance limit/test.

The second test is the APR threshold standard. State law applies a standard of more than 8% greater than the
yield of Treasury Securities of comparable maturities (established on the 15th day of the month immediately
proceeding the month in which the application is received by the creditor/lender) as the threshold for purposes
of determining “Covered Loan” status. This 8% APR threshold standard applies to both first or senior and
second or junior mortgage loans. Again, the FRB H15 Statistical Release identifies the yield of the Treasury
Securities of comparable maturities.

A third test is applied to determine whether a mortgage loan is subject to the California Predatory Lending Law.
This test is measured by the total points and fees paid by the consumer/borrower at or before closing for a loan
secured by a deed of trust or mortgage. If the total points and fees exceed 6% (including compensation paid to
MLBs) of the “total loan amount”, which fees and points are defined as the items required to be disclosed as
prepaid finance charges under Regulation Z (12 CFR Sections 226.4(a) and (b)); “Covered Loan” status applies
to the mortgage loan transaction, i.e., the mortgage loan is subject to the California Predatory Lending Law (the
common title applied to “Covered Loan” transactions).

When persons MLBs/MLOs arrange the “Covered Loan”, such persons are fiduciaries of the
consumer/borrower and any violation of these fiduciary duties is a violation of applicable law. Further, brokers
(MLBs/MLOs) arranging “Covered Loans” owe fiduciary duties to the consumers/borrowers in such loan
transactions, regardless of any other representation the brokers may have as agents and fiduciaries in “Covered
Loan” transactions (Financial Code Section 4979.5).

This means the brokers (MLBs/MLOs) who are delivering “Covered Loans” to private investors/lenders for
whom they must act as agent and fiduciaries are “dual agents”, and this status is to be disclosed and consented
to by each principal to the loan transaction. Brokers (MLBs/MLOs) are agent and fiduciaries of
consumers/borrowers in residential mortgage loan transactions (whether “Covered Loans” or otherwise) and
are agents and fiduciaries of private investors/lenders, regardless of the nature of the loan transactions or the
intended security properties. Brokers (MLBs) who are engaging in commercial loan transactions, as defined
(loans secured by other than 1 to 4 dwelling units) are the agents and fiduciaries of commercial borrowers,

unless such borrowers are either separately represented or have received and consented to disclosures that they
are unrepresented and no conduct has occurred that would otherwise establish and agency and fiduciary
relationship with the borrower. It is important to understand that brokers (MLBs) whether registered as MLOs
are not facilitators in mortgage loan transactions (Business and Professions Code Sections 10131(d) and (e),
10131.3, 10176(d), 10177(q), and 10237 et seq.; Civil Code Sections 2295 et seq., 2349 et seq., and 2923.1;
Corporations Code Section 25100(e) and 25206; Corporations Commissioner’s Regulations 10CCR, Chapter 3,
Sections 260.115 and 260.204.1; and Financial Code Sections 4979.5, 4995(c) and (d) and 4995.3(c), among
others).

The Predatory Lending Law restricts or prohibits loan terms that provide for prepayment penalties, balloon
payments, negative amortizations, advance payments, default interest rates, and single premium life and
disability insurance. The law also establishes rules for the payment of home improvement loan proceeds to
contractors. Generally, such loan proceeds are to be paid jointly to the consumer/borrower and to the home
improvement contractor (Financial Code Section 4973(a), (b), (c), (d), (e), and (g)).

To make or arrange a “Covered Loan”, the person originating such loan must have a reasonable belief, based on
certain criteria, the consumer/borrower can repay the loan from income or financial resources other than the
equity in the property securing the loan. The law also limits the amount of points and fees that can be financed
by the consumer/borrower as part of the loan proceeds. Persons originating “Covered Loans’ (whether
creditors/lenders or MLBs) must give consumers/borrowers a notice required by statute entitled, “Consumer
Caution and Home Ownership Counseling Notice”. This notice is to be delivered not less than three business
days prior to signing of the loan documents by consumers/borrowers. The font size, content, and format of this
notice is prescribed by statute (Financial Code Section 4973(k)).

This law provides for administrative and civil penalties for violators, other than an assignee who is a “holder in
due course” (which may not include private investors/lenders). In addition, violating certain restrictions or
prohibitions regarding loan terms can render those terms unenforceable. For example, this law establishes rules
for prepayment penalty fees and for a minimum loan term length, if a balloon payment transaction is
contemplated. Consumers/borrowers must be qualified in accordance with the guidance included in this law
applying debt to income ratios; and a “Covered Loan” is not to contain a “call” or acceleration provision that
would permit creditors/lenders (in their sole discretion) to accelerate the indebtedness evidenced by the
promissory notes and deeds of trust or mortgages, except as expressly authorized in accordance with this law
and in the loan documents (Financial Code Section 4973(a), (b), and (i)).

The three authorized circumstances permitting creditors/lenders to accelerate all sums due irrespective of the
maturity date include:

1. As a result of the consumer’s/borrower’s default;

2. Pursuant to a “due-on-sale” provision; or,

3. Due to a fraud or material misrepresentation by the consumer/borrower in connection with the
mortgage loan or the value of the security real property (Financial Code Section 4973(i)).

Further, persons who originate “Covered Loans” shall not refinance or arrange the refinancing if the new loan
is made for the purpose of debt consolidation or “cash-out”, unless the refinanced “Covered Loan” results in
identifiable benefits to the consumer/borrower measured by the stated loan purpose and the fees, interest rate,
points (including MLB compensation), and total finance charges.

This law further provides that it is unlawful for persons (creditors/lenders and MLBs) who originate (make or
arrange) “Covered Loans” to steer, counsel, or direct any perspective consumer/borrower to accept a loan
product with a risk grade less favorable than the risk grade for which the consumer/borrower would qualify
based upon the creditor’s/lender’s and the MLB’s then current underwriting guidelines, prudently applied,
including information available to such persons and as provided by the consumer/borrower. If the person is a
broker (MLB), the MLB/MLO is not to steer, counsel, or direct any prospective consumer/borrower to accept a
mortgage loan product at a higher cost than that for which the consumer/borrower qualifies, based upon the
loan products offered by the persons (creditors/lenders) with whom the broker (MLB) regularly does business
(Financial Code Section 4973(l)).

It is also important to understand persons who originate covered loans are not to avoid, attempt to avoid, or
otherwise circumvent the Predatory Lending Law by structuring the loan transaction for the purpose of evading
the law. This includes using an open-end credit plan (e.g., Home Equity Line Of Credit); dividing the loan into
separate parts; or proceeding in any other manner, whether specifically prohibited or of a different character,
that constitutes fraud (Financial Code Sections 4970(d) and 4973(m)(n)).

In addition, “stated income” loans may not be made or arranged unless the consumer’s/borrower’s income is
based upon a reasonable belief (supported by information in the possession of the person originating the loan
after the solicitation of all information customarily solicited in connection with loans of this type). A “Covered
Loan” is not to be knowingly or willfully originated as a stated income loan with the intent or the effect of
evading the Predatory Lending Law. Further, persons making or arranging “Covered Loans” must be able to
demonstrate a reasonable belief the consumer/borrower will be able to make the scheduled payments to repay
the loan based upon their current and expected income, current obligations, current employment status and
other financial sources, excluding the equity in the consumer’s/borrower’s dwelling (Financial Code Section
4973(f)).

Depending upon the issue, loan terms negotiated in violation of this law may result in voiding (rendering
unenforceable) such loan terms. Furthermore, persons who make “Covered Loans” (creditors/lenders) when the
person is on notice of, knew, or otherwise showed reckless disregard of violation(s) of the Predatory Lending
Law by MLBs, such persons and the brokers shall be jointly and severally liable for all damages awarded under
this law with respect to the unlawful conduct of the brokers (Business and Professions Code Section 10177(d)
and Financial Code Section 4974(b)).

The provisions of the “Covered Loan” law are in addition to the consumer/borrower protections established in
Article 7 of the Real Estate Law and in the Home Ownership and Equity Protection Act of 1994 (Section 32) of
TILA (HOEPA). Section 32 was discussed previously in this section as was Section 35 of TILA which also
provides additional consumer/borrower protections. Article 7 will be discussed later in this Chapter. The
following subsection will discuss recently enacted law, California “Higher-Cost/Priced Mortgage Loans”
(Financial Code Section 4995 et seq.). This law is also intended to provide further consumer/borrower
protections.

California “Higher-Cost/Priced Mortgage Loans”

The California law identified as “Higher-Cost/Priced Mortgage Loans” was codified in Financial Code Section
4995 et seq. The definition of loan transactions subject to this law to be applied for state purposes is the same
as established under federal law (Regulation Z, 12 CFR Section 226.35). This state law imposes limits on
prepayment penalty fees. Creditors/lenders and MLBs who violate the duty of fair dealing, i.e., licensed persons
(as defined) who in bad faith attempt to avoid the application of the law by engaging in one or more of a
defined series of prohibited activities or conducts, are subject to damages, civil sanctions, to license discipline,
and potentially to criminal sanctions.

“Higher-Cost/Priced Mortgage Loans” are defined under state law in the same manner as under federal law
(Financial Code Section 4995(a)). Each law applies to consumer credit transactions secured by the
consumer/borrower’s principal dwelling with an APR that exceeds the average prime offer rate for a
comparable transaction as of the date the interest rate is set on the subject mortgage loan. When the subject
mortgage loan is a first or senior encumbrance, the applicable APR that triggers this state law is set at 1.5% or
more than the applicable prime offer rate. If the loan is a second or junior encumbrance, the applicable APR
that triggers this state law is set at 3.5% or more than the applicable prime offer rate (Regulation Z, 12 CFR
Section 226.35). As previously mentioned, the applicable prime offer rate is the average prime offer rate of
conventional mortgage loans that may be determined by reference to the H15 statistical release.

This law applies to licensed persons and to mortgage brokers (MLBs), as defined. Licensed persons include real
estate brokers licensed under the Real Estate Law; finance lenders or brokers licensed under the Finance
Lenders Law; residential mortgage lenders/brokers licensed under the Residential Mortgage Lending Act;
commercial or industrial banks organized under the Banking Law; savings associations organized under the
Savings Associations Law; and credit unions organized under the Credit Union Law (Financial Code Section
4995(b)). Licensed persons also include mortgage brokers who are providing mortgage brokerage services
(Financial Code Section 4995(c)). “Mortgage brokerage services” means arranging or attempting to arrange, as

the exclusive agent of the consumer/borrower, or as a dual agent for the borrower and the creditor/lender, for
compensation or expectation of compensation (whether paid directly or indirectly) a “Higher-Cost/Priced
Mortgage Loan” made by an “unaffiliated third party” (Financial Code Section 4995(d)).

The language “unaffiliated third party” may prove to be difficult to interpret (Financial Code Section 4995(d)).
The reasonable interpretation would suggest if the mortgage broker (MLB) is delivering the loan to an affiliated
party that “mortgage brokerage services” are not being provided. MLBs are apparently presumed to be
exclusive agents of the affiliated party (creditor/lender) funding and making the loan and, therefore, are not
required to be the agent and fiduciary of the consumer/borrower (Financial Code Section 4995(d)).

This relationship may be altered by the conduct of the mortgage broker (MLB). For example, should the MLB
solicit or cause the consumer/borrower to be solicited with express or implied representations (including
through conduct) the mortgage broker (MLB) will act as an agent to obtain and arrange the loan (whether a
residential mortgage that is a “High-Cost Loan” or a “Higher-Cost/Priced Mortgage Loan”, or another form of
mortgage loan, regardless of the nature of the intended security property) and the mortgage broker (MLB) in
fact makes the loan to the borrower from funds belonging to or controlled by the MLB (an affiliated party); the
mortgage broker is acting within the meaning of subdivision (d), Section 10131 of the Business and Professions
Code.

Accordingly, the MLB would be unable to discharge the agency fiduciary relationship with the
consumer/borrower or with a borrower in other than a consumer loan transaction (Business and Professions
Code Sections 10240(b) and 10241(j); Civil Code Sections 2295 et seq., 2349 et seq., and 2923.1; and
Financial Code Sections 4979.5, 4995(c) and (d) and 4995.3(c), among others).

Notwithstanding any other provision of applicable law, prepayment penalty fees imposed by a licensed person
in connection with a “Higher-Cost/Priced Mortgage Loan” shall not exceed 2 percent of the principal balance
prepaid during the first 12 months, or 1 percent of the principal balance prepaid during the second 12 months
following loan consummation (Financial Code Section 4995.1).

As aforementioned, this California law imposes a duty of fair dealing upon licensed persons when making or
arranging “Higher-Cost/Priced Mortgage Loans”. This means licensed persons may not in bad faith attempt to
avoid the application of the law by dividing the loan transaction into separate parts with the purpose and intent
of evading the law or through any other form of subterfuge (Financial Code Section 4995.2(a)). Licensed
persons are prohibited from making or causing to be made, any false, deceptive or misleading statement or
representation in connection with “Higher-Cost/Priced Mortgage Loans” (Financial Code Section 4995.2(b)).

Mortgage Brokers (MLBs) who limit their business plan/model to arranging only California “Higher-
Cost/Priced Mortgage Loans” are required to disclose that fact, orally and in writing, to consumers/borrowers at
the time of initially engaging in mortgage brokerage services. Further, MLBs who provide mortgage brokerage
services are prohibited from steering, counseling, or directing a consumer/borrower to accept a loan at a higher
cost than for which the consumer/borrower could qualify based upon the loans offered by the person from
whom the broker regularly does business. In addition, mortgage brokers providing mortgage brokerage services
for a consumer/borrower, cannot receive compensation (including a yield spread premium, fee, commission, or
any other compensation) for arranging “Higher-Cost/Priced Mortgage Loan” with a prepayment penalty
exceeding the compensation the MLB would otherwise received for arranging such a loan without a
prepayment penalty. When MLBs provide mortgage brokerage services for consumers/borrowers, the broker’s
compensation is to be the same whether paid by the creditor/lender, the consumer/borrower, or by a third party
(Financial Code Section 4995.2(c), (d), and (e)).

Licensed persons are prohibited from making or arranging California “Higher-Cost/Priced Mortgage Loans”
that include provisions for negative amortization, and licensed persons are also prohibited from recommending
or encouraging consumers/borrowers to default on existing mortgage loans or other debts prior to or in
connection with the closing or planned closing of a “Higher-Cost/Priced Mortgage Loan” that refinances all or
any portion of existing loans or debts (Financial Code Sections 4995.2(f) and (g)).

Licensed persons may avoid some of the sanctions if they voluntarily undertake (prior to any institution of any
action under this section) to notify the consumer/borrower within 90 days of loan closing of any compliance
failure, offer to correct the failure, and offer to make restitution, including changing the terms of the loan in a

manner authorized by this law (i.e., offering the consumer/borrower at his/her option a California “Higher-
Cost/Priced Mortgage Loan” consistent with the requirements of this law, or offering to change the terms of the
loan in a beneficial manner so that the loan would no longer be considered a “High-Cost/Priced Mortgage
Loan”) (Financial Code Section 4995.2(h)). Some of the foregoing remedies may not be available for a licensed
person who is a MLB/MLO as they require acts of creditors/lenders.

The California “High-Cost/Priced Mortgage Loan” Law becomes effective July 1, 2010. It is important to note
that the remedies for violations of this law are not exclusive, but will include any other rights or remedies
available under applicable law, including a violation of Civil Code Section 2923.1. Practitioners should not
pursue a business plan/model that includes making or arranging loans intended to be secured by property that is
the principal residence of or the owner occupied dwelling of the consumer/borrower which is a California
“High-Cost Loan” or “Higher-Cost/Priced Mortgage Loan” (as defined) or when such loans are subject to
federal law (i.e., Sections 32 and 35 of Regulation Z of TILA); without first obtaining the advice of
knowledgeable legal counsel.

In Summary

The basic premise of both federal and state statutory and regulatory responses is to limit or control specified
loan terms and to prohibit creditors/lenders and brokers (MLBs) from engaging in defined activities or
conducts. The terms “High-Cost Loans” or “Higher-Cost/Priced Loans” were employed in both federal and
state law to new law intended to apply to loans that exceed a prescribed interest rate and/or fee threshold for
which additional disclosures and noticed of rights are required. These new laws describe certain transactional
terms, activities, and conducts of creditors/lenders and MLBs that are prohibited and deemed unlawful.
Further, consumers/borrowers are provided with the opportunity (as defined) to cancel the contemplated
residential mortgage loan transaction (i.e., a loan secured by an owner occupied or principal dwelling).
Creditors/lenders and MLBs violating these statutory and regulatory provisions are subject to sanctions,
including fines, economic and punitive damages, attorney’s fees and court costs, and to license discipline.

Additional federal and state laws to prevent creditors/lenders and MLBs from engaging in predatory practices
will be discussed in this Chapter. MLBs/MLOs are well advised to familiarize themselves with each of these
laws, including implementing regulations, as the remedies include (among those outlined in the previous
paragraph) rescission of the residential mortgage loan, license revocation or suspension, possible exclusion
from the mortgage and other real estate related industries, and in some circumstances the possibility of criminal
penalties. MLBs/MLOs should seek the advice of knowledgeable legal counsel prior to engaging in residential
mortgage loan transactions when the intended security property is the owner occupied dwelling of the
consumer/borrower.