Permitted Recapture or Illegal Prepayment Charge? by Harry Levy |
 |
In a variety of consumer lending situations, financial institutions frequently offer borrowers an incentive by waiving the borrower's payment of closing costs for a loan. That offer is sometimes conditioned upon the borrower's agreement not to refinance or pre-pay the loan for a specified period. For credit lines, such as home equity line products, the borrower agrees not to close the account for a stated period. The Court of Appeals of Maryland has determined that these arrangements violate Maryland law, at least in the case of closed end loans.
The facts are straightforward and typical. Andrew Bednar obtained a second mortgage from Provident Bank in August, 2003. Bednar signed a waiver certificate stating that, as a condition of Provident waiving Bednar's payment of closing costs, Bednar agreed not to repay the loan for three years following settlement. In the event Bednar paid the loan within three years, the waiver certificate allowed Provident to recapture the waived closing costs by adding them to the balance of the loan when paid in full.
The closing costs amounted to $681, and were initially paid by Provident, and disclosed as such on the HUD-1 Settlement Statement. Approximately two years later, Bednar refinanced and repaid the Provident loan. Provident collected the $681 in closing costs in addition to the loan balance.
Bednar sued Provident in a class action on his behalf and on behalf of others similarly situated to recover the closing costs collected by Provident. Bednar alleged that Provident had violated Maryland’s Credit Grantor Closed End Credit law ("CLEC'), which allows a consumer borrower to prepay a loan in full at any time and prohibits a lender from imposing any prepayment charge. Bednar further alleged that these events constituted a violation of Maryland's Consumer Protection Act (the "CPA") as an unfair or deceptive trade practice.
Prior to trial, the circuit court entered summary judgment in favor of Provident, holding that any closing costs were actually imposed at the time of loan closing, and not on the prepayment of the loan, characterizing the bank's action as simply "recapturing" lawful charges the bank had waived provided the borrower held up his end of the bargain, which Bednar failed to do. As a result, Provident had not violated either CLEC or the CPA.
Bednar appealed and the matter was accepted for review by Maryland's highest court. On appeal, Bednar argued that the language of CLEC was clear, that a consumer could prepay a loan in full at any time, and that Provident was prohibited from imposing a prepayment charge. Bednar further maintained that the waiver certificate was unenforceable under CLEC inasmuch as any agreement in violation of CLEC was unenforceable as a matter of law.
In response, Provident contended that it simply recaptured routine closing costs, and that there was no statutory time frame for collecting those costs. Consequently, in Provident’s view, any prohibition of a prepayment should prevent only recovery of costs that were not otherwise authorized by other statutory provisions.
The Court of Appeals found that the language of CLEC was unambiguous. The proper test was "whether there is a charge imposed at the time of prepayment that would not be imposed if the note were paid at maturity instead of at an earlier date." Here, since Bednar prepaid the loan within three years, Provident required Bednar to pay the closing charges. Thus, Provident’s recovery of the $681 from Bednar, no matter how the bank characterized or calculated it, was unmistakably an unauthorized prepayment charge. As a result, the waiver certificate was invalid and unenforceable.
The Court noted that state regulators had issued an interpretation of CLEC validating the "waiver/recapture" closing costs program utilized by Provident. However, the Court determined that the regulators’ interpretation would be entitled to deference only if CLEC were ambiguous. Since CLEC was unambiguous, the regulator's interpretation was entitled to no deference.
Accordingly, Maryland financial institutions may no longer simply "waive" the collection of closing costs at the time of making a loan, reserving a right to "recapture" them if the borrower pays the loan back before a stated term. Absent action by the Maryland legislature, such agreements are unenforceable and violate existing Maryland law. This same problem may be looming in Pennsylvania, whose law is similar to Maryland's, and where the Pennsylvania Department of Banking has similarly approved "waiver/recapture" closing costs programs.
Despite this development, there may be a means of achieving the same economic benefit to the borrower without causing the lender to fall into a nasty trap for the unwary. Suppose the bank charges the borrower the closing costs at loan closing, but gives the borrower a "Refund Certificate" stating that although the borrower may prepay the loan at any time without penalty, if the borrower repays the loan at any time after a certain period (e.g., three years, as in the Bednar case), the bank will refund to the borrower all of the borrower's closing costs. If an earlier prepayment occurs, the borrower is not charged any penalty, but simply does not get the closing costs refund. Although this situation was not before the Bednar Court, its ruling suggests that there would be no illegal "prepayment charge," but rather a legal "repayment refund," if the borrower satisfied the condition for the refund.
Please feel free to call us if you wish to discuss your particular lending program.
 |