Daily Development for
Friday, February 7, 1997

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

Federal Law Preempts Late Charge and Prepayment Regulation in Home Loans: Don Brewster, always one of our best informed and thoughtful DIRT contributors, sent to me some materials from several recent meetings of the ABA Consumer Financial Services Committee. Apparently your federal government has been busily at work gutting state law protections in a number of consumer areas.

The following information, however, relates to residential loans by S&L's, thrifts, and other non-commercial bank lenders. It does not apply to commercial banks. The equivalent preemptive regulations for commercial banks would have to come from the Comptroller of the Currency. So far no one has informed me of any such regulation.

The information on preemption of late payment penalties and prepayment penalties is VERY, VERY, CURRENT, so it is not unusual that most of us are unaware of it. But this underscores the necessity of having someone associated with DIRT and the ABA Section's current developments reporting process regularly watching the Federal Register to keep us appraised of pending and adopted regulations. I've tried recruiting such a person in the past, with no success.

Any volunteers? I'm happy to rework any submitted material into reports, but my resources to not permit me to track all the regulatory output and identify critical items.

Here is the latest on preemption in the residential area. We're still waiting for someone to report regarding commercial bank regulations.

As Georgette Poindexter pointed out, the Federal Home Loan Bank Board is no longer in the preemptive regulation business, but the cudgel has been taken up by the federal Office of Thrift Supervision. The OTC has the same authority to adopt preemptive regulations affecting regulated thrifts (all federally chartered ones) that the Supreme Court approved in de la Cuesta.

It is important to keep in mind the Alternative Mortgage Instrument Parity Act, adopted in 1982, takes preemptive regulations on mortgages that it covers and makes those regulations effective to state regulated institutional lenders in addition to the federally regulated ones. (I'm simplifying some complex definitions here - read the Act 12 U.S.C. 3801 et seq.)

Now for the big news. The OTC announced early in 1986 some proposed preemptive regulations extensively regulating late payment penalties and prepayment penalties, among other things. The regulations also regulated a number of other practices in connection with adjustable rate loans. They are set forth in the Federal Register for 9/30/96 (Volume 61, Number 190) Pages 50951-50984. You can find the federal register information for free by tracking through the hypertext links for federal register information on the DIRT Home Page found at http://cctr.umkc.edu/dept/dirt.

Section 560.33 of the new OTS regulations provides that an association may include a late charge after following certain procedural rules. The late charge may be assessed only once, but the regulation imposes NO MAXIMUM on the amount of the charge.

Section 560.34 of the new regulations provides as follows:

"Any prepayment on a real estate loan must be applied directly to reduce the principal balance on the loan unless the loan contract or the borrower specifies otherwise. Subject to the terms of the loan contract, a Federal savings association may impose a fee for any prepayment of a loan."

[Note that the Alternative Mortgage Instrument Parity Act would extend the preemptive authority to all state regulated S&L's, thrifts and some other housing lenders as well WITH RESPECT TO ALTERNATIVE MORTGAGE INSTRUMENTS. Alternative mortgage instruments are pretty much any loan that is not a 30 year fixed rate level debt service first mortgage loan (going by memory.)

(Note - in his haste to get this out, the editor has not reviewed all the federal regulations to see if there is some limit on the penalties appearing in some other portion of the regulations. But he has the actual text of the sections discussed, and these sections would be the logical place where any such limits would appear.)

Comment: The OTC published notice of intent to adopt these regulations in the federal register. It assumed that if you didn't track the federal register and didn't respond to the notice, then you assumed that these things were a perfectly good idea.

The bottom line is that the organized bar is not organized, and is neither tracking nor responding to the many new federal preemptions of state law that the big money folks are driving through the federal government.

It is hard to rely upon the ABA here, since the constituency of the Section on Real Property, Probate & Trust Law, for instance, includes real estate lawyers of all stripes, and many of these lawyers would welcome federal preemption of what they see as "nuisance" state consumer regulation. They would argue that consumers are best served by an efficient system and lower costs, and federal preemption supplies that.

On the other hand, when no one is minding the store, those who have a direct financial interest in various federal regulatory activity sometimes can get a little greedy - such as in the federal regulations above that preempt local regulation of these penalties but impose no limits on their amount.

The agency, and presumably the big money folks, will argue that the market will impose its own limits. All true, assuming that consumers, led by the nose by mortgage brokers and real estate brokers, are able to identify these charges as threatening. But since neither of them are "up front" costs, this editor suspects that the market will not react against overreaching provisions in this area.

The original concept of the equity of redemption was premised on the notion that real estate borrowers cannot protect themselves by bargaining at the time of a secured loan. It is the role of the law and equity courts to do so at the time of default. In the editor's view, that was a good idea in the sixteenth century, and is still a good idea. Federal regulations premised on the notion that borrowers can protect themselves by resisting overreaching "lender grabs" in standard loan instruments are whistling in the dark.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1-6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Stacy Walter at the ABA. (312) 988 5260 or stacywalter@staff.abanet.org

Items reported here and in the ABA publications are for general information purposes only and should not be relied upon in the course of representation or in the forming of decisions in legal matters. Accuracy of data and opinions expressed are the sole responsibility of the DIRT editor and are in no sense the publication of the ABA.