Lawsuit: steering mortgage applicants could mean more writedowns

When lenders violate the U.S. federal lending disclosure laws, they may get stuck with the loan losses. This is the case now being argued before the courts in Wisconsin, with major implications on the number of cases to be filed and the loan losses banks may have to write off.

Susan and Bryan Andrews of Cedarburg, Wisconsin, claim that Chevy Chase Bank hid the true terms on a low-interest loan. The Andrews say the interest rate more than doubled by their 2nd monthly payment, when they thought the loan was locked in for five years. Later, the interest rate rose well above a 5.75% fixed-rate loan they could have had. Now they’re in court and they are filing a class-action suit. The implications for banks could be enormous.

A lawsuit filed by a Wisconsin couple against their mortgage lender could have major implications for banks should a U.S. appeals court agree that borrowers can cancel their loans en masse when their lenders violate a federal lending disclosure law.

The case began like hundreds of others filed since the U.S. housing boom spawned a rise in sales of adjustable rate loans. Susan and Bryan Andrews of Cedarburg, Wisconsin, claimed that lender Chevy Chase Bank FSB (CCX_pc.N: Quote, Profile, Research) had hidden the true terms of what they believed was a good deal on a low-interest loan.

In their 2005 lawsuit, the couple said the loan’s interest rate had more than doubled by their second monthly payment from the 1.95 percent rate they thought was locked in for five years. The interest rate rose well above the 5.75 percent fixed-rate loan they had refinanced to pay their children’s college tuition.

The Andrews filed the case seeking class action status; and in early 2007, U.S. District Judge Lynn Adelman ruled that the bank had violated the Truth in Lending Act, or TILA, and that thousands of other Chevy Chase borrowers could join them as plaintiffs.

The judge transformed the case from a run-of-the-mill class action to a potential nightmare for the U.S. banking industry by also finding that the borrowers could force the bank to cancel, or rescind, their loans. That decision was stayed pending an appeal to the 7th U.S. Circuit Court of Appeals, which is expected to rule any day.

The idea of canceling tainted loans to stem a tide of foreclosures has caught hold in other quarters; a lawsuit filed last week by the Illinois attorney general asks a court to rescind or reform Countrywide Financial Corp (CFC.N: Quote, Profile, Research) mortgages originated under “unfair or deceptive practices.”

Reuters, 1 Jul 2008

This case is big. If this becomes a class-action suit that allows mortgage-holders to rescind their mortgages because they were steered unfairly to unsuitable products, lawsuits will explode and banks will have enormous liabilities as a result. This case has implications well into the tens of billions of dollars.

We already know that mortgage lenders may have pressured appraisers to inflate their appraisal value. We know that lenders may have turned a blind eye or even encouraged individuals to misstate their income in order to qualify for larger loans. Add to this the ‘steering’ class-action and you have a perfect storm. All of this is going to be settled in court.

Stay tuned.

Related post
Another writedown risk: Chapter 7 Bankruptcy

See: Credit Crisis Timeline for a full list of writedowns and capital raising by institution and a timeline of the credit crunch.

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