Door Could Open To Class Actions
WHEN BORROWERS FIGHT BACK: Banks watch closely to see if a couple's legal struggle with their lender will launch a new front in the battle over troubled mortgages.
By David Cho
Washington Post Staff Writer
Wednesday, February 27, 2008; D01
A federal appeals court is nearing a decision on a battle between Chevy Chase Bank and a Wisconsin couple that could for the first time enable homeowners across the country to band together in class-action lawsuits against mortgage firms and get their loans canceled.
The case is alarming Wall Street's biggest banks, which could bear the hefty cost of reimbursing all mortgage interest, closing costs and broker fees to groups of homeowners who uncover even minor mistakes in their loan documents.
After a federal judge in Milwaukee ruled last year that the Wisconsin couple had been deceived and other borrowers could join their suit, Chevy Chase Bank appealed to the circuit court in Chicago. Kevin Demet, the lawyer for the plaintiffs, said a decision by the appeals court is imminent, though others involved in the case said it could be a matter of weeks.
"It's one of the most important cases for the mortgage industry right now," said Louis Pizante, chief executive of Mavent, which provides consumer protection law services to major lenders. "The case was somewhat interesting a couple years ago when it started, but its ramifications and impact have completely changed given the current environment."
In recent years, home lending has boomed. But standards loosened at many mortgage firms and led to a rise of abuses, in particular predatory practices. Now, record numbers of people are finding themselves with loans that are more than they can afford and many want out.
Estimates vary widely on the number of homeowners who could benefit from the case. Those who have refinanced or hold a home equity loan are already eligible for a refund, while others can get monetary damages. The court's ruling won't change this. But by allowing plaintiffs to file class-action suits, the ruling would make it much easier and more affordable for groups of homeowners to get that relief, several lawyers and mortgage analysts said.
Dozens of class-action homeowner lawsuits have been filed in California and elsewhere against the nation's largest banks. The success of these claims could turn on the decision in the Chevy Chase case.
In its court filings, Chevy Chase said it would be "irreparably harmed" if the class-action lawsuits are allowed. About 7,000 borrowers have received loans from the bank similar to that of the Wisconsin plaintiffs.
"It's critical for the industry because if you allow class actions . . . in theory you could have thousands of people in a class and you could have enormous amounts of damages for the industry," said Thomas H. McCormick, vice president and general counsel for Chevy Chase.
The law states that even a minuscule violation by a lender can lead to a mortgage cancellation, or rescission. For example, if the annual percentage rate calculation is off by one-eighth of a percent between preliminary and final loan documents or if a monthly payment schedule does not conform precisely to federal guidelines, some borrowers could get a refund for all they have paid to live in their homes for years. They would have to pay back the entire amount of the loan, but they could then seek a new mortgage on better terms.
According to the inspector general for the Federal Deposit Insurance Corp., 83 percent of federally supervised banks that issued loans at the height of the housing boom in 2005 have been cited for "significant compliance violations." Lending abuses were more frequent among the tens of thousands of state-regulated banks and thrifts, such as the now-bankrupt New Century Financial, industry analysts said.
But few homeowners have been successful in getting their loans canceled. Most people are unaware they have this right, consumer advocates said. Others have found the process too arduous and expensive, often requiring long legal battles. Chevy Chase said it negotiated two mortgage cancellations all of last year.
That could change if the U.S. Court of Appeals for the 7th Circuit rules in favor of allowing homeowners to join class-action suits. Plaintiff attorneys also would have far greater financial incentive to take up such cases.
"It's preposterous to think an individual can fight the bank on a loan," said Demet, the lawyer for the Wisconsin plaintiffs. "And any attorney who's worth his salt does not want to pursue individual action. You could spend $50,000 to $70,000 on a case where you are going up against huge law firms that want to delay and hassle you for several years."
In previous cases, courts have been divided over whether plaintiffs can file class-action suits to have their mortgages rescinded. In general, lower courts have sided with homeowners, while federal courts have favored the banks. Attorneys on both sides of the Chevy Chase case think the U.S. Supreme Court will have to settle the matter.
The case began when Bryan and Susan Andrews, a carpenter and a nurse from Cedarburg, Wis., got a tantalizing ad in the mail in 2004.
"Cashflow 5-Year Fixed; Note Interest Rate: 1.950%," the mailer advertised in boldface. The loan appeared far better than the fixed-rate mortgage they had at the time, which was charging 5.75 percent interest. With college costs rising for his four children, Bryan Andrews said he thought the mailer was a godsend.
But the loan was actually an unorthodox mortgage that allowed the interest rate to rise. The advertised 1.95 percent rate lasted only one month. It quickly soared to above 8 percent.
"The bank kind of trapped us into it," Bryan Andrews said. "We were thinking we were set at 1.95, that it was black and white, but it was not to be. It was pretty stressful the first few months."
Chevy Chase argued that it had disclosed the actual rate and definition of the loan in closing documents, but the district court judge in Wisconsin found those forms were confusing.
A year ago, McCormick said in an interview with The Washington Post that Chevy Chase was not worried about the long-term ramifications of the lawsuit. But times have changed since then, and he acknowledged last week that the bank is concerned about the possible precedent.
Wall Street banks are also worried. In many cases, the cost of reimbursement falls not on the mortgage lender but on the financial institutions that later bought and securitized the loans.
But this unnerving scenario is a source of optimism for lawyers like Demet.
"This is not going to save everyone in the country who got a bad loan, but a lot of people who were misled, we will be able to help those people," he said.
Staff researcher Richard Drezen contributed to this report.