Suit Challenges Enforcement of Option ARM Contracts

A federal judge in Wisconsin recently ordered Chevy Chase Bank to rescind a loan made to a couple who took out an adjustable-rate mortgage because the bank failed to clearly explain how the loan would work.

The case was brought by Susan and Bryan Andrews of Cedarburg, Wis., who took out an option ARM loan, refinancing their $191,000 mortgage, under the belief that a 1.95% introductory rate was fixed for five years. Two months later, the couple said they received a statement showing the rate had risen to 4.375%. As a result, the couple told the judge an increasing portion of the minimum monthly payment was needed to cover interest, and the payment itself soon became insufficient to cover interest that accrued. The rate has climbed above 7% and the couple's loan balance has grown by about $2,000, even though they've made extra payments toward the principal, according to Ms. Andrews.

The ruling, by U.S. District Judge Lynn Adelman, also certified the case as a class-action lawsuit, creating the possibility that others with similar option ARM loans from the Bethesda, Md.-based bank can get out of their mortgages. The lawsuit claimed the bank violated the federal Truth In Lending Act by misleading borrowers into thinking they were getting rates lower than those actually charged.

Kevin Demet, the attorney who filed the case, said borrowers affected by the decision will get back any payments to the bank, including closing costs and lawyers' fees. Calls to Thomas McCormick, the bank's general counsel, were not returned by press time. It has been reported Chevy Chase Bank will appeal the judge's ruling.

Other lawsuits are likely, according to Robert Lotstein, manager partner of Lotstein Buckman LLP in Washington. He said the popularity of the option ARM loan is a result of the litigation surrounding this product and the suggestion that the consumer did not understand the program details. The most likely claim will be a consumer-protection claim that borrowers weren't properly informed or were sold a product that wasn't suited to them.

"This debate is not unlike the yield-spread premium class actions of a few years ago. I believe this product will continue to be contentious and a concern of regulators and the class-action plaintiff's bar."

Over the past few years, industry insiders say innovative mortgage products such as interest only and option ARMs have allowed for a dramatic increase in the number of homeowners. Those products were designed to be affordable and meet cash flow requirements, and it was up to the borrower to monitor the additional risk exposure when choosing such a product.

While these products were created to get more borrowers into homes, the availability of these subprime products altered the landscape of the industry and has already started to contribute to the resurgence of REO properties, according to Allan Martin, chief executive officer, Mortgage Contracting Services. "The lenders who grew portfolios in the subprime segment are now trying to find creative ways to minimize the loss exposure that comes with these types of loan products."

Mr. Martin said foreclosures and real estate-owned assets have been on the rise across the U.S, and this market segment can expect to continue to rise due to a combination of factors, including the potential rise in interest rates, adjustment of interest only and pay-option ARMs, and the sheer volume of mortgages. "This is the industrywide perspective and everyone is in agreement about the state of the market," he said.

"Some of the more responsible lenders and servicers are now looking at ways to help borrowers avoid default whenever possible by looking at nontraditional disposition methods. Discussing default mitigation, incentives and good communication with borrowers can all yield positive results." (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com