Lender risk from CFPB underwriting rule tested in Ohio case
Lenders have long worried that borrowers would use the Consumer Financial Protection Bureau's mortgage underwriting rule to fight foreclosure in court. But the outcome of the first known legal attempt may discourage others from trying.
An Ohio man is appealing his case after he was unable to convince a federal judge that his local bank was negligent in verifying his income. The judge sided with the $163.2 million-asset First Federal Community Bank of Bucyrus, giving the bank a green light to foreclose.
Although G. Ralph Elliott filed an appeal last month and his foreclosure was put on hold because of the litigation, the eventual outcome could be a litmus test as to whether lenders face a deluge of lawsuits stemming from the CFPB's ability-to-repay rule.
“This is a positive sign for the industry,” David Scheffel, a partner at Dorsey & Whitney, said of the lower court's decision. "This would disincentivize plaintiff’s lawyers from pursuing these cases, though each lawyer has to see if they have a strong case or not."
Elliott, 83, a retired Realtor from Milford Center, Ohio, claimed the bank should have accounted for his losing spousal support from his former wife, which he had listed as income when refinancing his loan.
But Judge Algenon L. Marbley, of the U.S. District Court for the Southern District of Ohio, found “no genuine dispute of material fact” in the case. In March, he awarded summary judgment to the First Federal Community Bank of Bucyrus. It could take up to a year for the 6th Circuit Court of Appeals to rule on the case.
At issue is the CFPB's 2013 ability-to-repay rule. The rule provided lenders with liability protection for an ultrasafe class of loans known as "qualified mortgages." Yet borrowers can still attempt to use the rule as a basis to sue.
The timing of the case also coincides with the CFPB’s advance notice of proposed rulemaking last month asking for public comment on how to revise the ability-to-repay rule, including standards used to document a borrower's income.
A critical aspect of the case is whether First Federal Community Bank of Bucyrus, about 40 miles north of Columbus, Ohio, had some duty to document income beyond what Elliott provided on his 2014 application to refinance his mortgage.
At the time of the refinancing, Elliott was separated from his wife, Virginia Golan.
On the 2014 application, Elliott listed as income the alimony payments of $2,300 a month that he received from Golan, rental income of $1,400 a month, his base income and Social Security. When the couple's property and debts were re-divided as the result of a lengthy divorce proceeding, Elliott was ordered to receive just $250 a month in spousal support, according to Marbley's opinion.
He defaulted 18 months later and filed the lawsuit in January 2017.
Although Elliott reviewed and signed the 2014 application, he alleged in the complaint that First Federal violated the Truth in Lending Act by failing to make "a reasonable and good faith determination that, at the time the loan was consummated, [he] had a reasonable ability to repay the 2014 loan, according to its terms."
The lawsuit also claims the bank was negligent when it previously refinanced the home in 2013. Then, the couple were still married and wanted to take $70,000 in equity out of their 26-acre property.
Elliott’s attorney, Aaron Edmund Michel, said in an email that his client’s estranged wife negotiated both refinancings and convinced First Federal to take her name off the mortgage in 2013.
“Ms. Golan applied for another refi to get her off of the mortgage and [the] bank decided to keep her on the hook,” Michel wrote. “She twisted some arms and got them to do the refi without regard to Ralph’s ability to repay.”
Attorneys for First Federal declined to comment. Bradley Murtiff, First Federal’s president and CEO, did not return a call seeking comment. An attorney for Golan, a third-party defendant in the case, also declined to comment.
In a nine-page opinion, Marbley described how Elliott had been fired from his job at Golan’s realty office.
The judge noted that Elliott had been a "good customer" of the bank and, before defaulting on the 2014 loan, had not missed a mortgage payment. Though the bank’s loan committee initially denied the refinancing request, Golan had asked the bank’s loan officer to reconsider and she reassured the bank that she would pay spousal support sufficient to cover the mortgage.
“The data the bank had indicated he was a customer with the financial standing to allow for the refinancing,” the judge wrote. “The fact that Plaintiff and Ms. Golan did not keep the separation agreement and instead opted to divorce — a series of events which reduced Plaintiff's income by an order of magnitude — was not an event that was reasonably foreseeable to the Bank.”
The judge devoted two pages of the order to a discussion of Appendix Q, a little-known guide to documenting income, including alimony and child support. First Federal listed Elliott’s debt-to-income ratio as 37.367%. The bank also had a copy of the legal separation agreement, and tax returns that showed past rental income.
“The Bank had this information available when it made its refinancing decisions — indeed, that is why the Bank is now able, in its briefing, precisely to identify Plaintiff’s credit score and debt-to-income ratio,” Marbley wrote. "Plaintiff’s arguments that the Bank did not comply with Appendix Q are unavailing."
The judge also acknowledged that Elliott was unable to make his mortgage payments after the divorce.
"Though this is an unfortunate outcome, it is not the responsibility of the Bank, which met its statutory obligations," Marbley wrote.
The surprise to many mortgage experts is that the first litigation challenging the CFPB's ability-to-repay rule could end up being useful to lenders. It may also have a chilling effect on plaintiff's lawyers filing what would be considered frivolous lawsuits as a strategy to avoid foreclosure.
“Industry wanted a safe harbor so they had certainty that if they made loans in this space and made a reasonable effort to document a borrower’s ability to repay, they would not get sued,” said Scheffel at Dorsey, who was not involved in the litigation. “That’s why QM was so important to the industry."
Though the parties could settle, mortgage experts said they are waiting to see the final outcome from the 6th Circuit Court of Appeals.