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"No-Fee" Mortgage Lenders May Not Collect Closing Costs Upon Prepayment

January 15, 2008

By: Catherine K. Hopkin

A new ruling by the Court of Appeals of Maryland prohibits banks and lending institutions from recapturing closing costs on "no-fee" mortgages that are subsequently prepaid by the mortgagor.  Lenders who offer these types of mortgages will now have to "eat" the closing costs on prepaid mortgages, regardless of whether the closing documents contain language to the contrary.

In Bednar v. Provident Bank of Maryland, Inc., Maryland’s highest state court considered Provident’s practice of collecting closing costs from mortgagors who prepaid their no-fee mortgages.  A no-fee mortgage is one in which the lender does not charge the borrower traditional costs such as those for appraisal fees, title searches or recordation fees, among others.

In Bednar, the mortgagor signed a "Closing Costs Waiver Certificate" when giving Provident a second mortgage on his residence.  This document provided that Provident would waive closing costs on the transaction on the condition that Bednar keep his account open at least three years from the date of settlement.

Two years later, Bednar refinanced his home and fully prepaid the Provident loan and closed out the account.  Because Bednar did not keep the account open for at least three years, Provident added the closing costs that were incurred at settlement, but waived, to the total payoff amount.

Bednar filed a class action suit in state court against Provident alleging, among other things, that its practice of collecting the closing costs upon the mortgage prepayment was a violation of the Maryland Credit Grantor Closed End Credit Provisions (CLEC).  The CLEC provides that a consumer borrower may prepay a loan in full at any time, and that a lender may not impose any charges in connection with the prepayment of a loan by a consumer borrower.

Provident responded that the closing costs were not prepayment charges, but rather were deferred payments that were charged and disclosed at the time of the loan closing.  Provident claimed that, since the charges arose at the time of closing, and not at the time of prepayment, they would not technically be classified as a "prepayment charge," and thus would not be a violation of the CLEC.

Provident also relied on letters issued by Maryland’s Office of Commissioner of Financial Regulation, which approved the practice of charging closing costs on prepaid loans.  The lower court agreed with Provident, finding that Provident was merely recapturing closing costs on the transaction, and not charging newly incurred prepayment charges.  The case was reviewed by the Court of Appeals, Maryland’s highest appellate court.

In its ruling, the Court explained that the charges were not simply deferred payments, as Provident argued, because they were only imposed after Bednar paid off the loan.  Imposing the costs on the mortgagor would only occur if the mortgagor prepaid the loan.  Therefore, the costs were prepayment charges and were prohibited under the CLEC.

The Court also left open the possibility that imposition of these types of charges may be in violation of Maryland’s Consumer Protection Act, which prohibits unfair or deceptive trade practices.  The trial court found that Provident did not violate the Consumer Protection Act, but its decision was based solely on its finding that Provident did not violate the CLEC.  Therefore, the alleged Consumer Protection Act violation was not directly addressed by the Court of Appeals; however, lenders should be aware that they may be at risk of violating the Consumer Protection Act if they charge closing costs on prepaid no-fee loans.

This ruling will affect national and local lending institutions that offer the increasingly popular no-fee mortgages in Maryland.  While no-fee mortgages have been around for years, their rising popularity was due in part to the need for lenders to offer incentives to potential homebuyers in a slow housing market.  In May, 2007, Bank of America announced that it was the first financial institution to introduce the no-fee mortgage on a national scale, although several other institutions such as Wells Fargo & Co. and Wachovia Corp. were also beginning to reduce, if not completely eliminate, closing costs at that time.

Lenders who currently offer no-fee mortgages or who are considering doing so should be prepared to assume all closing costs, regardless of when the mortgage is actually paid off.  Any attempt to collect closing costs upon prepayment is now prohibited, even if the mortgagor expressly agreed to pay the costs upon prepayment.  Additionally, the Court of Appeals’ decision illustrates the uncertainty of relying on an administrative agency for approval of new lending practices.  As the Court noted, even when an agency has offered its own interpretation of a financial regulation, the Court must reject the agency’s interpretation if it contradicts the clear language of the regulation.

While the Court’s opinion conclusively determines that closing costs cannot be charged in connection with no-fee mortgages, lenders and financial institutions should also reconsider relying on administrative agency opinions when assessing the legality of other lending practices.  Lenders who have a concern about the legality of some of their practices are advised to consult their attorneys before instituting new practices or policies.

For more information about lenders’ rights and banking practices, contact Catherine K. Hopkin at 410.752.9768 or via email at chopkin@tydingslaw.com.

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