The Ameriquest settlement: the settlement between Ameriquest and the 49 state attorneys general provides a window into the AGs' thinking on mortgage lending litigation.

During the past several years the state attorneys general have aggressively pursued the mortgage industry, including companies such as Household International, parent company of Household Finance Corporation and Beneficial Finance Corporation ($484 million); Associates First Capital/Citigroup Inc., New York ($225 million); First Alliance Mortgage Co., Irvine, California ($60 million); and, most recently, Ameriquest Mortgage Co., Orange, California. [??] Iowa Attorney General Tom Miller stated that Citigroup Inc. and Household International (now a part of HSBC North America Holdings Inc., Prospect Heights, Illinois,) became "two of the best companies" in subprime lending after they reached settlements and changed their practices a few years ago, according to American Banker. As a result of the Ameriquest settlement announced on Jan. 23, 2006, Miller expects Ameriquest to become "one of the best" as well, according to American Banker. [??] The terms of the recent settlement agreement between Ameriquest and the 49 state attorneys general (AGs) requires significant new mortgage lending practices that have been agreed to by Ameriquest. Such new lending practices are binding only upon Ameriquest, but may provide a window into potential future AG litigation in the mortgage banking industry.

The attorneys general for all 49 states seem convinced the lending reforms included in the Ameriquest settlement agreement can be a road map for the creation of uniform national standards above and beyond existing federal and state laws and regulations. The disturbing feature of legislating by AG litigation is that simply complying with all applicable federal and state laws and regulations may not be enough.

The requirements from the settlement agreement, which were in most instances implemented by Ameriquest long before the settlement was reached, were not required under federal or state laws, but were designed to improve and enhance Ameriquest's ability to better serve its customers. The most important of such best practices are outlined below.

Disclosure of loan terms

The following disclosures to potential borrowers must be made, in addition to all other federal and state laws and regulations. These disclosures must be made orally if the loan application is verbal, and in writing no later than three days after written application:

1. Fixed-rate mortgage (FRM): "The loan we have been discussing is a [insert term of the loan] year fixed-rate loan for $ [insert loan amount]. The interest rate is [insert interest rate] percent. The monthly payment is $ [insert monthly payment], which does [or does not] include escrows for property taxes or insurance. Your loan does [or does not] include a prepayment penalty."

2. Discount points for FRM: "This loan includes payment of [insert number] discount points, a fee you pay at closing that reduces the interest rate on your loan and also the amount of your monthly payment, but increases the total amount of your loan. You may be eligible for a loan with fewer discount points."

3. Adjustable-rate mortgage (ARM): "The loan we have been discussing is an adjustable-rate loan for $ [insert loan amount], with an initial interest rate of [insert initial interest rate] percent. Your initial monthly payment would be $ [insert initial monthly payment], which does [or does not] include escrows for property taxes or insurance. Your loan does [or does not] include a prepayment penalty. Because this is an adjustable-rate loan, the initial interest rate and monthly payment I quoted you are only guaranteed for the first [insert length of initial fixed rate period] of the loan. After that, your interest rate can increase by up to [insert rate-adjustment cap] percent each year. But your interest rate can never be higher than [insert lifetime cap] percentage points over your initial interest rate." [Note: If the salesperson has not previously discussed a specific fixed-rate mortgage proposal with the potential borrower, the salesperson should also provide an additional oral statement in substantially the following form.] "You may be eligible for a loan with an interest rate that does not change."

4. Discount points for ARM: "This loan includes a payment of [insert the number] discount points, a $ [insert the amount of the discount points in dollars] fee you will pay at closing to lower your initial interest rate and monthly payment. You may be eligible to pay fewer discount points, but if you do that your initial interest rate and monthly payment will be higher."

5. Prepayment penalty: "This loan contains a prepayment penalty. That means if you pay off or refinance your loan within [insert the length of the period], you will pay a fee of as much as $ [insert the amount of the fee in dollars]. You may be eligible for a loan without a prepayment penalty, but you would then pay a higher interest rate and a higher monthly payment."

Revised Good-Faith Estimate (GFE) required if material loan terms change: If any material change in terms occurs after the initial disclosure, the mortgage company should mail a revised disclosure not less than six days before closing, or deliver or cause to be delivered by courier, facsimile transmission, e-mail or Web site access so as to be received or accessed by the potential borrower at least three days prior to closing for a nonprime refinance loan and as soon as reasonably possible but in no event less than one day prior to closing for any other loan.

Equal treatment requirement: The mortgage company should make loans in accordance with a pricing model that is designed to produce (before the use of any price exception) the same interest rate and number of discount points for all potential borrowers with the same credit-risk characteristics who are applying for the same loan.

Independent loan closers: The mortgage company should use an independent loan closer for all of its nonprime loan closings. The mortgage company should require the independent loan closer to provide a written report to designated senior management if the closing agent discovers unfair, misleading or unlawful behavior by any company employee. Disciplinary action should be taken against any independent loan closer for failure to report any such misconduct. Independent loan closers should also encourage borrowers to use the rescission period either to read the loan documents or address questions raised at the closing.

Independent loan closers should be instructed by the mortgage company to explain fully the closing process and loan documents to potential borrowers. They should also be told to answer all questions from potential borrowers to the best of their ability, unless the independent loan closer is prohibited by law or professional standards from doing so.

Further, independent loan closers should be instructed not to pressure or rush potential borrowers at closing, or encourage them to close by suggesting that potential borrowers may use the rescission period either to read loan documents or to address questions or objections raised at closing. Employees of the mortgage company should attend nonprime loan closings only if requested by a potential borrower.

Closings: Before closing a loan, the mortgage company should ensure that 1) the potential borrower has satisfied all credit underwriting requirements; 2) an appraisal or automated valuation model (AVM) has been submitted and evaluated (if required); and 3) standard title-related information has been received and reviewed.

Loan funding: The mortgage company should disburse the proceeds of all refinance loans to the borrower on the first business day after the expiration of any rescission period provided for by law or internal best practices; provided, however, that the mortgage company will not be deemed to have violated this requirement where: 1) closing contingencies as set forth earlier have not been satisfied; 2) a mortgage company is prevented from fully disbursing the proceeds because the wire transfer is delayed (by no more than one day) due to the volume of other scheduled closings; or 3) by other causes beyond a mortgage company's reasonable control and occurring without its fault or negligence, including acts of God, floods, fires, government restrictions, wars, strikes and insurrections.

Appraisals: The mortgage company should implement a system to ensure that appraisals are ordered as part of an automated, centralized process apart from the branch sales offices. Sales personnel should not select appraisers. If, for the initial appraisal only, the branch manager has a good-faith belief that the appraisal contains an error or is otherwise professionally deficient, the branch manager should submit a written or electronically transmitted request to the appraisal department explaining the objection and requesting the appraiser address the specific issue raised.

Stated-income loans: The mortgage company should not inflate or fabricate, or encourage a potential borrower to inflate or fabricate; the source or amount of a potential borrower's actual income or assets; or sign any document on behalf of a borrower. The underwriting guidelines employed by the mortgage company should require the amount of stated income to be reasonable for the occupation and experience claimed. If a stated-income loan is based upon self-employment or a home-based business, the mortgage company should request evidence of the existence of the business.

Employee compensation programs: The compensation system employed by a mortgage company should not provide incentives that encourage its employees 1) to include a prepayment penalty provision in a loan; 2) to quote a potential borrower an interest rate inconsistent with the same rate available provision of this settlement agreement; or 3) to otherwise increase compensation based on loan fees or closing costs.

Whistleblower policies and procedures: The mortgage company should adopt written policies and procedures to facilitate reporting of suspected improper conduct by mortgage company employees.

Employee training: The mortgage company branch employees shall complete a training course appropriate to the duties and responsibilities of each employee.

No coordination with debt collectors: Neither the mortgage company nor its employees should compensate debt collectors for providing referrals, nor should the mortgage company or its employees work in concert with debt collectors to pressure a potential borrower to obtain a loan from a mortgage company.

Final thoughts

In 1975, Congress found that certain geographic areas did not have available to them "adequate home financing to qualified applicants on reasonable terms and conditions." Congress' fix for "redlining" was to pass the Home Mortgage Disclosure Act. The stated purpose of the legislation was "to provide the citizens ... with sufficient information to enable them to determine whether depository institutions are filling their obligations to serve the housing needs of the communities and neighborhoods in which they are located and to assist public officials in their determination of the distribution of public-sector investments in a manner designed to improve the private investment environment."

Federal, state and local officials initially encouraged risk-based lending as a means of providing critical financing for their neighborhoods. Informed legislation and regulations followed that were designed to provide full disclosure to each borrower. With the recent advent of growing attorney-general attention to the mortgage banking industry, the Ameriquest settlement bears careful review by the mortgage banking industry.

Bernard LeSage is chair of Buchalter Nemer's litigation department in Los Angeles, focusing his practice in the areas of complex business and financial institutions litigation, class-action defense and unfair competition. He can be reached at [e-mail].