Court of Appeals to Decide Fate of “No Closing Cost” Home Equity Loans

By Catherine Brennan

Hudson Cook LLP

 

Maryland mortgage lenders anxiously await the Court of Appeals’ ruling in Bednar, et al v. Provident Bank of Maryland, (Baltimore City Circuit Court Sep. 13, 2006, Case No. 24-C-05-011136), cert. granted, Case No. 142, Sept. Term 2006, in which the high court will decide whether a mortgage lender may impose “closing costs” on a borrower who fully prepays a second mortgage loan at the time of prepayment.

Andrew Bednar obtained a “no closing cost” closed-end second mortgage from Provident in 2003. The mortgage required Bednar to keep the mortgage open for three years; otherwise, he would have to repay the third-party closing costs Provident paid at closing. Bednar paid off the loan short of the three-year time frame, and Provident sought to recoup $681 in closing costs. Bednar sued Provident, arguing that the attempt to recoup the closing costs operated as a prepayment penalty, which Maryland law prohibits in connection with junior lien mortgages. Bednar also claimed that Provident violated the Maryland Consumer Protection Act, Md. Com. Law II §§ 12-1001 et. seq., because the bank failed to disclose that Maryland law prohibits prepayment penalties on junior lien loans. Bednar sought class certification for his lawsuit, but the Baltimore City Circuit Court granted the bank’s motion for summary judgment. Prior to this litigation, the Maryland Division of Financial Regulation had issued three letters in which the Division concluded that, for loans like Bednar’s governed by the Credit Grantor Closed End Credit Provisions, Md. Com. Law II §§ 12-1001 et. seq., lenders may defer closing costs and “recapture” them if the borrower pays off the loan within a predetermined time period. According to the Department, such recoupment does not constitute a prepayment penalty.

Bednar appealed, and the Court of Appeals granted certiorari on March 14, 2007 because of the importance of the outcome to the mortgage industry. The high court heard arguments in Bednar in early June 2007. During the argument, the court seemed to agree with Bednar that Provident’s attempt to recapture the closing costs operated as a prepayment penalty. Maryland law permits a consumer borrower to prepay a loan in full at any time. Md. Com. Law II § 12-1009(a). Further, in connection with any prepayment of any loan, the lender cannot impose “any prepayment charge.” Md. Com. Law II § 12-1009(e). The court focused on the fact that the imposition of the closing costs at the time of the prepayment operated as an unlawful prepayment charge – even though the lender could clearly impose the fees had it done so at closing. Maryland permits the imposition of closing costs in connection with the type of loan Bednar obtained if the costs represent actual verifiable expenses paid to third parties and are limited to: (1) attorney’s fees for services rendered in connection with the preparation, closing or disbursement of the loan; (2) any expense, tax or charge paid to a governmental agency; title examination, appraisal, or other costs necessary or appropriate to the loan’s security; and (3) premiums for voluntary credit insurance and required property, title or credit loss insurance. Md. Com. Law II § 12-1005(d). Although the Bednar case involves a closed-end loan, the ruling will also impact lenders offering home equity lines of credit because similar provisions apply to such lines of credit.