Banking and Mortgage Industry Standard and Practices Useful in Loan Index Change Litigation
A look at some of the important nuances of banking and mortgage banking litigation involving the mechanics of loan index changes.
Loans of any type that have an interest rate that floats over some benchmark rate may be referred to as floating rate loans, adjustable rate loans, index loans, or some other term used by a lender to describe its particular lending program.
Situations sometimes arise where a loan is originated with its interest rate stated as a certain percentage rate or number of basis points over a certain index, and then the index is discontinued for whatever reason. In this situation, the normal industry standard procedure is to find a new index that has performance characteristics as similar to the original index as possible. Therefore, when the replacement index is applied, the economic result for the borrower should be as close as possible to the economic result from the originally structured loan transaction.
The reason for the governmental banking regulators establishing and enforcing this rational policy is that it is considered extremely important that a borrower know before signing a promissory note and mortgage or deed of trust exactly how the interest will be calculated on the proposed loan.
In some instances, the percentage rate or the number of basis points that the interest rate floats over the index may have to be adjusted when changing to the new index.
12 CFR § 560.35(d) deals with the requirements for changing from one index to another index for the calculation of interest due under a home mortgage loan contract. It states the following:
“(1) Any index used must be readily available and independently verifiable. If set forth in the loan contract, an association may use any combination of indices, a moving average of index values, or more than one index during the term of a loan.
"(2) Except as provided in paragraph (d)(3) of this section, any index used must be a national or regional index.”
It is a requirement that an index used for mortgage loans must be transparent and available for a borrower to examine so that they are able to find figures that would support the stated index figures and resulting interest rates that they are charged.
Another factor and reason why the governmental banking regulators specify a “national or regional index” is that the governmental banking regulators consider it very important that the index used to calculate borrowers’ interest is beyond the manipulation of a lending institution that would stand to gain from artificially manipulating the index to produce a higher return to the lender at the expense of a borrower that had agreed to pay interest according to another index. This is why 12 CFR § 560.35(d) (2) clearly states that “… any index used must be a national or regional index”.
Remember what I stated earlier regarding a strong desire on the part of the governmental banking regulators to ensure that a borrower knows going into a mortgage loan how her or his interest will be calculated.
The governmental banking regulators have as one of their goals to protect the public welfare by helping to avoid mortgage loan repayment problems where a borrower becomes delinquent on his loan due to his interest being calculated on an index other than the index named in the borrower’s mortgage loan documents, and that may result in the borrower paying a higher interest rate than expected, and going into default, resulting in a loss for the deposit insurance fund. Avoiding these delinquent mortgage payment problems and the resulting foreclosure problems helps minimize the number of bank failures for which the FDIC may have to pay out funds from its insurance fund.
ABOUT THE AUTHOR: Banking and Lending Expert Witness Don Coker
Expert witness and consulting services. 600 cases for plaintiffs & defendants nationwide, 146 testimonies, 12 courthouse settlements, all areas of banking and finance. Listed in the databases of recommended expert witnesses of both DRI and AAJ.
Clients have included numerous individuals, 100 banks, and governmental clients such as the IRS, FDIC.
Employment experience includes Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, BofA, Regions Financial, and a two-year term as a high-level governmental banking regulator.
B.A. degree from the Univ. of Alabama. Completed postgraduate and executive education work at Alabama, the Univ. of Houston, SMU, Spring Hill College, and the Harvard Business School.
Called on by clients in 36 countries for work involving 64 countries.
Widely published, often called on by the media.
Don Coker serves clients worldwide from his Atlanta metro area office.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.