This is the second part of a five-part series that explores issues related to discount points. The previous article provided a primer on discount points. This article explores UDAAP concerns that result from unearned discount points.
Unearned discount points may result in charges of unfair, deceptive or abusive acts or practices (UDAAP). An act or practice is deceptive when:
- The representation, omission, or practice misleads or is likely to mislead the consumer;
- The consumer’s interpretation of the representation, omission, or practice is reasonable under the circumstances; and
- The misleading representation, omission, or practice is material.
Mislead the Consumer – Charging unearned fees may be considered deceptive if the lender falsely represents that points are discount points. Unearned discount points may result in charges of UDAAP violations if the lender knew, prior to closing, that the interest rate reduction was inappropriate relative to the discount points charged and if borrowers were informed they were paying discount points.
If the lender charges 5% and one point how would the consumer or the examiner know if discount points are imposed? Points are reflected on the closing statement, are reported on the IRS Form 1098, and may be disclosed in other ways. But even when disclosed in one way or another it is not clear whether points are imposed, and if imposed, whether the points are discount points or origination fees.
HUD-1 – On the current HUD-1 points are lumped in line 801 with other charges and none of the charges included in line 801 are itemized on the form. On the version of the HUD-1 in use prior to January 1, 2010 discount points were separately itemized on Line 802. And the instructions for the new Closing Disclosure, that will replace the HUD-1 sometime in the next few years, specifically require discount points to be separately itemized in the “Origination Charges” section of the form. So the issue of whether discount points were imposed was a greater concern in the past and will be a greater concern again in the future.
Form 1098 – Points are included in Block 2 on the Form 1098, but the total may include “loan origination fee,”, “loan discount,” “discount points,” or “points,” if computed as a percentage of the stated principal loan amount.
Other Ways – A lender might mention points orally, in an advertisement, or in an a offering memorandum, but unless the term “discount points” is used it is not clear whether the points are discount points or origination fees.
Interpretation is Reasonable – The test is whether the consumer’s expectations or interpretation are reasonable in light of the claims made. If a financial institution represents that a consumer can lower their loan rate by paying discount points, and those points are itemized on the final HUD-1 Settlement Statement or in some other manner, the consumer may reasonably believe that the lender will provide a discounted interest rate.
Materiality – Finally, the misrepresentation would be considered material if it concerned a sufficiently large amount of unearned fees or affected a large group of borrowers. Claims made with the knowledge that they are false should be presumed to be material. When a lender has knowledge that fees disclosed as discount points do not result in a discounted interest rate to the borrower would be presumed material.
A few simple steps can assure these UDAAP issues do not become violations.
- Spread the Word. Share this article with lenders to make them aware of potential problems.
- Make sure your pricing policy or guidelines are specific and state that loan officers are prohibited from charging discount points that do not result in a proportional lowering of the interest rate.
- Create controls to assure, before closing, that any discount points are earned.
- Make sure audit/compliance review procedures specifically require testing to assure discount points are earned.