The following is general legal infomation only and not legal advice. For specific questions about your case please consult an attorney.
Attorney Steve Vondran is licensed to practice law in California and Arizona and is currently helping homeowners with forensic loan audits, loan modifications and predatory lending issues. Mr. Vondran can be reached at steve@vondranlaw.com or by phone at (877) 276-5084.
Ambiguous Contract Terms May Provide Clarity In Determining Legal Remedies Against Lenders
When two parties enter into a contract, the contract is said to represent the mutual assent of the parties. In other words, the contract represents the written understanding of the parties' responsibilities to each other. When the terms of the written contract are ambiguous, confusing, contradictory, or unclear, a court may decide that the intent of the parties cannot be sufficiently determined and therefore the contract is unenforceable. In the context of a mortgage loan, ambiguous terms may avail the borrower of certain legal remedies including, but not limited to: rescission of the contract under the federal Truth in Lending Act ("TILA"), a preliminary injunction to prevent foreclosure (pending the resolution of a trial), or monetary damages under state law. These ambiguous terms are particularly useful when seeking an injunction to prevent foreclosure. Courts are more likely to enjoin a foreclosure where the drastic implications of foreclosure are especially apparent, such as where the borrower and lender have a dispute under the contract.
There are four contract terms frequently appearing in loan notes that courts have found are at least ambiguous enough to advance to trial and may support these legal remedies. In Monaco v. Bear Sterns, 554 F.Supp.2d 1034 (C.D.Cal. 2008) and Plascencia v. Lending First Mortgage, 2008 WL 1902698 (N.D.Cal. Apr. 28, 2008), two federal district courts examined these terms. Below are some terms to look for in your loan note and the courts' analysis explaining the ambiguity these terms exhibit.
The Use of "Will" and "May" In the Terms of the Note.
Often times, lenders will use the words "will" and "may" in a way that contradicts each other and creates confusion. For example, in the note examined by the court in Monaco, Section 2 stated that the borrower "will pay" interest at a yearly rate of 1% but that the rate "may change" according to Section 4. However, Section 4 provided that the interest rate "will change" on the first payment due date and that it "will never be lower than 3.500%. By reading these two sections together, Section 2 informs the borrower that his rate "may change," while Section 4, informs him that the rate "will change." Thus, as the court notes, Section 4 is inconsistent with Section 2 because Section 2 states that a change in the interest rate is a "mere possibility," while Section 4 states that a change in the interest rate is an "absolute certainty."
Stating a Flat Interest Rate, While Providing a Formula for Calculating the Actual Interest Rate
Similar to the use of "may" and "will" when talking about changing interest rates, lenders will state a flat interest rate in one section and then provide a formula for calculating the actual interest rate in another section. This technique was used by the lender in Plascencia. There, the note disclosed in Section 4 the rules for calculating the interest rate on the mortgage, but provided in Section 2 that the interest rate will be 1%. Moreover, in Plascencia, the lender provided a TILA disclosure statement that listed the initial monthly payment on the basis of 1% interest. Based on these terms, it is easy to see how the court concluded that there might have been some confusion on the part of the borrower. As the court pointed out, this "could have led Plaintiffs to believe that the loan would accrue interest at a low rate," but when "considered as a whole, the disclosures provide confusing and seemingly contradictory information concerning the true interest rate of the loan."
A Description of How the Payments Will Be Applied and the Possibility of Negative Amortization.
Another trick lenders use to create confusion on the part of the borrower is to hide the fact that negative amortization may result under the terms of the loan, by using confusing terms to describe how payments will be applied. Negative amortization occurs when the monthly payment is not sufficient to cover the amount of interest that is due. If the monthly payment does not cover the full amount of interest, the balance of the interest is added to the principal amount, resulting in an increase in the principal due.
In Monaco, for example, Section 3 of the note states "I will pay principal and interest by making a payment every month." Immediately below this statement, the note provides: "I will make these payments every month until I have paid all of the principal and interest and any other charges described below that I may owe under the Note."
Later provisions of the note add to the confusion. In Section S(F), the Note describes three additional payment options, which describe how payments are to be distributed between principal and interest. Two of these payment options ensure an amortized payment by requiring the borrower to "pay the amount necessary to pay the loan off (Principal and interest)...." On these terms, one could reasonably interpret these statements to mean that payments will be applied to both principal and interest, while the second statement in Section 3 indicates that negative amortization is a possibility.
However, in light of the ambiguous interest rate described above, the possibility exists that payments will not necessarily be applied to both principal and interest. Therefore, the court concluded that "just as the Note uses the term ‘may' to warn of interest rate change that is certain to occur, the Note describes negative amortization as a possibility when in fact it is certain to occur under the terms set by [the lender]. At the top of the Note's first page, the borrower is warned that the Note ‘may require' - as opposed to, more accurately, ‘will require' - unpaid interest to be added to loan principal."
The Initial Interest Rate was Discounted
Finally, the lenders may attempt to hide the fact that the initial interest rate is discounted from the rate that will actually be imposed throughout the life of the loan. This technique was demonstrated in Plascencia. There, the loan stated that it will accrue interest at a rate of 1%, although the Note further states that the rate "may change in accordance with Section 4 of the Note." Section 4 goes on to state in detail the rules for subsequent interest rate changes. The court found that these terms suggest that the borrower may be able to demonstrate that they were not alerted in clear and conspicuous terms that the 1% interest rate was a discounted rate, and would be adjusted upwards in the near future. Moreover, the lender provided materials must clearly advise the borrower to inquire about the amount of the discount.
Conclusion
Although not dispositive on the merits of any claim, contract ambiguities may go a long way to saving a mortgage facing foreclosure. By demonstrating that the terms were so ambiguous, confusing, and contradictory, a lender may be able to provide the court with adequate reason to enjoin the foreclosure, so as to decide what the loan terms are, as well as, possible damages under the many consumer protection laws. Furthermore, the court in so doing, will interpret the contract in favor of the non-drafting party. In other words, the contract will be interpreted in favor of the borrower. This might provide either (1) a de facto modification of the contract to the most favorable terms in the contract; or (2) an incentive for the holder of the note to work with the lender to modify the terms of the note. Either way the loan terms will be more beneficial to the non-drafting borrower in the sense that ambiguous contract terms will be construed in favor of the non-drafting borrower and the borrower and might be permitted to obtain an injunction allowing them to stay in the home.
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