Introduction

A recent decision by the Massachusetts Court of Appeals highlights some of the challenges lenders may face when seeking the dismissal of allegations of unfair and deceptive lending practices in connection with a loan that requires a balloon payment at the end of the loan’s term.

The case, Moronta v. Nationstar Mortgage, LLC, 41 N.E.3d 311 (Mass. Ct. App. 2015), involved a borrower who purchased a home in 2004. The borrower later refinanced his loan, and the modified loan included a balloon payment approaching 90% of the note’s full value. The borrower later defaulted on the loan and brought an action alleging “unfair and deceptive” practices.

On appeal, the Massachusetts Court of Appeals analyzed the issues under two prior precedents–one setting forth four specific factors for the presumption of unfairness and deception, and the other holding that a court’s determination need not be strictly limited to those factors. The Court of Appeals reversed the trial court’s denial of the lender’s motion for summary judgment, finding that the borrower had raised “a genuine issue of material fact as to whether the loan is unfair under” Chapter 93A of Massachusetts General Laws, and that the decision of unfairness or deception should be left to the fact finder.

The Allegedly Unfair Loan Modification

According to the allegations in the complaint, the borrower financed his purchase with an adjustable-rate mortgage loan for approximately $330,000. He later sought the assistance of a mortgage broker to refinance his loan. The borrower alleges that the broker obtained an appraisal of the borrower’s property, which had a value of $420,000, and then the broker submitted the borrower’s application to Fremont Investment & Loan (“Fremont”). Although the borrower received various disclosures from Fremont, he admittedly read none of these important documents.

The refinancing resulted in two separate loans totaling $370,000, including: (1) an adjustable-rate loan for $296,000 with an initial interest rate of 7.9%; and (2) a fixed-rate loan for $74,000 with an interest rate of 10.5%. The loans were later transferred to Nationstar Mortgage, LLC (“Nationstar”). The adjustable-rate loan would have its first adjustment three years after the loan’s issuance. However, before any interest rate adjustment occurred, the borrower defaulted.

The borrower alleges that he sought a loan modification from Nationstar, but the modification was rejected and Nationstar notified the borrower of its intent to foreclose. The borrower then brought an action against Nationstar and Fremont in 2010, claiming wrongful foreclosure and violations of Massachusetts’s consumer protection laws. The lower court granted Nationstar’s motion for summary judgment.

The Trial Court’s Analysis

The Superior Court of Massachusetts granted Nationstar’s summary judgment motion. The court rejected the borrower’s wrongful foreclosure claim because the injunction imposed upon Fremont in another case had no retroactive application to loans already assigned. The court also rejected the borrower’s claim that Nationstar’s loan modification practices were unfair because he failed “to present facts sufficient to constitute unfair and deceptive acts” under Chapter 93A.

The Superior Court analyzed the borrower’s Chapter 93A claim under the Fremont factors. See Com. v. Fremont Inv. & Loan, 897 N.E.2d 548 (2008). Courts in Massachusetts use the four Fremont factors to determine if a loan should be presumed to be unfair. The factors are as follows:

1) The loan is an ARM loan with an introductory period of three years or less;
2) The introductory rate for the initial period is at least 3% below the fully indexed rate;
3) The borrower’s debt-to-income ratio for the loan would have exceeded 50% if one measured the borrower’s debt by the monthly payments due under the fully indexed rate rather than the introductory rate; and
4) The loan-to-value ratio is 100% or the loan included a substantial prepayment penalty.

The borrower argued that his loans met the Fremont factors. The Superior Court, however, disagreed, concluding that no genuine issue of material fact existed regarding the fourth Fremont factor and granted summary judgment to Nationstar. The borrower’s loans were only 88% of the property’s appraised value—well short of the 97% required by the fourth factor. See Commonwealth v. H & R Block, 2008 WL 5970550 (Mass.Super.Ct. Nov. 24, 2008) (modifying standard set forth in Fremont).

Moreover, the court found that the borrower did not even know his property’s value. His use of an assessor’s valuation and a Zillow valuation were found unreliable by the court. The court cited another ruling where the judge, when presented with a Zillow.com “zestimate,” ruled that “[i]nternet searches are insufficient evidence of property value because they are at best questionable and at worst evidence of nothing.”

The Appellate Decision

Although the Massachusetts Court of Appeals affirmed the Superior Court’s first two findings, it disagreed with the Superior Court’s analysis of the Fremont factors. The appellate court analyzed all four Fremont factors, concluding that the first two factors were met. Regarding the third and fourth factors, the Court noted several instances in the record that raised questions about the borrower’s ability to repay the loans such as whether Fremont had considered the balloon payment in the debt-to-income ratio, whether the broker was Fremont’s agent, whether Fremont inflated the borrower’s income, and whether the loans were actually 100% financed.

Moreover, because Fremont had used a “piggy-back loan” split in another case that the Supreme Judicial Court had deemed unfair and because neither Fremont nor Nationstar provided an explanation for the use of two loans, the appellate court concluded that this supported an adverse inference that the loan-to-value ratio approached 100%.

The Massachusetts Court of Appeals also found that the borrower’s loans did “not exactly meet the criteria set forth in [Fremont], in terms of loan-to-value ratio and percentage of financing” and that the borrower received some benefits from the refinancing. However, the appellate court relied on the Supreme Judicial Court’s analysis in Drakopoulos v. U.S. Bank National Association, 991 N.E.2d 1086, 1095 (Mass. 2013) that a determination of unfair and deceptive was not limited to the Fremont factors.

The overarching consideration for courts was whether at origination, the lender “should recognize at the outset that the borrower is not likely to be able to repay.” Id. at 1095. As a result, the Massachusetts Court of Appeals concluded that the overall refinancing, which used a balloon payment approaching 90% of the note’s full value, raised “a genuine issue of material fact as to whether the loan is unfair under” Chapter 93A and the decision of unfairness or deception should be left to the fact finder. 41 N.E.3d at 318.

Conclusion

This case is an important reminder that, in some jurisdictions, certain technical criteria regarding ability to repay may operate only as presumptions. Lenders should take note of the Moronta decision, not just as a notable precedent in Massachusetts but also a possible indication or predictor of how some courts in other states may approach an ability to repay analysis.