During the subprime mortgage boom, several subsidiaries of Wells Fargo Bank, including Wachovia Bank, offered pick-a-payment adjustable rate mortgage (ARM) loans. Borrowers could choose to make interest-only payments or lower minimum payments. If a payment was insufficient to cover the interest owed, unpaid interest was added to the loan balance.
When the banks sold the ARM loans, the documents said the payments would amortize both principal and interest and that “from time to time” the monthly payment “may be insufficient” to pay the total amount of monthly interest due. But the low monthly payment the banks listed in the loan contracts was based on a 1 percent to 3 percent interest rate, which was much lower than would ever be applied to the ARM loans. If borrowers paid only the scheduled payment amount, it didn’t cover the monthly interest. Thus, their equity in their houses was reduced each month to subsidize the low payments—a process called negative amortization—and the amount of debt the borrowers owed increased with every payment they made.
The loan contracts also contained a prepayment penalty clause, so that even if borrowers realized that negative amortization was occurring, they couldn’t pay more each month to cover the debt without incurring substantial penalties. Because their equity had decreased, they were also ineligible for refinancing or loan modification, leaving them no way to reduce the debt.
Several borrowers filed class actions against Wachovia Bank, Wells Fargo Bank, and other subsidiaries on behalf of about 600,000 people who entered into pick-a-payment loans between August 2003 and December 2008. The suits were consolidated into multidistrict litigation in South Carolina.
The plaintiffs claimed the defendants violated the Truth in Lending Act (TILA) by not clearly and conspicuously disclosing that the payment schedule was not based on the interest rate that would apply to the borrowers and that borrowers would be subject to negative amortization if they adhered to the schedule. The class also alleged breach of contract and the implied covenant of good faith and fair dealing, fraudulent inducement, and state consumer fraud violations.
The plaintiffs were divided into three subclasses: those who no longer had their loans, non-defaulting borrowers who still had their loans, and borrowers in default who still had their loans.
The banks claimed that the loan documents clearly disclosed the loans’ terms. They also argued that the TILA and fraudulent-inducement claims were time-barred and that the state law claims were preempted by the Home Owners’ Loan Act, which gives the Office of Thrift Supervision exclusive authority to regulate federal savings associations.
The parties settled for $50 million, to be allocated on a pro rata basis, plus attorney fees. The banks agreed to offer permanent loan modifications to eligible members who are in default on their loans or are in imminent danger of default because of a substantial reduction in income. Members who do not qualify for loan modification will be offered up to $1,500 for a short sale or deed in lieu of foreclosure. The modification program is valued at about $600 million.
The court has granted preliminary approval and will consider final approval at a fairness hearing in April.
Citation: In re: Wachovia Corp. Pick-a-Payment Mort. Mktg. & Sales Pracs. Litig., No. 5:09-md-02015 (N.D. Cal. Dec. 16, 2010).
Plaintiff counsel: David M. Arbogast and Jeffrey K. Berns, both of Woodland Hills, California.