3.4 Prohibited Acts, Fee Restrictions & High-Cost Mortgages

3.4 Prohibited Acts, Fee Restrictions & High-Cost Mortgages

California maintains robust consumer protection statutes to protect homeowners from predatory lending practices, abusive fee structures, and high-cost loan traps. Key statutory protections include prohibited conduct rules under the California Financing Law (CFL) and California Residential Mortgage Lending Act (CRMLA), statutory prepayment penalty caps under Civil Code Section 2954.9, and High-Cost Mortgage restrictions under California Financial Code Sections 4970–4979.8.

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Prohibited Acts & Practices under CFL and CRMLA

Licensees and MLOs are subject to severe civil administrative fines and license revocation for engaging in any of the following prohibited sales practices:

1. Loan Churning (Repeated Refinancing)

Churning is the practice of inducing a homeowner to refinance an existing mortgage repeatedly within a short timeframe when the transaction yields no Net Tangible Benefit (NTB) to the borrower. Churning generates origination fees for the MLO while stripping equity from the consumer.

• Net Tangible Benefit Standard: A refinance must provide a verifiable benefit, such as a significant reduction in APR, switching from an adjustable-rate mortgage (ARM) to a fixed-rate loan, or eliminating private mortgage insurance.

2. Steering

Steering occurs when an MLO directs a qualified applicant into a higher-cost or riskier loan product (e.g., a high-rate subprime ARM) when the borrower qualifies for a lower-cost, safer loan (e.g., a prime fixed-rate mortgage). Steering is typically driven by higher MLO compensation schedules.

3. Unearned Fees & Kickbacks (RESPA & California Law)

Under state law and RESPA Section 8, licensees are prohibited from paying or receiving unearned referral fees, kickbacks, or splits of unearned charges. Charging a borrower an inflated "markup" for third-party appraisal or credit report fees and pocketing the difference is strictly illegal.

4. Misrepresentation & Fraud

Falsifying borrower income, altering bank statements, fabricating employment verifications, or colluding with appraisers to artificially inflate property valuations constitutes mortgage fraud under California Penal Code § 532f.

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California Prepayment Penalty Limitations (Civil Code § 2954.9)

A prepayment penalty is a fee charged to a borrower who pays off or reduces their principal loan balance ahead of schedule. Under California Civil Code Section 2954.9, prepayment penalties on residential loans (1-to-4 unit owner-occupied dwellings) are governed by strict statutory limits:

1. Five-Year Absolute Window

Prepayment penalties are permitted ONLY during the first 5 years (60 months) from the date of loan execution. Any contract provision attempting to assess a prepayment penalty after 5 years is completely void and unenforceable.

2. The 20% Annual Penalty-Free Allowance

In any 12-month period during the first 5 years, the borrower has the statutory right to prepay up to 20% of the original principal loan balance WITHOUT incurring any penalty.

3. Maximum Penalty Calculation

If a borrower prepays more than 20% of the original principal balance within a 12-month period during the first 5 years, the maximum penalty that may be assessed is capped at:

• Six (6) months' advance interest calculated on the amount prepaid in excess of 20% of the original principal balance.

                  CIVIL CODE § 2954.9 PREPAYMENT PENALTY CALCULATION
                                          |
                  Is Loan Age > 5 Years (60 Months) from Execution?
                                          |
                   +----------------------+----------------------+
                   |                                             |
                  YES                                            NO
                   |                                             |
       PENALTY STRICTLY PROHIBITED               Prepayment Amount within 12 Months
                                                         |
                                    +--------------------+--------------------+
                                    |                                         |
                           Up to 20% of Principal                    Exceeding 20% of Principal
                                    |                                         |
                              PENALTY = $0                        MAX PENALTY = 6 Months Interest
                                                                  on Amount OVER 20%

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Covered Loans / High-Cost Mortgages (Cal. Fin. Code §§ 4970–4979.8)

California Financial Code Sections 4970 through 4979.8 establish statutory consumer protections for Covered Loans (California's High-Cost Mortgage Act). A loan secured by a 1-to-4 unit residential property is legally classified as a Covered Loan if it satisfies either the APR Trigger or the Points and Fees Trigger.

Statutory Triggers (§ 4970)

1. APR Trigger:
   • First Liens: APR exceeds the Average Prime Offer Rate (APOR) by more than 8 percentage points.
   • Subordinate Liens: APR exceeds APOR by more than 10 percentage points.
2. Points & Fees Trigger:
   • Total points and fees payable by the borrower at or before closing exceed 6% of the total loan amount (or a statutory dollar threshold for small loans).

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Prohibited Terms & Mandatory Restrictions in Covered Loans

Once a loan meets the Covered Loan definition under § 4970, statutory law strictly prohibits the inclusion of specific high-risk loan features:

1. Prohibition on Short Balloon Payments

A Covered Loan cannot contain a balloon payment provision if the loan term is less than 5 years (60 months). (The loan must provide full amortization over at least 5 years).

2. Prohibition on Negative Amortization

Covered Loans strictly ban negative amortization. The scheduled monthly payments must fully cover accrued interest so the principal balance never increases.

3. Restrictions on Refinancing Covered Loans

A lender cannot refinance an existing Covered Loan into another Covered Loan within one year of origination unless the new loan provides a demonstrated financial benefit to the borrower.

4. Advance Interest & Fee Restrictions

Lenders cannot collect more than two months of advance interest from loan proceeds. In addition, yield spread premiums cannot be paid to brokers without full written disclosure.

5. Mandatory Housing Counseling Disclosure

Before executing a Covered Loan, the lender must provide the borrower with a written notice advising them to seek independent housing counseling from a HUD-approved counseling agency.