Carnell, a self-employed 64 year old single man with no dependents, applied to KMC Mortgage Co. (KMC) to refinance a first and second mortgage and get cash to buy tools for his small business. Besides what he earned as a general handyman, he received Supplemental Security Income (SSI) for a disability. At application he talked loudly to himself, had questionable personal hygiene and wore slightly ragged clothing. He boasted loudly how he “took care of himself,” doing his own cooking, etc. The broker determined that – subject to the appraisal – there was sufficient equity to pay off the underlying mortgages, cover loan costs, and leave about fifteen hundred dollars, but warned him that his monthly payment was likely to be much higher than his current payment. Carnell advised KMC to go ahead with the deal because he “needed the money.”

The appraisal was sufficient but noted that the home’s interior was so filled with personal items, books, magazines and debris that the owner had made high narrow lanes in order to use the rooms. A preliminary title report showed a junior lien in favor of King County Public Assistance securing a loan that was used to assist in purchasing the property. The loan terms required no monthly payments with interest at 4% per annum to accumulate as long as Carnell occupied the home as his principal residence. Upon sale of the home, the entire principal balance was payable. There was a property tax abatement certificate on the home as long as Carnell used it as his principal residence.

The credit report showed 1×30 and 2×60 in the last two years and the credit score was within the guidelines of KMC’s investor. His use of credit was sparse and included one very small balance, never exceeding three hundred dollars. An old pickup truck used in the business was paid for and the business was run on a cash basis. His tax returns showed an average combined monthly income for the last three years of $1,066. and the current monthly payment on the first mortgage was $454. He had little cash reserves with an average bank balance in the high threes.

The broker contacted CALFUND (the investor) by phone to discuss “how we can put this together.” The investor advised that this was a case where the underwriting theory of attributable income could be used.  Because Carnell’s SSI income was not taxable, and the property tax abatement lowers even more tax liability, it would allow KMC to “gross up” the SSI income “to an appropriate amount.” KMC adjusted Carnell’s income by 25%. The investor subsequently indicated by phone that the loan would be approved provided there were no debts other than the new mortgage; and he paid an additional 1% of the loan amount because of the increased risk.

The broker telephoned Carnell with the loan approval and informed him of the new monthly payment, then asked if he had any questions. He responded that he was quite happy and had no questions. KMC did not notify him of the additional cost at this time, explaining that they prepared a new GFE and mailed it to his residence as required by regulation. Carnell claims he never received the notice.

In preparation to close the loan, final payoff statements were ordered from the holders of the first and second mortgages. King County P.A. responded with a final principal amount that included all of the accumulated interest and a per diem charge.

Examination of the loan documents showed that KMC changed its initial GFE and final Settlement Statement to include an additional two percent with one percent going to the investor and an additional percent listed on line 808 of the closing statement as a brokerage fee. A brokerage fee had already been combined with the investor’s fee and reported on line 801 of the closing statement. Carnell signed all final documents without comment or question and the investor wired the funds to escrow.

Seven months later, failing to cure payment delinquencies, Carnell defaulted on the loan. The file showed that he had difficulty meeting monthly payments. The investor demanded that the broker buy the loan back. KMC responded that the investor itself had helped put the loan together. When asked for proof of this, KMC revealed the phone conversations it had with an employee of the investor. The investor found no record of the conversation. The issue between KMC and the investor remained unresolved.

Several months later, the property was foreclosed upon and Carnell lost his home. A lawsuit was brought against both KMC and the investor to recover damages and rescind the entire transaction, seeking to put Carnell in the position he was before applying to refinance. Several violations of state and federal law were claimed in the suit.

KMC’s position was that it did nothing wrong, claiming that a customer had applied to refinance his home; the company followed usual and customary lending procedures and gained loan approval.  It was not unusual for details to have been discussed with the investor. It followed all regular procedures of loan brokerage and complied with disclosure rules. After learning that the final loan costs were greater than estimated they acted in good faith by re-disclosing. They further pointed out that the final settlement statement revealed all of these charges but were not challenged at closing.

The investor claimed that it dealt with KMC at arms length and could find no record of offering “extraordinary assistance” in qualifying Carnell. It was against their policy to offer step-by-step procedures to brokers in order to customize a loan to fit corporate matrixes, “A loan either fit our program or it didn’t,” according to their testimony. Further, the contract between KMC and the investor contained a provision with regard to early defaults, which they chose to exercise.
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Questions.
A broker must use reasonable care in managing a file from application through closing to assure a standard of care commensurate with the duties of agency and brokerage. Some courts have even held licensed brokers to a higher than reasonable standards because the general public considers them experts. In considering how this case was handled, what would have caused you concern if it were given to you for review? Be prepared to discuss the following:

1. What kind of a borrower does Carnell look like on paper?  Does an applicant’s conduct and demeanor at application have relevance to the case or should they be overlooked? After all, they have nothing to do with credit – by law the only basis on which we are to judge credit worthiness.

2. Documentation. Are there any inquiries you would have made or any additional documents/exhibits you would have required before continuing to process and submit this case for approval? Explain what and why you would order more documentation.

3. Customer Service. Consider the position of the borrower before and after dealing with KMC Mortgage Company. Did the broker help the borrower achieve what he wanted? Was the borrower well served?

4. Verdict.  If you were on the jury would you find in favor of Carnell or the broker/lender?