When the California predatory lending law (CA Financial Code Section 4970 et seq.) (the "Covered Loan Law") became effective on July 1, 2002, we noted that there was some confusion regarding the treatment of yield spread premiums and other lender-paid back end compensation for purposes of the Covered Loan Law's total points and fees test. Based on our interpretation of the applicable provisions of the Covered Loan Law, we concluded that such compensation should not be included as points and fees. In a recent California appellate court case, the court reached the same conclusion that we did: YSPs should not be included as points and fees under the Covered Loan Law. Wolski v. Fremont Investment & Loan, 125 Cal. App. 4th 12, December 2, 2004.

The plaintiff, Daniel Wolski, working through a a mortgage broker, sought and obtained an ARM loan from Fremont Investment & Loan. Mr. Wolski's mortgage broker received a YSP payment of $3,700 from Fremont in connection with the loan. Fremont did not include the amount of the YSP in its points and fees calculation. Therefore, according to Fremont's points and fees calculation, total points and fees were less than 6% of the total loan amount, and hence the loan was not a covered loan.

After the loan closed, Mr. Wolski discovered that he could have obtained a loan with a lower and fixed rate. Mr. Wolski filed suit against Fremont claiming, among other things, a violation of the Covered Loan Law because Fremont had failed to make certain required disclosures and had included a prepayment penalty in the terms of his loan. Mr. Wolski argued that Fremont's YSP payment to the broker was a point and fee, and when so construed, total points and fees exceeded 6% of the total loan amount rendering his loan a covered loan. The trial court concluded that the YSP payment was not a point and fee and that the loan was not a covered loan. Wolski appealed. The appellate court upheld the trial court's decision.

The appellate court began its discussion by quoting the relevant definition from the Covered Loan Law: a covered loan is one where "total points and fees payable by the consumer at or before closing for a mortgage or deed of trust will exceed 6 percent of the total loan amount." (emphasis added.) The court then explained that a YSP is a bonus paid by a lender to a broker for delivering a loan with an interest higher than minimum otherwise approved by the lender for the loan. In return for the lender's payment of the YSP to the broker, the borrower pays a higher interest rate for the life of the loan.

Fremont contended that because a YSP is paid by the lender and not the borrower, a YSP falls outside the definition of points and fees because it is not "payable by the consumer." Wolski contended that he did in fact pay for the YSP in the form of a higher interest rate. Fremont countered that even if the statute could be construed as Wolski suggested, the fact is that the YSP is not "payable at or before closing." The court agreed with Fremont.

The court noted that the meaning of the phrase "at or before closing" was unambiguous and "does not include payments made after closing and over the life of the loan, such as interest." The court then dismissed Wolski's argument that "even though the YSP is not 'paid' at or before closing, it is 'payable' at that time," concluding that such a reading of the word "payable" was "strained and anomalous," and that "[t]o construe the language to include one payment made over the life of the loan, when all others are paid at closing, would lead to an absurd consequence, in derogation of rules of statutory interpretation." (citations omitted.) Finally, the court rejected Wolski's claim that the legislative history supported his position, noting both that the legislative history was devoid of any discussion of the treatment of YSPs, and that in any event, resorting to legislative history was appropriate only in cases where the statutory language was ambiguous, uncertain or unclear, a precondition that did not exist in this case. After its analysis, the court concluded: "Thus, we may safely infer the Legislature was aware of the mechanics of YSPs and understood that they are paid by the lender with a concomitant higher interest owed by the borrower. Had it intended that a YSP be included as "points and fees payable by the consumer at or before closing" (§4970, subd. (b)(1)(B)), it would have included appropriate language."

Despite the favorable outcome, the court's rationale is a bit curious. The court largely ignores the strongest argument for excluding YSPs from points and fees, namely the clear and unambiguous language of the Covered Loan Law that points and fees must be payable by the borrower. The fact that YSPs are paid by the lender would seem to settle the matter. To buttress its conclusion, the court could have noted the similarity of the Covered Loan Law's definition of points and fees to the definition under Regulation Z (indeed, the Covered Loan Law makes numerous references to Regulation Z) and pointed out that the Federal Reserve Board's official staff commentary to Regulation Z expressly excludes YSPs from points and fees. Comment 1 to Paragraph 226.32(b)(1)(ii) entitled Mortgage broker fees provides: "In determining "points and fees" for purposes of this section, compensation paid by a consumer to a mortgage broker (directly or through the creditor for delivery to the broker) is included in the calculation whether or not the amount is disclosed as a finance charge. Mortgage broker fees that are not paid by the consumer are not included. Mortgage broker fees already included in the calculation as finance charges under §226.32(b)(1)(i) need not be counted again under §226.32(b)(1)(ii)." (emphasis added).

The court could have noted that the Covered Loan Law in fact expressly excludes interest as a point and fee. Specifically, the definition of points and fees includes in part "all items required to be disclosed as finance charges under Sections 226.4(a) and 226.4(b) of Title 12 of the Code of Federal Regulations, including the Official Staff Commentary, as amended from time to time, except interest." (emphasis added). A clearer expression of a legislative desire and intent could hardly be asked for. The court could have concluded that the express language of the Covered Loan Law's points and fees test excludes interest, whether paid at closing (in the form of interim or odd days' interest) or over the life of the loan.

A final word of caution: the possibility remains that this decision could be appealed to a higher court. Should that happen, we will be sure to notify our readers.