Make sure you understand your option arm

With college costs looming for their four children, Bryan and Susan Andrews were looking for a way to cut their monthly expenses.

The sales pitch that came in the mail seemed perfect: A mortgage at 1.95 percent, fixed for five years.


Bryan and Susan Andrews of Cedarburg, Wis., sued Chevy Chase Bank, saying the lender misled them into taking a high-interest mortgage. (By Darren Hauck For The Washington Post)

"It sounded like a really good program," Susan Andrews recalled recently.

But after the deal closed, in 2004, the couple realized to their horror that the $191,000 loan they got from Bethesda-based Chevy Chase Bank was an adjustable-rate mortgage. The rate has climbed to 8.3 percent and, because of the way the mortgage is structured, the couple now owe more than they did when they signed for the loan

They went to court, saying they were deceived. A federal judge has sided with the couple and is allowing a class-action suit involving up to 7,000 borrowers against Chevy Chase.

The bank is appealing, and on Friday, an appeals court granted its motion for an expedited appeal. The bank says the terms were clearly stated in the contract and that if the family has a grievance, it should be taken to the mortgage broker who sent the original sales flier and acted as an intermediary between them and the bank.

Bryan Andrews, 49, a carpenter, and Susan, 51, a nurse, previously had a 5.75 percent fixed-rate mortgage. The couple, who live in Cedarburg, Wis., say they didn't realize what they had done until they got their first payment coupon for the new loan in the mail. They considered refinancing into a different loan but couldn't do so without a $5,700 prepayment penalty. They sued two years ago.

Last month, U.S. District Court Judge Lynn Adelman, a federal judge in Milwaukee, ruled that Chevy Chase had violated the 1968 Truth in Lending Act, which requires lenders to clearly explain loan terms to borrowers. Chevy Chase's disclosures to consumers showed a "lack of forthrightness" and "would both confuse and mislead an ordinary consumer about the cost of the loan," the judge wrote.

Adelman ruled that while the borrowers were not eligible for damages, they could be permitted to turn back or "rescind" their mortgages. Recision would permit borrowers to be released from the loans, receive reimbursement of any interest they paid to Chevy Chase and get back their closing costs, too.

In other words, the ruling may give some borrowers a refund of everything they have paid to live in their houses for years.

The case worries the lending industry because of the potential for hefty losses if other borrowers are allowed to rescind mortgages they claim were misleading.

The Chevy Chase case underscores the rising uncertainty surrounding the kinds of loans that have emerged in the past five years, said Glenn Costello, managing director of Fitch Ratings Residential Mortgage Backed Securities Group. These loans include such variations as interest-only loans and what are known as option ARMs, which allow people the choice of paying less each month than the interest would be. In many of these loans, the amount owed is deferred to keep monthly payments down. The downside is that at some point payments can rise sharply. The amount owed can rise, too.
Banking regulators have only recently begun offering new information to borrowers about these loans and warning lenders to explain them more carefully. In the meantime, the loans have proliferated. In the Washington area, for example, nontraditional mortgages accounted for almost half of the purchase and refinance loans made last year.

"Some percentage of borrowers don't understand the terms of these loans, and it is to be expected that there would be some issues emerging," Costello said.


Bryan and Susan Andrews of Cedarburg, Wis., sued Chevy Chase Bank, saying the lender misled them into taking a high-interest mortgage. (By Darren Hauck For The Washington Post)

Chevy Chase says it has done nothing wrong. The bank complied with the truth-in-lending law, said Thomas H. McCormick, the bank's general counsel.

In its court filings, Chevy Chase lawyers said the Andrewses' loan was appropriate for them because it gave them more "flexibility" by letting them choose what level of payment they would make each month, and that if the family has a grievance, it should be taking it to the mortgage broker, First Mortgage, which arranged the loan.

"Simply put, to the extent that Plaintiffs have a legitimate grievance, they have sued the wrong party," Chevy Chase's lawyers wrote. First Mortgage, which was not sued, did not return calls seeking comment.

At the core of the dispute are some words that appeared on the top right corner of a document the lender must provide under the Truth in Lending Act. One line read: "WS Cashflow 5-year fixed," and the line under it said "Note Interest Rate: 1.950%."

The Andrewses said those words led them to believe the loan was a fixed-rate mortgage for five years, at 1.95 percent interest, and that they were reassured of its meaning by the broker at First Mortgage who handled the loan on behalf of Chevy Chase. In fact, the 1.95 percent offer was a teaser rate that lasted one month, and the interest charged on the loan started rising the next month. And the "fixed" feature had nothing to do with the interest rate. Rather, it meant the lowest possible payment stayed the same -- $701 a month -- over five years, although the interest rate rose, with the additional expense deferred to the end of the loan.

"This statement was confusing because although it is true that the payments on the loans were fixed for five years, the interest rate was not," the judge wrote.

Chevy Chase argued that there were many other places in the loan documents that signaled the loan was not a traditional fixed-rate product, noting that one section had a bold-faced title: ADJUSTABLE RATE NOTE and that another section was titled "Calculation of interest rate changes."

In addition, the same federal disclosure form cited by Bryan and Susan Andrews included another box, labeled ANNUAL PERCENTAGE RATE, which noted that the interest rate was 4.047 percent, and said below that the loan had variable-rate features.

According to Chevy Chase's McCormick, the WS Cashflow reference and the 1.95 percent notation were loan identifiers used by Chevy Chase "for internal purposes," to identify the kind of loan and that the full phrase that was supposed to be on the document was "WS Cashflow 5-year fixed pay," but that the last word sometimes got lopped off when the documents were being photocopied.

"The inadvertently truncated language was found by the court to create the possibility of confusion," McCormick said.

The Andrewses should have reviewed the documents more thoroughly, according to McCormick and other bank lawyers. The couple showed "consistent and stunning lack of interest in reading the documents they signed," Chevy Chase lawyers said. The bank also quoted Susan Andrews as saying in a deposition that she trusted the broker and did not think she needed to "read every tiny word."

Kevin Demet, the couple's lawyer, said Chevy Chase was trying to dodge responsibility. "Chevy Chase's attitude was to blame the broker," Demet said.

McCormick said the banking industry doesn't think the Andrews case will set a precedent. Last week the 1st Circuit Court of Appeals in Boston ruled in a similar case that a lower court "lacked the authority" to give these lending claims class-action status. In that case, according to the judges who issued the ruling in favor of the lender, First Horizon Home Loan, the bank's exposure could have been $200 million.

The ultimate cost to Chevy Chase if it loses its appeal is uncertain; so is the number of loans that could be affected. McCormick declined to say how many loans would be involved, except that it would be much fewer than the 7,000 the judge estimated.