California Passes Homeowner Bill of Rights, Increases Liability for Servicers

California lawmakers passed a package of foreclosure prevention bills Monday that will slow foreclosures, impose stricter rules on mortgage servicers and potentially raise the cost of getting a home loan in the most populous state.

The Homeowner Bill of Rights, sponsored by California Attorney General Kamala Harris, expands some of the requirements of the national mortgage settlement to all mortgage servicers in the state.

The state assembly approved the legislation by a 53-25 vote, and the Senate approved it by a 25-13 vote.

The legislation allows California homeowners to sue servicers to stop foreclosures under certain conditions or to seek monetary damages if the lenders intentionally or recklessly violate state law. Some lenders said the liability provision would lead to more lawsuits against servicers and force bank's mortgage lending arms to raise borrowing costs.

The cornerstone of the legislation mirrored provisions of the national settlement earlier this year between federal regulators and the five largest servicers, including Ally Financial (ALLY), Bank of America (BAC), Citigroup (NYSE: C), JPMorgan Chase (JPM) and Wells Fargo (WFC).

The Foreclosure Reduction Act prohibits mortgage servicers from foreclosing on borrowers while they are pursuing loan modifications, a practice known as "dual-tracking." The Due Process Rights Act requires a "single point of contact" for borrowers eligible for loan modifications. It also for the first time imposes civil penalties for "robo-signing," the practice of signing foreclosure documents without verifying their accuracy.

The California Bankers Association opposed the legislation because it would encourage "frivolous litigation," says Beth Mills, a spokeswoman for the trade group. She said the law also lacked clear language stating that there is no right to a loan modification. It also remains unclear how many times a borrower can request a loan mod.

But consumer advocates said the legislation will institute sensible reforms of banks' foreclosure practices.

"This legislation finally brings some accountability to the banks for harmful foreclosure practices," says Kevin Stein, associate director of the California Reinvestment Coalition. "Homeowners will now be able to protect themselves from the commonplace violations that banks have exhibited in this foreclosure crisis."

Mortgage lenders and servicers say the law essentially turns California into a judicial foreclosure state, making it more difficult for banks to recover the underlying collateral in a property. There also is concern that borrowing costs would rise if Fannie Mae and Freddie Mac roll out different guarantee fees for judicial and non-judicial states.

Matt Ostrander, chief executive of Parkside Lending LLC, a San Francisco mortgage lender, described the situation as, "If someone came to you and said: "Hey, I have two borrowers that want to borrow $100. The first one gets to default and not pay you back for 3 to 5 years, and the other must pay you back within one year if they default. What do you want to charge each one for your hard-earned money?"

Christopher Thornberg, an economist at Beacon Economics, says the law will increase losses incurred by mortgage servicers when they have to foreclose.

"The evidence screams that this will do more harm than good by delaying foreclosures," says Thornberg. "The law has all the wonderful warm fuzzies on the surface that politicians like even if it makes no economic sense whatsoever."

Thornberg wrote in a report that there is no evidence to suggest that longer foreclosure timelines produce higher numbers of loan modifications or fewer delinquent borrowers moving into foreclosure. He argues that the large number of foreclosures in California is not attributable to misconduct by mortgage servicers but rather to "individuals who borrowed more than they could afford," including those who took cash out of their home when they refinanced.

Only a few years ago, loose lending standards helped create a frenzy of buying activity in the state. The median price of a single-family home in California hit a peak of $519,714 in early 2007, up 84% from the first quarter of 2003, according to San Diego data provider DataQuick.

The law takes effect Jan. 1. Other bills still advancing through the state legislature include provisions to reduce blight, protect tenants in foreclosed properties, strengthen law enforcement response to mortgage fraud and allow the use of a statewide grand jury to prosecute complex, multi-jurisdictional fraud and crimes.