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NovaStar Faces YSP Lawsuit

NovaStar Faces YSP LawsuitWashington case certified as class action

November 19, 2006

WASHINGTON correspondent for

Allegations of undisclosed yield spread premiums paid to mortgage brokers have NovaStar Mortgage Inc. facing thousands of borrowers in a class action lawsuit.A federal court judge in Washington State has certified the class action lawsuit against NovaStar. The case is expected to involve at least 1000 plaintiffs who claim they were charged higher interest rates because their mortgage brokers did not disclose the yield spread premium in violation of state and federal law.

“This is an important decision for borrowers who obtained these home loans from NovaStar,” Ari Brown, one of the plaintiffs’ lawyers, said in a written statement. “Most of them don’t even know their rights have been violated. Now, not only will they discover they had rights to bargain for a lower interest rate loan, but well be able to pursue claims for them and, we hope, get them the deal they should have gotten in the first place.”

Richard Johnson, a spokesman for Missouri-based NovaStar, said the borrowers’ allegations have no merit and the real estate investment trust will vigorously defend against the lawsuit.

The court action, which started with eight plaintiffs, could balloon to several thousand borrowers.

Plaintiffs’ attorney John Phillips, in a telephone interview, said his firm reviewed 153 loan files and found that in nearly 70 percent of them the yield spread premium was not disclosed or was not properly disclosed. Based on this, they estimate that at least 1000 homeowners in Washington State and possibly several thousand more were affected.

Phillips said, as a result, borrowers probably paid about $3,000 more than they should have from their first payment until they could refinance without a penalty. The lawsuit covers mortgage loans granted from July 30, 1999, to the present.

Both federal and Washington State law require brokers to disclose any YSP no later than three days after the date the borrower applies for a residential mortgage. A failure to disclose the payment of a YSP before closing violates the Real Estate Settlement Procedures Act and the Truth in Lending Act, the Washington Consumer Loan Act and, by extension, constitutes a deceptive act under Washington’s Consumer Protection Act, according to the complaint.

The plaintiffs say they were hit with the inflated interest rate because NovaStar agreed to pay mortgage brokers thousands of dollars to negotiate loans carrying a higher interest rate and did not disclose the YSP or, if disclosed, was included as a line item in documents signed at closing. The higher the interest rate, the more NovaStar paid the broker.

The plaintiffs say that if a YSP is paid in connection with a residential mortgage, it must be fully disclosed early in the loan process so that borrowers have an opportunity to reject the fee, to negotiate a lower rate or lower fees with the broker, or to find a better interest rate through a different lender. The failure to disclose the YSP before closing, deprived them of the right to demand that a YSP not be paid and to negotiate a better interest rate.

The plaintiffs also said in the complaint that NovaStar “made significant efforts to avoid disclosing the YSP in any meaningful manner.” For example, they claim the company employs “veiled and vague references to the YSP, the use of warehouse lines of credit to disguise the identity of the lender, and generates multiple good faith estimates wherein the one that omits the YSP is provided to the borrower while the version that includes the YSP is placed in the borrower’s file but not shown to the borrower.”

NovaStar fought the action to certify the lawsuit as a class action, but

The court rejected NovaStar’s attempt to “jump the gun” and block the class action certification by arguing the case on its merits.

For example, NovaStar contended that a borrower on verbal notice of the YSP is in the same bargaining position as a borrower whose estimate lists the YSP. Admonishing the company that whether such a requirement was violated was not the issue before the court at the time of the request to certify the case as a class action, the court said that it was sufficient at that stage in the proceedings to note that RESPA apparently requires written disclosure.

Washington state law also imposes written disclosure requirements, providing that for all loans made by a licensee that are secured by a lien on real property, the licensee shall provide to each borrower within three business days following receipt of a loan application a written disclosure containing an itemized estimation and explanation of all fees and costs that the borrower is required to pay in connection with obtaining a loan from the licensee.

NovaStar contended that this language does not require written disclosure of YSPs because they are not “fees and costs that the borrower is required to pay.” The court noted that neither NovaStar nor the plaintiffs disputed that yield spread premiums are paid by lenders and not by borrowers. However, the plaintiffs contended the YSP is, in effect, paid by the borrower because “its payment is made possible by the borrower’s promise to pay a higher interest rate over the life of the loan.”

Once again, reminding NovaStar that it seemed to be arguing the case on its merits, the court said that whether NovaStar’s conduct violated the state’s Consumer Law Act was an issue not yet before the court. At this stage of the proceedings, the court responded, the homeowners’ had sufficiently alleged a violation of the act and demonstrated that the presence of verbal disclosures is irrelevant to determining whether NovaStar violated the law.

NovaStar also argued that the Consumer Law Act applies only to high interest rate loans and that a statutory exemption applied to NovaStar. NovaStar cited the statute’s statement of purpose as authority for the notion that only high interest loans are covered. The court rejected the argument, explaining that NovaStar had failed to establish how such a broad statement of purpose limited application of the act to high interest loans.

“The plaintiffs have sufficiently alleged that NovaStar committed a per se violation of the CPA by failing to comply with written disclosure requirements under the CLA, TILA, and RESPA. Whether the plaintiffs will ultimately persuade the Court that NovaStar violated disclosure requirements under these statutes is an issue better left for summary judgment or trial. At this juncture, it is sufficient that the plaintiffs have demonstrated that verbal disclosures are arguably irrelevant to determining whether a per se violation of the CPA has occurred for class certification purposes,” Judge Robert J. Bryan wrote in the order.

A ruling in the case on the homeowners’ motion to compel documents is expected next week. Phillips said a favorable ruling for the plaintiffs would be significant as the requested documents are expected to show that NovaStar coaxed brokers not to disclose the yield spread premium and how to develop strategies to keep the fee hidden.

The case is expected to go to the jury in April.

Lisa D. Burden is a legal analyst for and holds a law degree from the University of Maryland. She is currently a freelance journalist who previously wrote for Institutional Investor publications and the Baltimore Daily Record.

e-mail Lisa at:

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