B. F. Saul Co. v. West End Park North, Inc.

Finan, J., delivered the opinion of the Court. This is an appeal from a declaratory decree entered in equity by the Circuit Court for Prince George’s County pursuant to the Uniform Declaratory Judgment Act Code (1967 Repl. Vol.), Art. 31A §§ 1-16 construing Chapter 453, 1968 Laws of Maryland (House Bill No. 11) which repeals §§ 1-16 of Art. 49 of the Maryland Code entitled “Interest and Usury” and replaces it with §§ 1-11. The new law, hereinafter referred to as the Act, had an effective date of July 1, 1968. ⁷¹⁰ The three plaintiffs are corporations whose principal business is residential construction and development and the three defendants are corporate lenders.

In each instance the defendant had entered into a contract with the plaintiff to supply it with money for the permanent financing of mortgage loans to be made to prospective home purchasers, either insured by the Federal Housing Administration (FHA), or guaranteed by the Veterans Administration (VA). In each instance the commitment was well in excess of a half million dollars ($500,000). Subsequent to the passage of the Act, each mortgage loan broker notified the developers that they could not honor their original financing commitment because of the ambiguity created by the Act with regard to the legal rate of interest, the computation of points and uncertainty regarding the judicial interpretation which might be given to certain fees and charges set forth in the Act and normally paid by the borrower or seller and at times retained by the lender. The purpose of the plaintiffs in the action below was to seek clarification of provisions of the Act, so that the loan commitments made on the part of the mortgage brokers might be specifically enforced by the developers.

After answers were filed by the defendants the cases were consolidated in the court below and the Attorney General was permitted to intervene on behalf of the State of Maryland. This Court is somewhat hard pressed to discern in these proceedings a justiciable matter because all parties are corporate entities whose common gravamen is the possibility of unwitting exposure to penalties attached to usurious interest as provided by § 3 of the Act. It was thought that Art. 23 § 125 of the Code (1967 Repl. Vol.) which provides “No corporation shall interpose the defense of usury in any action,” provided an escape hatch which would exculpate the corporate plaintiffs from any usurious conduct and thus render the question of usury moot.

However, we do acknowledge a valid question regarding the applicability of the disclosure provisions of the Act, commonly referred to as the “Truth in Lending” provision, found in Section 10, as the same may relate to the parties to this action and their transactions. We are also aware that the home mortgage financing ultimately contemplated by the par ⁷¹¹ ties, and the purpose for which they have entered into a commitment agreement, would involve, in practically every instance, individual residential property owners to which transactions the provisions in the Act pertaining to usury, as well as disclosure, would be applicable. We therefore are of the opinion that we have a justiciable matter before us. At the beginning of the 1968 Session of the General Assembly of Maryland, the Legislature addressed itself to the crisis precipitated by the demand for higher interest rates for home financing, induced by a tight money market, juxtaposed against Maryland’s Usury Law (Code Art. 49, § 1) which established the maximum legal rate of interest at six per cent (6%).

To alleviate the situation, House Bill No. 11 was introduced which permitted the lender and borrower to agree to an interest rate not to exceed a legal maximum of eight per cent (8%). However, the Act coupled the raise in interest rates with certain restrictive provisions designed to regulate unscrupulous lenders, and by § 2(A) specifically prohibited the practice of charging “points,” except for business or commercial borrowers of more than 85,000 and in the case of “* * * any loan guaranteed or insured by FHA, VA or any other instrumentality of the Federal Government where the maximum interest rate is not more than 7%; * * The Act also contained a “truth in lending” provision which required that certain disclosures be made by the lender to the borrower. Long before the Governor’s imprimatur was on the Act, home mortgage brokers were posing, not the metaphysical question of “how many angels may be balanced on the point of a needle,” but the very mundane question of how many “points” may be charged at the inception of the loan while keeping the transaction within the framework of the legal maximum interest rate of eight per cent (8%). If for example, in the case of $10,000 mortgage loan, bearing interest at six per cent (6%) per annum, payable over a 20 year term, a fee of five “points” were to be charged at the inception of the loan and the “points” were to be construed as interest payable during the initial year of the loan, the interest rate for the first year would be eleven per cent (11%) and obviously usurious.

On the other hand, if the five “points” were to be computed or spread over the twenty ⁷¹² year life of the loan it would come within the permissive rate of the Act, as we shall later illustrate. The legal acceptance of the spreading of “points” was the main issue presented to the court below and argued on appeal, however, the “truth in lending” or disclosure provisions of the Act, as well as the treatment to be given other items of expense attendant to the consummation of a mortgage financed real estate .transaction, were challenged for ambiguity. The consternation within the home mortgage market created by the possible legal construction which might be placed on various provisions of the Act, wrought little short of havoc. 1 For the sake of clarity our discussion of the Act will be divided into four categories: (1) the proper method for computing interest in determining if a given loan is usurious; (2) the treatment to be given interest when the loan is prepaid; (3) the nonapplicability of the disclosure provisions of the Act to commercial loans in excess of $5,000 and the manner in which disclosure regarding the interest in construction loans may be met; (4) which of the many items involved in the settlement of a loan are required to be considered as interest and which are not. The lower court in an able opinion by Powers, J., specifically delineated answers to the problems encountered under the above categories with the exception of that of prepayment of the loan, under category 2.

The primary question before the court below was the manner in which interest should be computed and we agree with its concept of the spreading of “points” over the ⁷¹³ life of the loan in computing the effective interest rate. We further agree with the court’s treatment of expenses collected by the lender at the time of the consummation of the transaction and its designation as to which items should or should not be construed as interest. However, we disagree with the court’s conclusion that the disclosure provisions of the Act were intended to be applicable to commercial loans in excess of $5,000. We shall discuss all categories seriatim.

I All parties agree that the most troublesome problem raised by the Act is the manner in which “points” should be treated in context with the term “interest,” “stated interest” and “effective rate of simple interest,” all terms used rather inartistically, in various sections of the Act. To fully understand this problem a brief discussion of the anomalous term “points” should be helpful. Our search reveals that there is no mysterious connotation to the word “point.” It simply denotes a fee or charge equal to one per cent (1%) of the principal amount of the loan which is collected by the lender at the time the loan is made. It may be used interchangeably with the term “bonus,” “premium,” “loan origination fee” or “service charge.” The basic tenent to remember is that it is a fee or charge which is collected only once, at the inception of the loan, and is in addition to the constant long term stated interest rate on the face of the loan.

This Court discussed the question of a “bonus” in Birmingham v. Maryland Land and Homestead Association, 45 Md. 541 (1876) and again we find the use of the term “premium” in Washington National Building and Loan Association v. Andrews, 95 Md. 696 , 53 A. 573 (1902). Mr. James D. Laudeman, Jr., Chairman of the Legislative Coordinating Committee of the Savings and Loan Industry in Maryland, a member of the American Bar Association Committee on Real Estate, Probate and Trust Law and a member of the Governor’s Study Commission on Interest and Usury Laws, testified as an expert witness on the custom and usage of “points” in the home mortgage finance industry in Maryland. He emphasized the acceleration given to the practice of exacting points since the ⁷¹⁴ advent of the FHA and VA programs to the extent that today it is a term given universal acceptance in the lending industry throughout the country. 2 One theory advanced in justification for charging “points” is the recoupment of the administrative or operating costs attendant to negotiating the loan. See 91 A. L. R. 2d 1392 Anno.

Usury-Procuring Money Loaned-Expense § 3. To bring into focus the tolerance allowable for “points” within the framework of the eight per cent (8%) legal maximum interest rate permitted by the Act, when dealing with FHA or ⁷¹⁵ VA guaranteed or insured loans or those insured by any other instrumentality of the Federal Government as provided by § 2(A), we can employ no better example than that used by the lower court to illustrate both the problem and the answer. Let us assume that the borrower has applied for a loan of $10,000 bearing interest at the rate of six per cent (6%), with the interest and unpaid balance being paid in fixed monthly installments over a period of twenty (20) years, with a charge of five “points” being deducted by the lender. This $10,000 loan with five “points” charged results in a five per cent (5%) discount applied to the principal sum and yields a $9,500 net loan to the borrower. 3 The borrower who thus receives a net of $9,500 after deducting five “points” and pays back $10,000, plus interest, in monthly installments over twenty (20) years is not paying the $500 deducted from the face amount of the loan in the first year but is paying a small portion of this each month over the entire twenty (20) years.

The determinative factor as to whether or not the interest in such a case is usurious is the annual effective rate of interest (not to be confused with the term “stated interest”). If the annual effective rate of interest does not exceed eight per cent (8%) then it is not usurious and this annual effective rate of interest is computed as follows, again borrowing the example used by the court below : “The dollar amount of interest payable during the life of the loan is ascertained by multiplying the amount of each monthly payment by the number of months and subtracting the net principal of the loan. Hence, in the case of a $10,000 loan at six per cent (6%) ⁷¹⁶ with five points deducted, payable over 20 years, with the fixed monthly payment of $71.65 : $71.65 X 240 (20 years X 12 mos.) =....... $17,196.00 total paid by borrower Less net loan after subtracting points deducted ................................ 9,500.00 Total dollar amount of interest paid for the use of $9,500.00 during life of loan........... 7,696.00 The stated rate of interest in the note itself is ... 6% The current yield to the lender, who receives interest at the rate of $600.00 per year for a $9,500.00 loan, is $9,500.00 divided into $600.00= ... 6.31% But because the lender not only receives a current yield of 6.31% but during the life of the loan also receives back the $500.00 deducted from the face amount of the loan, he has a yield to maturity of ... 6.65%” 4 (6.65% being the annual effective rate of interest) The 6.65% annual yield to maturity set forth in the above example is the annual effective rate of interest and is not usurious. 5 Adopting the validity of the above illustration this Court concludes that the charge of a fee, commonly called “points” made at the inception of the loan, should not be considered interest paid in the initial year of the loan but is to be computed or spread over the term of the loan. Although the Act manifests legislative hostility to the charging of points, as may be deduced from § 2(A), yet the language of § 2(B) expresses an expectation of the usage of points with regard to the FHA, VA and other federally insured or guaranteed loans.

We do not think it was the intent of the Legislature that Maryland should be different from other jurisdictions, where such charges made at the inception of the loan, are not ⁷¹⁷ construed as usurious when the amount obtained plus the interest actually charged spread over the life of the loan is less than the legal maximum interest. 57 A. L. R. 2d 649 Anno: Usury-Interest In Advance § 6. We think that the Legislature, although eliminating “points” with regard to conventional home mortgage loans, (§ 2(A)), did not intend to eliminate them with regard to FHA and VA loans, or other loans guaranteed by an instrumentality of the federal government where the maximum interest rate was not more than seven per cent (7°/o), but rather to regulate them. ( § 2 (B) ). We think this Court also should attempt to resolve any ambiguities occasioned by the usage in various sections of the Act of the term “interest” (§ 1(A)), “simple interest” (§ 3) “effective rate of simple interest” (§ 10(a) (2)), and “stated rate” (§8 (2)) and their interrelation with each other. “Interest” is defined in § 1 (A) of the Act as follows: “(A) The term interest as used in this Article means any compensation imposed directly or indirectly by a lender for the extension of credit for the use or forbearance of money, including but not limited to loan fees, service and carrying charges, discounts, interest, time-price differentials, investigators’ fees and any amount payable under a point, discount, orgination fee or other system of additional services except as specifically provided in this section. * * *” “Simple interest” is that paid on the principal lent as distinguished from compound interest which is interest paid on unpaid interest.

See 47 CJS 11, § 1. The “effective rate of simple interest,” as we have already stated, refers to the yield to maturity rate received by the lender after deducting any premium, discount or points. We think that the Legislature intended that this “effective rate” should be the rate recited in the disclosure statement which the lender must furnish to the borrower pursuant to § 10(a) (2). Section 3 of the Act which provides that the interest rate, by written agreement between the borrower and the lender, may be ⁷¹⁸ as high as eight per cent (8%) per annum simple interest on the unpaid balance requires that: “* * * This agreement must set out the annual rate of interest which is charged, stated in percentage and be a separate instrument from the contract of indebtedness * * It is our interpretation of the language used in § 3 that it was the intent of the Legislature that the rate of interest set forth in the agreement required by § 3 should be the rate of interest which appears on the face of the mortgage and mortgage note, if the latter is used.

This would be the stated rate of interest. See also § 8(2). Referring to the example previously used in this opinion, it would be the six per cent (6%) item illustrated therein. Again, we emphasize that the test as to whether the loan is usurious would be the amount of the effective annual interest rate (yield to maturity) which in our example is 6.65%.

This latter figure, as we have already stated, should appear in the disclosure statement. Any discussion regarding the proper computation of interest and the treatment of “points” in relation to the rate would be incomplete without a clarification regarding “points” which are charged to the seller. We think that § 2(A) adequately covers this question and that it makes no difference whether the “points” are to be collected from the seller or the borrower insofar as their being included within the computation of the interest rate is concerned. The pertinent language in § 2(A) states “a charge or fee commonly called ‘points’ or mortgage origination fee, and extracted by a lender from either the borrower or any other person as additional compensation for the loan of money * * (Emphasis supplied.) ; obviously, the seller in any transaction comes within the definition of “any other person.” The fact that § 2(A) specifically prohibits such charges with regard to conventional loans, that is, loans other than FHA, VA or those guaranteed by other federal instrumentalities where the maximum rate is not over seven per cent (7%), leaves but one conclusion and that is that points were to be permitted with regard to those loans guaranteed by FHA, VA or other federal instrumentalities and that “points” col ⁷¹⁹ lected from the seller must be incorporated in the computation of the interest rate.

See Opinion of the Attorney General, June 7, 1968 (Daily Record June 18, 1968). II The question of the manner in which interest should be treated under the Act when the prepayment of the loan occurs was not pressed in the court below nor did the court discuss it in its opinion, however, we think it germane to the issues presented on this appeal. The problem which arises is that prepayment of the loan has the effect of increasing the interest yield to the lender and accordingly, depending upon the construction adopted, may render the loan usurious. It must be remembered that the loan agreement between the lender and the borrower is prospective in its operation and it is reasonable to anticipate that there will be compliance with its terms.

We are of the opinion that where the annual effective interest rate is within the legal rate of interest, there can be no question but that the lender is entitled to accept prepayment of all the outstanding principal without rebate. Such actually would be the case in the event of foreclosure of the mortgage lien. In cases where the loan contract provides for prepayment of the loan at the election of the borrower (FHA and VA mortgages provide for such an election) should the borrower exercise this option to prepay the loan and such action in fact renders the effective interest rate greater than eight per cent (8%), the transaction is not usurious as long as the interim payments of the effective interest rate would have been legal in contemplation of continued payments to the maturity specified in the contract. 55 Am. Jur. 360 , Usury, Sec. 48; 75 A. L. R. 2d 1265; 130 A. L. R. 73; 100 A. L. R. 1431; 84 A. L. R. 1283.

See Opinion of the Attorney General, July 11, 1968 (Daily Record, October 1, 1968). It would appear that the Legislature recognized the possibility of prepayment of the loan and intended that this could be accepted without requiring a rebate on the part of the lender. Section 1(B) (2) specifically provides that the collection of a prepayment penalty be allowed, where such is provided in the original loan contract, during the first three years of a loan se ⁷²⁰ cured by certain types of property, including homes, and prohibits prepayment penalties thereafter. Section 1(B) (2) is silent as to any rebate requirements in the event of prepayment; this gains significance by contrast with § 5(a) wherein it is specifically provided, in case of loans not secured by real property, that rebate be made of any excess interest, by way of refund to the borrower or by a credit to his account, should an excess occur by reason of prepayment of a loan prior to maturity.

Ill The question as to legislative intent regarding the application of the disclosure or “truth in lending” provision of the Act, § 10 raises two issues of general concern to the mortgage industry: (a) whether the disclosure provisions of § 10 apply to commercial loans in excess of $5,000; and (b) the difficulty of accurate disclosure of interest in construction loans. (a) Section 7 of