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SCHMIDT v. INTERSTATE FED. S&L ASSN.

November 1, 1976

GEORGE AND KATHRYN SCHMIDT, Plaintiffs,
v.
INTERSTATE FEDERAL SAVINGS & LOAN ASSOCIATION, Defendant



The opinion of the court was delivered by: SIRICA

 This is an action for declaratory, injunctive and monetary relief to recover certain payments made to defendant Interstate Federal Savings & Loan Association (Interstate) by plaintiffs George and Kathryn Schmidt, who prepaid a home loan they had with Interstate prior to the date of maturity. The complaint is based on alleged violations of federal regulations, breach of contract and unjust enrichment. The answer admits the charges were made but denies that they were wrongful and sets forth a counterclaim to recover reasonable attorney fees. The case is presently here on Interstate's motion for summary judgment as to plaintiffs' federal claim and cross-motions for summary judgment as to Interstate's counterclaim.

 I.

 The essential facts are these. On June 28, 1972, the Schmidts took out a loan from Interstate to purchase a home in Rockville, Maryland. Interstate is a Savings and Loan Association organized under the Home Owners' Loan Act of 1933, as amended, 12 U.S.C. § 1461 et seq. (1970) and regulated by the Federal Home Loan Bank Board (FHLBB) through FHLBB regulations. The loan was secured by a deed of trust on the home and was evidenced by a promissory note in the amount of $45,300. The note called for payments of $325.00 per month payable the first of each month for 30 years until June 1, 2002. Additionally, the note permitted the Schmidts to "make payments in larger amounts or to pay the entire unpaid balance of this indebtedness on the first day of any month after three years from the date" the note was signed. Just less than three years after the loan was made, the Schmidts sought to prepay the note in full and, on April 11, 1975, they delivered Interstate a check for $44,418.67 representing the amount stated by Interstate as necessary to fully pay off the obligation.* This amount reflected the unpaid principal ($44,151.05), a release fee ($10.00), interest for the entire month of March as well as April ($570.26) and a prepayment charge for retiring the obligation before maturity ($375.22).

 Although the Schmidts paid the full amount called for by Interstate, they did so under protest and questioned whether Interstate had the right to demand either the prepayment charge or the interest attributable to the period in April after the debt was fully paid (approximately $180.00). This action action followed. In their complaint, the Schmidts have alleged that the prepayment and April interest charges (1) violate applicable FHLBB regulations, (2) are in breach of contract and (3) unjustly enrich defendant Interstate. Defendant has answered by denying the claims and by asserting a counterclaim based on a clause of the deed of trust obligating the Schmidts to pay Interstate for attorney fees incurred in connection with litigation arising out of the loan transaction.

 Interstate has moved for summary judgment on plaintiffs' federal cause of action and both parties have moved for summary judgment on the counterclaim.

 II.

 Before turning to the merits of Interstate's motion for summary judgment on plaintiffs' federal claim, it is helpful to set out the several points on which the parties are in agreement. Both parties agree that the Schmidts took out a home loan from Interstate under a 30 year deed of trust and that, on fully paying off the loan before the date of maturity, the Schmidts were charged a prepayment fee and interest for the remainder in April after the debt was paid on April 11, 1975. The parties also agree that Interstate is a member of the FHLBB and is governed by FHLBB regulations. Finally, both parties agree that the prepayment transaction at issue is to be judged by reference to 12 C.F.R. § 545.6-12(b), which provides in pertinent part:

 
Each borrower from Federal associations on a loan secured by a home . . . shall have the right to prepay the loan without penalty unless the loan contract makes express provision for a prepayment penalty. (emphasis supplied)

 Against this background of substantial agreement, the areas of dispute between the parties stand out clearly. They are (A) whether the challenged payments made by the Schmidts to Interstate are to be characterized as a "penalty" within the meaning of the FHLBB regulation and (B) whether the loan agreement fails to make "express provision" for charging a prepayment penalty. For the reasons which follow, this Court concludes that the payments at issue should be characterized as a prepayment penalty and that no provision of the loan documents makes express provision for them.

 A. Prepayment Penalty.

 The test for characterizing a charge as a "prepayment penalty" is whether the amount "would not be imposed if the note were paid at maturity instead of at an earlier date." Goldman v. First Federal Savings & Loan Association of Wilmette, 518 F.2d 1247, 1252 (7th Cir. 1975). Applying the Goldman test to the facts of this case, it is clear that the $375.22 prepayment fee paid to Interstate falls within the definition of "prepayment penalty." For had the Schmidts not decided to fully pay off their loan before maturity, they would not have incurred the prepayment charge.

 Similarly, the approximately $180.00 charge for interest attributable to April 12 through April 30 also qualifies as a prepayment penalty. The reason for this is clear. By charging the Schmidts interest for the entire month of April, Interstate was in effect requiring them to pay advance interest for the privilege of prepaying their loan. An examination of the loan documents indicates that, before the date of prepayment with one insignificant exception, the Schmidts were never required to pay interest in advance. Settlement occurred on June 28, 1972, and on that date two days advance interest was paid to bring the loan up to July 1 and put it on a first-of-the-month basis. The next payment was due on August 1, 1972, and covered the interest charge for July. From that time forward, monthly payments were called for on the first of each month until June 1, 2002, covering interest for the immediately preceding month.

 Figuring the Schmidts' payments on this basis, no interest for April 1975 was due until May 1, 1975. It follows then, that by charging the Schmidts interest for the entire month of April as an incident to prepaying the loan in full on April 11, Interstate was receiving a premium which it would not have received had the note been paid at maturity. Accordingly, the portion of the interest ...


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