Establishes certain requirements on alternative mortgage instruments and graduated payment mortgages

This bill would further amend subdivision 5 of section 279 of the Real Property Law to prohibit the making of graduated payment adjustable rate mortgages to home consumers.

Section One Legislative intent

Section Two

Amends subdivision one of section six-f of the banking law to permit the making of residential mortgage loans and cooperative apartment unit loans which provide for periodic readjustment of the rate of interest charged for the loan as successive terms of the loan; terms of loan which are shorter than the term of the mortgage; repayment of the principal amount of the loan by regular payments which are not equal in amount throughout the term of the mortgage; or any combination of the above subject to the provisions of subdivision two of section six-f, provided that such loans limit initial interest rate discounts to not more than two and one-half percent below the market index, limit interest rate increases to not more than three percent above the market index, include lifetime and annual caps on interest rate increases, and limit negative amortization to one hundred ten percent of the amount of the loan.

Section Three

Amends subdivision five of section two hundred seventy-nine of the real property law to prohibit the making of graduated payment adjustable rate mortgages for one to six family residences.

Justification

Despite increased interest rates, adjustable rate mortgages (ARMS), which put the risk of the interest rate rising on the consumer, account for slightly less than half of all mortgages issued in the United States and New York. There are problems associated with ARMs, however, which result in a significant number of delinquencies and foreclosures. The purpose of this bill is to protect homeowners and banks from those problems by providing stricter requirements for lending institutions which make ARMs, like those required by the Federal National Mortgage Association (Fannie Mae). The proposed legislation addresses the three major problems associated with ARMs which lead to delinquency and foreclosures: teaser rates, negative amortization, and payment shock. Teaser rate mortgages are ARMs with extremely discounted interest rates for the first period of the mortgage and are used to entice consumers to take out adjustable rate mortgages. After the first payment period, the interest rate is adjusted to a level equivalent to or higher than the rate for current fixed rate mortgages. Such rapid increases in monthly payment of the loan causes payment problems for the borrower and often result in taking a second loan or in defaulting on the ARM. This bill would limit initial interest rate discounts lending institutions can offer to two and one-half percent below the market rate.

Negative amortization occurs when payments on the mortgage are not enough to cover the interest due and the interest shortage is added to the principal. Often the result is that the amount of the loan increases rather than decreases after the monthly payment and homeowners are forced to pay interest on unpaid interest. This leads to both default and the inability of many people to payoff their mortgages when they sell their houses. This legislation would change the cap on negative amortization from the current 125 percent to 110 percent of the original amount mortgaged.

An increase in monthly payments to a mortgager already struggling to make monthly payments can result in "payment shock", where the borrower simply cannot afford the added interest. Payment shock is the most obvious in teaser ARMs, where the lower initial interest rate allows more consumers to qualify for the loans. When the interest rate on the loan rises, many households cannot afford the added cost. Although payment shock occurs in non-teaser ARMs as well, for those who were barely able to qualify at the initial rate, the rise in monthly payments can result in either default or negative amortization. This legislation would limit interest rate increases to not more than three percent above market rate and further require lending institutions to provide lifetime and annual interest rate caps on all ARMs.

The graduated payment ARM (GPARM) is an alternate type of ARM which also creates delinquency and foreclosure problems. The GPARM begins at a low level of interest and increases in fixed percentages at specific times throughout the life of the mortgage. Although payments on GFARMs rise on a predetermined schedule, GPARMs erode a homeowner's equity by deferring interest owed to later dates. Like the Fannie Mae regulations, this legislation would prohibit the making of GPARMs to home consumers. This legislation, designed to protect the homeowner, would not extend to the making of GPARMs to commercial consumers.

ARMs are available alternative for many consumers who might otherwise be unable to afford to purchase their own home. The consumer takes on the risk of rising interest rates in anticipation that the interest rate will remain stable or go down. When the interest rate rises, however, many homeowners are faced with delinquency or foreclosure. This legislation would serve to minimize the problems inherent in ARMs and thereby preserve their value to both homeowners and consumers.

Fiscal implications

None.

Effective date

This act shall take effect on the thirtieth day after it shall have become a law and shall apply with respect to any residential mortgage loan or cooperative apartment unit loans commitment for which is extended or made on or after such date.