The following article is reprinted from Basis Points® , Vol. 1, Issue 11, Copyright © 2002, with the permission of CounselorLibrary.com, LLC. All Rights Reserved. Further reproduction is prohibited without permission.

News of the New York high cost loan statute reaches us from Grace Sterrett in Hudson Cook's Albany, NY office. The statute contains much tougher standards than exist under Part 41 of the Banking Department's existing rules. The new law becomes effective 180 days after enactment, or approximately April 1, 2003. Governor Pataki signed the measure into law on October 3, 2002 - the same day it was sent to him by the legislature.

Possible Changes. Many lenders and investors hope the legislature will consider amending the onerous penalty provisions and/or issue clarifying amendments before the effective date, but the prospects for either are generally rated as ranging from unlikely to slim.

Will the Regulators Pitch In? Among other issues, the statute provides that "the superintendent of banks is authorized to promulgate any and all rules and regulations and take any measures to implement this act on its effective date on or before such date." However, in New York legislative parlance, an "authorization" is not the same as a "directive." As a consequence, the Banking Department is not required to implement regulations. Absent such a requirement, the Department may elect to sit this one out and refrain from issuing any regulations. If this happens, the industry will be at a great disadvantage. Without a regulator who can provide implementing rules and guidelines, matters of interpretation will be settled through enforcement actions brought by the attorney general, the superintendent, or a private party. Finally, the new law does not contain a preemption clause, so that other municipalities are free to adopt their own version of an anti-predatory lending law or ordinance.

Recent Changes to Part 41. While the legislative process for enacting this new law was at a stand-still, the Banking Board proceeded to amend its High Cost Mortgage Regulation, known as "Part 41" to:

• Prohibit any lender or affiliate from financing single premium credit insurance offered in connection with a high cost loan subject to Part 41;
• Provide two alternative sources for lenders to determine the applicable yield on US Treasury securities (vital for calculating the APR "triggers"), and
• Enact several other clarifying amendments making the regulation comport with many of the unofficial interpretations provided by the Banking Department since October 1, 2000, the date the regulation initially became effective.

These amendments were published in the New York State Register on October 2, 2002 and are expected to become effective in early November. To find out more information on Part 41, click on the Banking Department's website at www.banking.state.ny.us and look for references to "High Cost Loans." Unless the Banking Department takes some action, Part 41 will be obsolete and replaced by the new statute on its effective date.

Is This New Law Much Different (Worse) Than Part 41?

Penalties - Much Worse. With respect to the penalty and related enforcement provisions, the new act is much tougher than Part 41. The current banking regulations impose requirements on brokers and lenders soliciting and originating Part 41 loans. Those who violate Part 41 are subject to administrative penalties. The Banking Department is authorized to impose administrative sanctions on lenders and brokers. Those penalties could be as severe as canceling a mortgage broker's registration or a mortgage banker's license to do business in New York. However, Part 41 does not create a private cause of action for consumers or affect the rights of assignees in the loan.

The new law provides for actual damages, statutory damage - including forfeiture of all interest on the loan (earned and unearned), fees and closing costs. A court may rescind any loan that violates the new law. The penalty for intentional violations is even more draconian - the court may declare the entire transaction void and mandate a complete refund of all principal and interest to the borrower.

Assignees who seek to foreclose a high-cost home loan, or to take some enforcement action after the loan has been in default for 60 or more days, may be subject to claims under the act in recoupment or defense to payment that the borrower could have asserted against the original lender.

Foreclosure Uncertain. A companion act provides borrowers with a defense to a foreclosure proceeding if anyone violates the act. Lenders will be required to affirm that they have complied with all requirements under Banking Law §595-a (which addresses various compliance procedures ranging from advertising to the making, closing, and funding of mortgage loans with various disclosure and substantive obligations) and the new law, Banking Law §6-1. This may be difficult for any lender to do. It will be virtually impossible for an assignee to do when that assignee has no real factual knowledge of everything that was given (or not given) to the borrower in the course of the solicitation, application and closing process. Due diligence regarding the purchase of loan portfolios does not typically include a total review of each loan transaction for technical and substantive compliance with every New York requirement.

Threshold Triggers. The new law applies to all loans/lines of $300,000 or less (higher limits may apply for 2-4 family dwellings per Fannie Mae thresholds) made for consumer purposes secured by an owner-occupied principal residence. The loan could be purchase money or non-purchase money. The loan could be open or closed-end. Reverse mortgages are not included.

APR Test. A first lien loan is subject to the act if the APR at consummation exceeds the yield on US Treasury Securities with a comparable term to maturity plus eight percentage points. For junior lien loans, the margin is nine percentage points. In either case, you use the Treasury yield in effect on the 15th day of the month preceding the month in which the application is taken. If the initial rate is discounted, then you use the fully indexed rate for this test.

Points and Fees Test. A first lien loan is subject to the act if the points and fees exceed five percent of the total loan amount (six percent if the loan is a purchase money FHA/VA loan).

Special rules apply if the total loan amount is less than $50,000. In this case, the loan is subject to the act if the points and fees exceed the greater of $1,500 or six percent of the total loan amount. However, you are also allowed to charge and exclude from the points and fees test up to two "bona fide loan discount points" if either of the following is true:

• The interest rate that would have applied without the discount points is no more than one percentage point over the Treasury yield used for the APR Test, described above, or
• The discount points are funded, directly or indirectly, through a grant from a federal, state or local government agency, or a charitable organization registered under Section 501(c)(3) of the Internal Revenue Code.

Definitions. While the New York act steals phrases like "points and fees" and "total loan amount" from the HOEPA rules, the definitions of those terms differ from the definitions under HOEPA. Here are some key definitions under the New York law.

Points and Fees. "Points and fees" are calculated the same as under the HOEPA rules, with one major exception. In New York, the "points and fees" include:

• All prepaid finance charges,
• All fees excluded from the finance charge under Section 226.4(c)(7) if the fee is paid to the lender or its affiliate,
• All credit insurance premiums, paid at closing or financed, that have somehow escaped the definition of prepaid finance charge (i.e., the creditor has complied with the rules under Section 226.4(d)(1) to exclude the premiums from the finance charge), plus
• All compensation paid directly or indirectly to a mortgage broker, including a broker who originates loans in its own name through table funded transactions.

The HOEPA rules do not include the last category, fees paid to a mortgage broker that are not finance charges, in the calculation. As a result, you must include things like yield spread premium payments in the New York calculation of points and fees even though those same sums are excluded from the HOEPA calculation.

Total Loan Amount. The "total loan amount" is also dramatically different under New York law. Under New York law, the "total loan amount" equals:

• The principal amount minus
• Any portion of NY points and fees that are financed.

Under the HOEPA definition, the "total loan amount" is the principal minus all prepaid finance charges (whether financed or not), minus the sum of the following items, provided they are financed (added to the principal):

• All fees excluded from the finance charge under Section 226.4(c)(7) if the fee is paid to the lender or its affiliate, plus
• All credit insurance premiums, paid at closing or financed, that have somehow escaped the definition of prepaid finance charge (i.e., the creditor has complied with the rules under Section 226.4(d)(1) to exclude the premiums from the finance charge).

So, if you have prepaid finance charges or voluntary credit insurance premiums that are paid out of pocket by the borrower, the NY total loan amount will be less than the HOEPA total loan amount.

Bona Fide Loan Discount Points. Bona fide loan discount points include loan discount points that:

• Are knowingly paid by the borrower or funded through any source
• For the purpose of reducing the interest rate
• And actually reduce the interest rate
• By an amount reasonably consistent with established industry norms and practices for secondary market transactions.

The act presumes a point is a bona fide loan discount point if it reduces the interest rate by a minimum of 25 basis points, assuming all other loan terms remain constant. Notwithstanding this presumption, you may want to use a disclosure or agreement where the consumer acknowledges each of the four criteria set forth in the definition.

Limitations and Prohibited Practices. A high-cost home loan is subject to the following limitations:

• No Call Provisions. You may not have the right, in it your sole discretion, to accelerate the indebtedness. This does not prohibit you from accelerating the loan in good faith due to borrower's failure to abide by material terms of the loan.
• No Balloon Payments. No scheduled payment may be more than twice as large as the average of earlier scheduled payments, unless the balloon payment is due 15 years or more after origination. Exception: This prohibition does not apply to loans where the payment schedule is adjusted to the seasonal or irregular income of the borrower.
• No Negative Amortization. The payment schedule may not provide for regular periodic payments that cause the principal balance to increase.
• No Increased Interest Rate After Default. (This does not prohibit interest rate changes under a variable rate formula, provided the increase is not triggered by an event of default.)
• Limitation On Advance Payments. You may not consolidate and pay in advance from the loan proceeds more than two periodic payments required under the loan terms.
• No Modification Or Deferral Fees. You may not charge the borrower any fee to modify, renew, extend or amend (collectively called a "change") a high-cost home loan, or to defer any payment due under a high-cost home loan if:
  • After the change the loan is still a high-cost home loan or
  • Even if no longer a high-cost home loan, the APR has not been decreased by at least 2 percentage points.
  • If you lend "new money" in connection with any "change," you may charge points and fees in connection with any additional proceeds received by the borrower as a result of the "change" (over and above the current principal balance of the existing high-cost home loan), provided that any charges on the additional proceeds reflect your "typical point and fee structure for high-cost home loans."
• No Oppressive Mandatory Arbitration Clauses. The loan terms cannot contain any such clause that is unfair, unconscionable, or substantially in derogation of the rights of consumers. Note that this provision is likely preempted by the Federal Arbitration Act.
• No Financing Of Single Premium Insurance. You may not finance the cost of single premium credit insurance or related products. Debt cancellation or suspension agreements are included in this category of prohibited credit insurance. Note that premiums calculated and paid on a monthly basis are not considered " financed" by the lender and so are permitted.
• No "Loan Flipping." No lender or mortgage broker making or arranging a high-cost home loan may engage in "loan-flipping." This is defined as making a home loan to a borrower who refinances an existing home loan when the new loan does not have a "tangible net benefit" to the borrower considering all of the circumstances, including the terms of both the new and refinanced loans, the cost of the new loan and the borrower's situation. The term " tangible net benefit" is not defined.
• No Refinancing of Special Mortgages. Absent documentation by a HUD certified housing counselor or the original lender that the borrower has received counseling regarding the advantages and disadvantages of refinancing, you may not refinance an existing home loan that is a "special mortgage" into a high cost loan. A "special mortgage" is one originated, subsidized or guaranteed by or through a state, tribal, local government or nonprofit organization and which bears a below market interest rate at the time of origination or has non-standard payment terms beneficial to the borrower. The types of non-standard payment terms contemplated here include payments that vary based upon income or where no payments are required under certain conditions.
• No Lending Without Due regard To Repayment Ability. You are prohibited from making or arranging a high-cost home loan without due regard to repayment ability. Factors to consider include:
  • Current and expected income;
  • Current obligations;
  • Employment status; and
  • Other financial sources.

You may not consider the borrower's equity in the home. Such information must be "… verified by detailed documentation of all sources of income, as and corroborated by independent verification."

You have a "rebuttable presumption" that a loan was made with due regard to repayment ability if you can demonstrate that, at the time the loan was made, the borrower's total monthly debts, including amounts owed under the loan, did not exceed 50% of the borrower's monthly gross income, provided the lender also followed the residual income guidelines established by the Veterans Administration as set forth in 38 C.F.R. § 36.4337(e) and VA Form 26-6393.

• No Financing of "points and fees" in excess of 3% of the principal amount of the loan. Note: This 3% limit is of the principal loan amount, not the " Total Loan Amount," which would be a lower number.
• No Direct Payment of Home Improvement Contractors. You must make payments from the loan proceeds to a contractor under a home improvement contract by one of the following 3 methods:
  • By instrument payable to the borrower only,
  • By instrument payable jointly to the borrower and contractor, or
  • At the election of the borrower, through a third party escrow agent pursuant to the terms of a written agreement signed by the borrower, the lender and the contractor prior to the disbursement.
• No Encouragement Of Default. You may not recommend or encourage default on an existing loan or debt prior to or in connection with the closing or planned closing of a high-cost home loan that refinances all or some portion of that existing loan or debt.
• No Payments to Mortgage Brokers, Other Than For Reasonable Value Of Goods, Facilities or Services Actually Provided. No lender or broker may accept or give any "…fee, kickback, thing of value, proportion, split or percentage of charges, other than as payment for goods or facilities that were actually furnished or services that were actually performed." Payments must also be reasonably related to the value of the goods, facilities or services provided.
• No Points and Fees By Lender Refinancing A High-Cost Loan Held By It. You may not charge a borrower any points and fees in connection with a high cost loan, if the loan proceeds will be used to refinance an existing high cost home loan held by you or your affiliate.

Disclosures. The new act requires you to make the following disclosures.

Application Disclosures. At time of application, the lender or broker must deliver, mail, fax or electronically transmit the following notice - in at least 12-point type - to the borrower:

You should consider financial counseling prior to executing loan documents. The enclosed list of counselors is provided by the New York State Banking Department.

This disclosure must be on a separate form. The notice must be accompanied by the list of approved counselors, which is available from the New York Banking Department. If you take the application by telephone, you must provide the disclosure "immediately after receipt of the application by telephone." If you send the notice electronically, you must first obtain written or electronic permission from the borrower.

Pre-Closing Disclosure. You may not make or arrange a high-cost home loan unless the following notice is given in writing to the borrower within 3 days after you determine the loan is a high cost home loan, but no less than 10 days before closing.

CONSUMER CAUTION AND HOME COUNSELING NOTICE

If you obtain this loan, which pursuant to New York State Law is a High-Cost Home Loan, the lender will have a mortgage on your home. You could lose your home, and any money you have put into it, if you do not meet your obligations under the loan.

You should shop around and compare loan rates and fees. Mortgage loan rates and closing costs and fees vary based on many factors, including your particular credit and financial circumstances, your earnings history, the loan-to-value requested, and the type of property that will secure your loan. The loan rate and fees could vary based on which lender or mortgage broker you select. Higher rates and fees may be related to the individual circumstances of a particular consumer's application.

You should consider consulting a qualified independent credit counselor or other experienced financial adviser regarding the rate, fees, and provisions of this mortgage loan before you proceed. The enclosed list of counselors is provided by the New York State Banking Department.

You are not required to complete any loan agreement merely because you have received these disclosures or have signed a loan application. If you proceed with this mortgage loan, you should also remember that you may face serious financial risks if you use this loan to pay off credit card debts and other debts in connection with this transaction and then subsequently incur significant new credit card charges or other debts. If you continue to accumulate debt after this loan is closed and then experience financial difficulties, you could lose your home and any equity you have in it if you do not meet your mortgage loan obligations.

Property taxes and homeowner's insurance are your responsibility. Not all lenders provide escrow services for these payments. You should ask your lender about these services.

Your payments on existing debts contribute to your credit ratings. You should not accept any advice to ignore your regular payments to your existing creditors. Accordingly, it is important that you make regular payments to your existing creditors.

Notice that the form indicates that the list of counselors as provided by the New York Banking Department is "enclosed." However, the act instructs you to deliver the list with the application disclosure, not the pre-closing disclosure.

Mortgage Legend. You must insert a legend in 12-point type on the top of each mortgage that secures a high-cost home loan to indicate to any potential purchaser that the loan is a high cost loan. Unfortunately, the New York act does not provide the legend itself. Until contrary regulatory guidance appears, the following would seem to meet the statutory requirements:

THIS MORTGAGE SECURES A HIGH-COST HOME LOAN SUBJECT TO NEW YORK BANKING LAW §6-1.

Operational Requirements : Annual Reports to Credit Bureaus. Lenders making high-cost home loans are required to report both the favorable and unfavorable payment history of each borrower to a nationally recognized consumer credit bureau at least annually, for as long as lender holds or services the high-cost loan. Surprisingly, this requirement does not appear to apply to loan servicers who did not originate the loan.

Penalties/Remedies. Any person found "by a preponderance of the evidence" to have violated the law is liable to the borrower for the following:

• Actual damages - including consequential and incidental damages;
• Statutory damages as follows:
  • All interest, points and fees and closing costs charged on the loan must be refunded, and any amounts not yet earned must be forfeited. This appears to mean that the borrower is entitled to a cost-free loan. Or
  • The greater of: $5,000 per violation or twice the amount of points and fees and closing costs if the violation involves (a) the prohibitions against "loan flipping" or (b) the requirement to verify that the borrower has the "ability to repay" and the lender fails to demonstrate that it verified, by detailed documentation, all sources of the borrower's income and corroborated it with independent verification at the time the loan was made.
• Reasonable attorneys' fees
• A court may grant injunctive, declaratory or similar relief as the court deems appropriate in an action to enforce compliance with this law
• Upon a finding by a court of an intentional violation by the lender of this law or any implementing regulation, the home loan agreement is void and the lender may not "collect, receive, or retain" any principal, interest or other charges. The borrower may also recover any payments made.
• If a court finds that a high-cost loan violates any provision of the law, the loan transaction may be rescinded. The remedy of rescission is available as a defense, without time limitation.
• The statute expressly provides that the remedies provided for in the statute are not intended to be the exclusive remedies available to a borrower.

Scope Of Penalty-Enforcement Provisions. The act applies to brokers and lenders that arrange for or make high cost mortgage loans, and to any person, who in bad faith attempts to avoid application of the law "by any subterfuge, including but not limited to splitting or dividing any loan transaction into separate parts for the purpose of evading the provisions of this section."

Assignee Liability. If an assignee brings an action to enforce a loan against a borrower who is in default more than 60 days or who is in foreclosure, the borrower may assert any claim under the provisions of this law in recoupment and defense to payment. In addition, as discussed above, the borrower has the right to rescind the loan at any time if he or she discovers that the lender or broker have violated the act.

Who Are The Enforcers? The act can be enforced by the state attorney general, the superintendent of banks, or any party to a high-cost loan.

Opportunity to Correct/Cure Violations? A lender, who, acting in good faith, nevertheless violates a provision of the law, will not be deemed to have violated the law:

• Provided within 30 days of the loan closing and prior to the institution of any action under this law, the borrower is notified of the "compliance failure," appropriate restitution is made and at the choice of the borrower, the necessary adjustments are made so that: i) the high-cost home loan complies with the law or ii) the terms of the loan are changed in a manner beneficial to the borrower so that the amended loan is no longer a high cost home loan; or
• If the "compliance failure" resulted from a bona fide error, notwithstanding the maintenance of procedures reasonable adopted to avoid such errors, and, within 60 days after the discovery of the violation, but before the commencement of an action under the law or receipt of written notice of the violation, the borrower is notified of the "compliance failure," appropriate restitution is made and at the choice of the borrower, the necessary adjustments are made so that: i) the high-cost home loan complies with the law or ii) the terms of the loan are changed in a manner beneficial to the borrower so that the amended loan is no longer a high cost home loan.

Crystal Ball Readings. At this point it's too early to predict whether Banking Law §6-1 will be launched as is, or whether lenders and investors will be successful in their efforts to have any amendments adopted. In addition to encouraging lawmakers to reconsider the potential chilling impact that some of the sweeping penalty provisions may have on the availability of mortgage credit for higher credit-risk borrowers in New York, it would make sense to have a uniform state law, rather than a patch-work quilt of laws and ordinances on state and local levels - so the addition of a preemption clause should surely be sought. The new law could benefit from a clarification or reconsideration of the use of a "bona fide discount points" to buy down the interest rate. Currently such discount points can only be excluded from the "points & fees" threshold for a conventional loan if the interest rate (which will be bought down by the points) does not exceed by more than 1 percentage point, the yield on United States Treasury Securities having comparable periods of maturity to the loan maturity. Stayed tuned for further developments.

For more information on NY Banking Law § 6-1, feel free to contact Grace Sterrett at (518) 383-9440.

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Basis Points® is a concise, easy-to-read, monthly legal update for the mortgage lending industry. Basis Points® addresses complex legal issues from an industry perspective and keeps you informed on new legal developments affecting your business. Written in plain English, Basis Points® provides familiar factual scenarios, identifies the legal issues involved, presents real court resolutions and suggests how you might avoid similar legal pitfalls. Topics featured in Basis Points® include: Predatory Lending; Yield-Spread Premiums; RESPA - Fee Splitting and Up charges; Privacy; RESPA - Joint Venture; Bankruptcy; Fair Lending and Discrimination; and Truth in Lending/ Regulation Z. Basis Points® is published by CounselorLibrary.com, LLC, an affiliate of the Hudson Cook, LLP law firm. The CounselorLibrary.com, LLC is also the publisher of CARLAW®, HouseLaw®, Spot Delivery®, and the Counselor Library Series. For more information, please visit: www.counselorlibrary.com.