The State of New York has created a new category of loans called "subprime home loans."  The new law is set forth in new Section 6m of the New York Bank Law (a copy of the bill enacting this new section is available here).  The new law applies to loans closed on or after September 1, 2008.  Many investors, including but not limited to Fannie Mae,1 have already announced that they will not purchase and/or securitize New York subprime home loans.  Below is a description of the new law along with a description of the audit DocMagic is implementing to identify New York subprime home loans.

Applicability Rules: New York Banking Law Section 6m defines a "subprime home loan" as a "home loan" that meets certain criteria described below.  A "home loan" is defined as a loan with the following characteristics: (1) the loan amount is less than or equal to the then-current Fannie Mae conforming loan limit; (2) the borrower is a natural person; (3) the debt is incurred for a consumer purpose; and (4) the home securing repayment of the loan is a one- to four-family, owner-occupied principal dwelling.

The coverage of the law includes purchase money and refinance loans, regardless of lien position, as well as VA and FHA loans.  Loans excluded from coverage include construction loans; loans secured by commercial, multifamily, second homes, and non-owner-occupied properties; "bridge loans" (loans with terms of 12 months or less); and HELOCs.

Subprime Home Loan Defined: A "subprime home loan" is defined as a home loan in which the fully indexed annual percentage rate exceeds by more than either 1.75% (for first lien loans) or 3.75% (for junior lien loans), the average commitment rate for loans in the northeast region with comparable terms as published in the Freddie Mac Primary Mortgage Market Survey (PMMS) for the week prior to the week in which the lender receives a completed loan application.

Subprime Home Loan Determination: The process by which a subprime home loan determination is made, and the important factors to consider in that process, are as follows:

1. Determine the APR: "Annual percentage rate" (APR) is defined in the new law as the annual percentage rate calculated in accordance with the Truth in Lending Act (TILA) and Regulation Z.  However, the new law calls for a comparison of the "fully indexed" annual percentage rate to the applicable average commitment rates plus the applicable spread.  The statute defines "fully indexed rate" as essentially the index plus margin at closing, ignoring any periodic interest rate change limitations.  Accordingly, for adjustable rate (ARM) loans with discounted interest rates (that is, start rates below the index plus margin), we will calculate the APR in accordance with TILA and Regulation Z by ignoring the start rate and instead using the index plus margin.  However, if the applicable interest rate at closing is greater than the index plus margin (that is, reflects a premium and not a discount so that the start rate is higher that the applicable index plus margin), we will calculate the APR in accordance with TILA and Regulation Z by using the higher premium rate rather than the index plus margin.
2. Determine the comparable average commitment rate: The Freddie Mac Primary Mortgage Market Survey (PMMS) is published weekly and posted online here.   The PMMS lists average commitment rates for the US as well as the Northeast, Southeast, North Central, Southwest and West regions. There are four rates published weekly: a 30-year fixed, a 15-year fixed, a 5/1 ARM and a 1-year ARM.   Section 6m sets forth specific rules for determining what terms are "comparable" as follows:

   a. ARM with initial fixed term of less than 3 years: the 1-year ARM average commitment rate is used.

   b. ARM with initial fixed term of 3 years or more: the 5/1 ARM average commitment rate is used.

   c. Fixed rate with term of 15 years or less: the 15-year fixed average commitment rate is used.

   d. Fixed rate with term of more than 15 years: the 30-year fixed average commitment rate is used.

   The average commitment rate for the week prior to the week the lender receives the complete application is the rate that is used. 

3. Determine lien position and add the applicable rate spread: for first lien loans, 1.75% is added to the comparable average commitment rate; for junior lien loans, 3.75% is added to the comparable average commitment rate.
4. Compare the APR to the comparable average commitment rate plus the applicable rate spread: if the loan APR is greater than  the comparable average commitment rate plus the applicable rate spread, then a warning displays substantially as follows:

Warning: This is a NY Subprime Home Loan (NY Banking Law Section 6-m(1)(c))

Prohibitions Applicable to Subprime Home Loans: A subprime home loan is subject to the following limitations:

• No call provisions.
• No negative amortization (e.g., hybrid ARMs); there is an exception for borrower-sought temporary forbearances.
• No default rate of interest.
• No more than two periodic payments may be consolidated and paid in advance from the loan proceeds.
• No modification or deferral fees; excludes, among other limited exceptions, workouts.
• No oppressive mandatory arbitration clauses.
• No financing of insurance or other products sold in connection with the loan; premiums or fees calculated on a monthly basis are not considered financed.
• No "loan flipping." Loan flipping is defined as making a home loan to refinance another home loan without a tangible net benefit to the borrower.
• No refinancing of special mortgages, that is, loans originated, subsidized or guaranteed by or through a state, tribal or local government, or a nonprofit organization, that bears a below market interest rate or other nonstandard terms beneficial to the borrower.
• No lending without required counseling disclosure at application and list of counselors.
• No encouragement of default on an existing loan.
• No lender or mortgage broker shall accept or give any fee, kickback, thing of value, portion, split or percentage of charge, other than payments for goods or facilities actually furnished or services actually performed, which payments are reasonably related to the value of the goods or facilities provided or the services actually performed.
• No prepayment penalties are permitted on subprime home loans.
• No abusive yield spread premiums. A mortgage broker must disclose, at the time of application and on a form prescribed by the New York Banking Superintendent, the exact amount and methodology for determining the direct and indirect (i.e., lender paid) compensation the mortgage broker will receive. Any amount in excess of the disclosed amount must be credited to the borrower.
• Mandatory escrow of taxes and insurance effective July 1, 2010. The borrower may waive this requirement after the first year. Subordinate lien loans are excluded, provided taxes and insurance are escrowed on the prior lien or the borrower demonstrates 12 months of timely payments on a prior loan.
• Mandatory disclosure of taxes and insurance payments.
• No teaser rates of less than six months.

In addition to the foregoing, a lender and mortgage broker may not make or arrange a subprime home loan unless they have a reasonable and good faith belief at consummation that one or more of the borrowers has the ability to repay the loan (along with any contemporaneously made loan) according to its terms, including applicable real estate taxes and hazard insurance premiums.  If the loan is an ARM, the monthly payment amount is calculated assuming the loan proceeds have been fully disbursed, the loan is repaid in substantially equal monthly payments of principal and interest over the term of the loan, and the interest rate over the entire term of the loan is the fully indexed rate.  In determining a borrower's ability to repay, the following factors must be considered: credit history; current and expected income; current obligations; employment status; and other financial resources other than the borrower's equity in the real property securing repayment of the loan.  Reasonable steps must be taken to confirm the accuracy and completeness of the information provided by or on behalf of the borrower by using tax returns, payroll receipts, bank records, reasonable alternative methods, or reasonable third-party verification.  A lender or mortgage broker may utilize reasonable commercially recognized underwriting systems so long as they comply with the above requirements.

Subprime home loans are required to include a 12-point legend at the top of the mortgage stating that the mortgage is a subprime home loan subject to Section 6m.

The provisions of Section 6m apply also to any person who attempts in bad faith to avoid application of Section 6m by subterfuge such as, for example, splitting a loan transaction into separate parts for evasion purposes.

There is a safe harbor provision for a lender acting in good faith if, prior to the institution of any action and before the borrower is prejudiced, the lender notifies the borrower of the compliance failure and makes appropriate restitution and whatever adjustments necessary to make the loan satisfy the requirements of Section 6m. Any person found by a preponderance of the evidence to have violated Section 6m is liable to the borrower for actual damages, and a court may also award reasonable attorneys' fees to a prevailing borrower in a foreclosure action. A court may also grant injunctive, declaratory and other equitable relief as the court deems appropriate to enforce compliance with Section 6m. The foregoing remedies are not exclusive. A borrower in default more than sixty days or in foreclosure may assert as a defense, any violation of Section 6m. Finally, the attorney general or the superintendent may enforce the provisions of Section 6m.

Please feel free to contact DocMagic's Compliance Department if you have any questions or comments regarding this audit.

1 Fannie Mae Announcement 08-21 is available here .