The Office of General Counsel issued the following opinion on September 6, 2005, representing the position of the New York State Insurance Department.
RE: Mortgage Guaranty Insurance
Would the below-described loan product constitute an "authorized real estate security" as defined by New York Insurance Law § 6501 and thus qualify as a loan for which mortgage guaranty insurance may be written?
No, the below-described loan product does not constitute an "authorized real estate security" as defined by New York Insurance Law § 6501 and thus would not qualify as a loan for which mortgage guaranty insurance may be written.
The inquirer represents various mortgage banking interests and have inquired whether a proposed loan product would qualify as an "authorized real estate security" under the New York Insurance Law so as to be qualified as a loan for which mortgage guaranty insurance may be written.
According to the inquiry, the proposed loan is a first lien, closed end mortgage for one to four-family dwellings in which negative amortization may but need not occur. At inception of the loan, the loan-to-value ratio will not exceed 100%. The loan would be offered with an adjustable interest rate, which would change monthly. The required monthly payment, however, will be adjusted only yearly. Because of the disparity in the timing of the scheduled changes of the interest rate and minimum payment, it is possible that a loan structured in this way could result in negative amortization.1 The borrower of such a loan would be permitted (but not required) to increase the amount of his monthly payment to maintain the loans initial amortization schedule. The new payment schedule established each year would be calculated as the amount needed to amortize the principal balance of the loan over the remaining term.
New York Insurance Law § 6503 provides that mortgage guaranty insurance may be written only on loans that constitute "authorized real estate securities," which are in turn variously defined, in pertinent part, by N.Y. Ins. Law § 6501 as follows:
(c) "Authorized real estate security" means:
(1) an amortized instrument of indebtedness evidencing a loan secured by a first lien on real estate which at the time the loan is made is not less than eighty percent but not more than one hundred three percent of the fair market value of the real estate with any percentage in excess of one hundred percent being used to finance the fees and closing costs on such indebtedness, except, however, for reverse mortgage loans made pursuant to sections two hundred eighty and two hundred eighty-a of the real property law...
(2) an amortized instrument of indebtedness evidencing a loan secured by a junior lien on real estate which, when combined with all existing mortgage loan amounts at the time the loan is made, is not more than one hundred percent of the fair market value of the real estate...
(3) an amortized instrument of indebtedness evidencing a loan secured by an ownership interest in, and a proprietary lease from, a corporation or partnership formed for the purpose of the cooperative ownership of real estate in this state and which at the time the loan is made is not less than eighty percent nor more than one hundred percent of the purchase price of the ownership interest and the proprietary lease, if the loan is one which a regulated mortgage investor is authorized to make... or
(4) an amortized instrument of indebtedness, evidencing a loan which otherwise conforms to the requirements of paragraph one or three of this subsection, and which has been amortized to less than eighty percent of the fair market value of the real estate at the time said loan was made; provided the borrower is not obligated directly or indirectly to pay any premium for mortgage guaranty insurance authorized under this article...
N.Y. Ins. Law § 6503(c) (McKinney 2000) (emphasis supplied).
The Department construes the term "amortized instrument of indebtedness" as meaning one in which there is a gradual extinguishing of debt through the repayment of principal and interest, and has consistently taken the position that mortgage guaranty insurance may not be written in connection with negative amortization loans. In the event of increasing interest rates, the proposed loan product is certain, due to the mismatch in timing between the imposition of rate adjustments (monthly) and payment adjustments (yearly), to result in cases where the loans so structured will become negative amortization loans for some period of the loan term.
The view that mortgage guaranty insurance should not be permitted in the case of negative amortization loans is also consistent with subsequent legislative changes to the mortgage guaranty insurance statute. Specifically, the 1993 amendment to the statute excluded reverse mortgages (which are by definition negative amortization loans) from the definition of "authorized real estate securities". See L. 1993, Ch. 613, § 11.
Accordingly, the Department views the proposed loan product as one for which mortgage guaranty insurance could not be properly written.
For further information please contact Supervising Attorney Michael Campanelli at the New York City office.
1 Since these loans may be made with an initial loan-to-value ratio of up to 100%, it is foreseeable that, in an environment of increasing interest rates, such a loan structure would likely lead to accrual of additional outstanding interest, which would increase the principal balance above the original loan amount (i.e., negative amortization).