The Office of General Counsel issued the following opinion on September 6, 2005, representing the position of the New York State Insurance Department.

Question:

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?

Conclusion:

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.

Facts:

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 loan’s 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.

Analysis:

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:

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).