Banking Interpretations

April 11, 2002

Ms. Elisabeth C. Prentice
Director, New York/Puerto Rico District
Neighborhood Reinvestment Corporation
New York/Puerto Rico District
Clinton Hall
108 North Cayuga Street, 3rd Floor
Ithaca, NY 14850-4346

Re:       Request for Legal Opinion

Dear Ms. Prentice:

Your letter dated February 28, 2002 to Sara Kelsey, Deputy Superintendent and Counsel, requesting an opinion from the Banking Department ("Department") that mortgages offered with a product known as "equity assurance" are not prohibited by Part 82 ("Part 82") of the General Regulations of the Banking Board has been forwarded to me for a response.  In particular, you ask for the Department's confirmation that the product would not violate the prohibitions against a price level adjusted mortgage (PLAM) or shared appreciation mortgage (SAM) contained in that Part.

According to your letter, the Neighborhood Reinvestment Corporation is helping to develop a pilot product in New York State to encourage investment in urban neighborhoods where there is concern over the potential for declining property values. Called "equity assurance", the product would provide homeowners with financial protection against such a decline in their area.  The pertinent details are as follows

  • The equity assurance product would be offered simultaneously with the homebuyer's mortgage.  In order to purchase the product, the borrower would pay points upon origination of the loan, which would be passed on to a third-party guarantor.

  • In the event that home prices fall when the borrower seeks to pay off the mortgage, the guarantor would have the responsibility of paying the amount of the protection to the note holder, thereby reducing the cost to the borrower of paying off the loan.

  • The amount of protection would be tied to the change in a house price index for the geographic area in which the home is located.  For example, if the house price index in the particular area drops by 10% between the times of purchase and resale, then the guarantor will provide financial protection equivalent to 10% of the original note amount.[1] If, instead of dropping, the house price index were to stay the same or rise, no financial protection would be provided.

  • In the event that the house price index did not accurately reflect the homeowner's actual loss experience, an appraisal-based mechanism would adjust the amount of the protection provided while excluding any impact due to the homeowners" home maintenance and improvement decisions.

  •  The note amount and amount of the borrower's monthly payment would not be affected by any movement in the house price index.

  •  Under no circumstances would the homeowner share with the note holder any appreciation that occurred in the value of the property.

Section 82.1(a) of the General Regulations of the Banking Board (Authorization for alternative mortgage instruments) constitutes the exclusive authority for "banks, trust companies, savings banks, savings and loan associations, credit unions, persons and entities engaging in the business described in section 590, article 12-D of the Banking Law .to make, sell, purchase or participate in mortgage loans in a principal amount of less than $250,000 other than fixed-rate, self-amortizing loans." Section 82.1(b) specifically excludes from authorization a mortgage loan that is structured either as a PLAM or a SAM.

A PLAM is commonly understood to be a mortgage loan in which the interest rate remains fixed, but the outstanding balance is adjusted periodically for inflation according to an appropriate price index, such as the Consumer Price Index or Cost-of-Living Index. At the end of each period the outstanding balance is adjusted for inflation and monthly payments are recomputed based on the new balance.

For example, let us assume that the original loan terms provided for $100,000 mortgage at 8% for 30 years, with a yearly adjustment.  If we assume that at the end of the first year the outstanding loan balance was $90,000 and the Consumer Price Index was 5%, then the monthly payments would be adjusted to reflect the payments for a loan with an outstanding balance of $94,500(or $90,000 +5%).

A SAM, on the other hand, is a mortgage loan in which the lender offers the borrower a lower interest rate in exchange for a portion of the profit upon eventual sale of the property.

As you have described the equity assurance product, the note amount and accordingly the amount of the borrower's monthly payment, would not be affected by any movement in the house price index.  The only change would be in the party who makes the final payments in the event of an equity assurance claim.  If there is no equity assurance claim, the borrower simply pays the principal balance due at mortgage termination.  If there were an equity assurance claim, the guarantor would write the check for debt relief to the note holder while the borrower pays the net amount.  In all cases, the note holder gets the full original scheduled mortgage and note amount.

Given the structure that you describe, noting in particular that the note amount and the amount of the borrower's monthly payments would not be tied to the house price index, we concur that the product is not akin to a PLAM, which is subject to adjustments in the outstanding balance.  Moreover, as you have stated that under no circumstances would the homeowner share with the note holder any appreciation that occurred in the value of the property, it would not be considered a SAM and likewise would not be prohibited by Part 82.  Accordingly, the equity assurance product does not violate Part 82.

Please be advised that this conclusion is based on the facts as you have outlined them to the Department.  In addition, this opinion should be deemed applicable only to the pilot program you described, and the Department expressly reserves the right to reconsider the views expressed herein after it has had an opportunity to consider the operation of the pilot program.

I trust that this letter will be of assistance to you.

Very truly yours,

Alvin A. Narin
Assistant Counsel

cc:  Barbara Kent
Gail Bernstein-Gold
Jeffrey Bryson, General Counsel

[1]  It is assumed that the amount of the financial protection will be based on the original note amount, not the remaining balance on the note at the time of resale.