With bail outs of all types on the agenda for Wall Street and other sophisticated financial organizations, the New Jersey legislature has responded with a “bail out” of sorts in favor of some New Jersey homeowners, the Save New Jersey Homes Act of 2008 (Assembly Bill 2780, now known as P.L. 2008, c. 86) (the “SHA”). The SHA provides relief for residential mortgage borrowers that were “teased” into taking out loans with alluring low initial interest rates and payments. Many of these loans are resetting at higher rates resulting in correspondingly higher payments and in some cases “payment shock,” which the legislature fears may exacerbate the nationwide foreclosure epidemic, including here in New Jersey. The legislature’s solution is to require the holders of these loans in essence to rewrite their loan contracts to allow the borrowers to continue to make payments, based on the initial teaser rate well beyond the period set forth in those contracts. Lenders, servicers and mortgage investors need to take immediate action to implement the new law.
The SHA became effective immediately upon signing by New Jersey Governor Corzine Sept. 15, 2008, and will remain in effect until Jan. 1, 2011. It requires new notices in advance of the rate resets, empowers borrowers with loans that are about to reset to extend current payments at the introductory rate for three additional years, and provides for suspension of foreclosures upon a borrower’s request for an extension of the initial rate and payment. These are significant intrusions into the mortgage contract between borrower and lender, and could seriously impact the secondary market that has already been rocked with uncertainty.
Coverage & Scope
To What Loans Does the SHA Apply? The SHA applies to a limited set of residential mortgage loans identified as “introductory rate mortgages” (“IRMs”). Unfortunately, the SHA’s definition of an IRM is extremely complex and difficult to apply. An IRM is an adjustable rate “consumer credit transaction” secured by a consumer’s principal residence which meets either one of two tests:
- The first test is met if the loan has an “introductory payment rate” that is set at least 3 percent (presumably the drafters meant to say “percentage points”) below the fully indexed rate when originated, and allows for payments to adjust by more than 3 percent at the reset date, regardless of whether the variable rate index has increased.
- The second test is met if (i) the “interest rate” may adjust by more than 2 percent at the end of the initial fixed rate period, (ii) the “interest rate at origination,” “notwithstanding the payment rate in effect,” is more than 200 basis points over the Freddie Mac 30-year conventional interest rate, and (iii) the “introductory rate” is set below the fully indexed rate at origination and may adjust at the reset date, regardless of whether the variable rate index has increased. The quoted terms in this second test are not defined, making application of the test difficult.
Excluded from this definition are adjustable rate mortgages (“ARMs”) that provide for (i) an initial fixed interest rate period that lasts for at least five years, or (ii) an introductory rate below the fully indexed rate at origination solely as a result of the borrower’s payment of “bona fide discount points” (which are not defined). It is unclear whether a business-purpose loan secured by a borrower’s principal 1–4 family residence that meet one of the two tests for an IRM is intended to be covered under the SHA.
Every residential loan with a “teaser” rate must be measured carefully against the IRM definition. Since the IRM definition appears to cover both first- and subordinate-lien loans, as well as closed- and open-end loans, those within the residential mortgage industry who service these separate loan products on behalf of covered “creditors” should be alerted.
To Whom Does The SHA Apply? The SHA only applies to “creditors.” Creditors are defined in the SHA as New Jersey-chartered banks, savings banks, savings and loan associations, and credit unions; persons required to be licensed under the New Jersey Licensed Lenders Act; and any entity that acts on behalf of the creditor named in the debt obligation, such as loan servicers.
National banks, federal savings banks and savings associations, and federal credit unions are not covered, unless, perhaps (subject to possible preemption arguments discussed below), they are an assignee of an IRM or are servicing an IRM or acting in some other capacity with respect to an IRM on behalf of a New Jersey “creditor” whose name is on the note.
New Disclosure Required Prior to Rate Reset. Rather incredibly, outside of foreclosure and independent of whether or not the borrower is in default, the SHA gives some IRM borrowers the right, notwithstanding their contract terms, to extend the lower “teaser” rate for up to three years after the reset date. To ensure that IRM borrowers have a meaningful opportunity to exercise this new right, the SHA requires creditors to provide them, on two separate occasions, with a prescribed form of notice (the “Extension Notice”). This notice tells them about their right to extend the introductory payment rate and how to exercise it. The Extension Notice must be given to an IRM borrower 60 days and 30 days prior to the first rate adjustment on the IRM loan, and cannot be combined with other correspondence. (Interestingly, the federal Truth-in-Lending Act [“TILA”] already requires an advance notice of rate and payment changes in connection with ARMs. One could argue that the New Jersey notices are inconsistent with the TILA procedures, yet that determination would need to be made by the Federal Reserve Board.)
The Extension Notice must be in plain language in at least 14-point bold type, and must contain specific information about the borrower’s current rate and payment and anticipated reset rate and payment, as well as a list of alternatives to the rate reset, such as refinancing opportunities or renegotiation of terms offered by the creditor. An explanation of the borrower’s right to take advantage of the extension period (explained below) must also be included, along with an explanation of the procedure for doing so. In addition, each Extension Notice must include a “Certification of Extension” form that must be completed by the borrower to take advantage of the extension option. IRM servicers must immediately develop this notice and have it delivered as required.
Borrower’s Right to Extend Teaser Rate at Reset. The SHA could not be more direct in perhaps its most striking section: “Notwithstanding any law or contract right to the contrary, prior to the initial interest rate reset of an introductory rate mortgage, a creditor shall provide an [IRM] borrower a period of extension for three years…during which the interest rate on the introductory rate mortgage shall not increase above the original introductory rate…” (the “Reset Extension”).
Certification of Extension. To obtain the Reset Extension, the IRM holder must submit a completed and signed “Certification of Extension” prior to the date the rate resets. There appears to be no time allocated to the servicer to process and implement the extension, so conceivably the Certification of Extension can be received the day before the reset and would still have to be honored.
The Certification of Extension must state the name and address of the borrower and identify the property. It must also require the borrower to affirmatively state that he or she does not have sufficient monthly income, after deductions for necessary living expenses, to pay the monthly payments that will apply after the interest rate resets. (Incredibly, there is no opportunity under the SHA for the creditor or servicer to verify or dispute the borrower’s assertion in this regard. The only comfort the creditor can take from the SHA in this regard is that the SHA makes it a crime of the 4th degree for a borrower to make a “knowing material misrepresentation in a certification of extension.”)
Additionally, the Certification of Extension must state that the borrower agrees: (i) to make payments during the extension period based on the teaser rate, including payment of any other amounts for taxes, insurance, etc., in accordance with the terms of the IRM before the rate reset; (ii) to pay the creditor, upon full repayment of the IRM, any interest to which the creditor was entitled under the terms of the loan, but which was deferred on account of the period of extension; and (iii) to sign a “modification of mortgage” that contains the terms of the extension and secures the deferred interest.
Again, incredibly, the SHA gives a creditor or servicer no right or opportunity to check whether the extending IRM borrower is otherwise complying with its mortgage obligations. It simply says that “[t]he creditor, upon receiving the completed certification of extension shall grant the [IRM] borrower the three-year period of extension, which shall commence on the date the introductory rate is due to reset…” (italics supplied). For example, if the IRM borrower does not maintain insurance or allows waste to occur on the property, that would not appear to excuse the creditor from its extension obligation under the SHA. (Nothing in the SHA, however, appears to prohibit a mortgage holder from pursuing its contractual remedies against the borrower for noncompliance with such obligations.) Furthermore, the creditor may not require an IRM borrower to limit or waive any rights against the creditor as a condition of accepting an extension pursuant to the SHA.
Acknowledgement of Receipt. The process does not stop there. The creditor must provide a “written acknowledgment” of receipt of the completed certification of extension “within a reasonable amount of time after receipt…” The acknowledgment must contain the monthly payment amount that is due during the period of extension (including principal, interest, taxes, insurance and other amounts being paid), a schedule of payments, the address to which such payments must be sent, a notice that a “modification of mortgage” will be filed to secure repayment of the deferred interest, and an explanation of how that deferred interest will be calculated.
Modification of Mortgage. The modification of mortgage is deemed to be effective on the date it is executed and to have the same priority as the original IRM. If the borrower does not return the executed modification of mortgage within 30 days after receipt, the creditor may record the Certification of Extension itself, with the same effect as if it had recorded the Modification. If the borrower fails to comply with the terms of the modification “such that the modification of mortgage becomes 60 days delinquent,” the borrower forfeits all rights concerning deferment of interest payments provided by the SHA. There is no indication in the SHA as to whether a creditor may add any other obligations to the modification of mortgage or whether a default, other than a payment default, can trigger forfeiture of the interest deferment. The SHA obviously gives IRM borrowers a powerful option to trump their contractual obligations and, by doing so, seems likely to further complicate the relationships between creditors, servicers and the secondary market.
New Disclosure Required Prior to and During Foreclosure Actions. New Jersey’s Fair Foreclosure Act (“FFA”) and applicable court rules require that various notices be given to homeowners prior to the institution of, and during, proceedings to foreclose on a residential mortgage. Now, because of the SHA, more notices must be sent to IRM borrowers (provided they have not previously exercised their right to obtain a Reset Extension). Within 10 days of issuing a notice of intention to foreclose, and, again, at the time the creditor applies for entry of final judgment of foreclosure, the creditor must send IRM borrowers separate written notices (respectively, the “10-day Notice” and the “Judgment Notice”), “by regular and registered mail,” informing them of their right to have the foreclosure action suspended for three years and to make payments at their teaser rate during that period.
These notices must name the SHA, must list alternatives to foreclosure such as refinancing options, explain the borrower’s right to obtain the three-year extension (discussed below), include a suggestion to consult counsel, and be accompanied by a Certification of Extension form. Interestingly, the envelope in which these notices are mailed must have printed on their “outside front portion” a three sentence statement that briefly informs the recipient as to its contents, encourages the recipient to carefully read what is inside, and suggests that he/she may wish to consult counsel. This raises an interesting issue—whether printing such information on the outside of an envelope might be deemed to violate federal or state debt collection laws and/or privacy laws.
Before entering final judgment in a foreclosure action involving an IRM, courts must be satisfied, from the pleadings and certifications on file, that the 10-day Notice and the Judgment Notice were provided to the borrower in accordance with the SHA.
Borrower’s Right to Suspend Foreclosure and Extend Teaser Rate. Similar to the Reset Extension option discussed above, the SHA empowers IRM borrowers who have received a Notice of Intention to Foreclose, as required by the FFA, to have the foreclosure proceeding suspended for three years and to obtain an extension of their teaser rate and payment during that same period (the “Foreclosure Suspension”). The SHA again is crystal clear:
“Notwithstanding any law or contract right to the contrary, a creditor shall provide [the] borrower a period of extension for three years…during which foreclosure proceedings…shall be suspended and the…borrower shall continue to pay monthly payments…at the introductory rate on the date that the [IRM] was originated…” As a result, the borrower would pay principal and interest calculated at the initial teaser rate, together with applicable escrow payments for taxes and insurance, during the three-year Foreclosure Suspension period. (Borrowers who are already paying interest at the fully indexed rate when they receive a Notice of Intent to Foreclose, and who then request a Foreclosure Suspension, would presumably be entitled to have their initial teaser rate reinstated, rather than extended, during the three-year period, a bizarre result.)
The process to obtain a Foreclosure Suspension is very similar to the process to obtain a Reset Extension. First, the IRM borrower must return the completed and signed Certification of Extension to the creditor no later than 90 days after the creditor sends the Judgment Notice. Interestingly, the SHA does not state that the court must delay entry of judgment of foreclosure until this 90-day period expires (although we suspect that judges will find such a requirement to be implied in the statutory scheme). Also, nothing in the SHA appears to prohibit an IRM borrower from requesting and obtaining a Foreclosure Suspension before receipt of the Judgment Notice. In such a scenario, once the Foreclosure Suspension expires, the creditor would presumably still be obligated to provide the Judgment Notice, which raises an issue as to whether the IRM borrower would be entitled to request and obtain a second Foreclosure Suspension. Finally, creditors are given discretion to grant a Foreclosure Suspension if the Certification of Extension arrives after the 90-day period.
Certification of Extension. The Certification of Extension required to obtain the Foreclosure Suspension is essentially the same as the one needed to obtain the Reset Extension, with two notable exceptions. First, it does NOT require the borrower to state affirmatively that he or she does not have sufficient monthly income, after deductions for necessary living expenses, to pay the monthly payments that will apply after the interest rate resets. Presumably, the onset of the foreclosure process is evidence enough of that. Second, it obligates the borrower to agree to pay the creditor upon full repayment of the mortgage not only the deferred interest, but also “any fees and costs incurred by the creditor in connection with the foreclosure proceeding,” and any arrearages for payments that the borrower was required to pay, but failed to pay, under the terms of the IRM.
As with Reset Extension requests, the SHA gives a creditor or servicer faced with a Foreclosure Suspension request no right or opportunity to check whether the borrower is otherwise complying with its mortgage obligation. Rather, the SHA requirement to provide the Foreclosure Suspension appears to be automatic: “The creditor, upon receiving the completed certification of extension…shall grant the…borrower the three year period of extension, which shall commence no later than 30 days from the date that the creditor receives the…borrower’s completed certification of extension; and suspend the foreclosure proceeding…” Again, the creditor may not require the borrower to limit or waive any rights against the creditor as a condition of granting a Foreclosure Suspension pursuant to the SHA.
Written Acknowledgment. Similar to the Reset Extension process, the creditor must also provide a “written acknowledgment” of receipt of the completed Certification of Extension “within a reasonable amount of time after receipt…” One item required in this acknowledgment that is not required in the Reset Extension acknowledgment is the statement that the foreclosure proceedings will be suspended.
Modification of Mortgage. The modification of mortgage executed as part of a Foreclosure Suspension secures not only the deferred interest, but also any fees and costs incurred in connection with the foreclosure proceeding, and any arrearages owed to the creditor, such as interest, principal, taxes or insurance, that the borrower had failed to pay. In all other respects, including the ability to record the Certification of Extension if the borrower fails to return the executed modification of mortgage within 30 days of receipt, the rules relating to the modification of mortgage during the Foreclosure Suspension process are the same as those during the Reset Extension process.
It appears at first glance that the SHA may be susceptible to challenge on several fronts, including that portions of it may be preempted as to certain creditors or is unconstitutional. Possible grounds for such challenges are discussed below. However, because the SHA is effective immediately, there is no time to obtain official guidance from a court or the New Jersey Attorney General (who is authorized to adopt implementing regulations, in consultation with the New Jersey Department of Banking and Insurance). Application of the legal arguments discussed below is very complicated and merits much more detailed analysis. As a result, lenders and services should consult counsel to assess their positions with regard to preemption and/or unconstitutionality of this new and significant legislation.
AMTPA. The federal Alternative Mortgage Transactions Parity Act (“AMTPA”) covers ARMS and other “alternative mortgage transactions” (“AMTs”), and essentially puts state-chartered and state-licensed lenders into the “preemptive” shoes of federally chartered depository institutions. AMTPA allows these state lenders to make AMTs, notwithstanding conflicting state laws, so long as they do so consistent with rules of the designated federal bank regulator. Implicit in the power to make AMTs is the power to enforce them in accordance with their terms.
State Bank Parity Act. New Jersey also has a parity law for state-chartered banking institutions. Its purpose is to put those institutions on a level playing field with their federally chartered counterparts, as well as, selectively, with their state-chartered counterparts in other states, thereby helping to make the option of a New Jersey state banking charter more attractive. Interestingly, the SHA specifically provides that the state bank parity act may not be used to avoid the requirements of the SHA. This means that state-chartered banking institutions will have to grant Reset Extensions and Foreclosure Suspensions, and provide the various notices required by the SHA, but federally chartered institutions will not.
National Bank Act/Home Owners Loan Act. As indicated above, the SHA does not apply to national banks, federal savings banks and savings associations or federal credit unions, at least not directly. However, it may be deemed to apply to such institutions indirectly; i.e., when they act as a servicer or in some other capacity on behalf of a covered creditor that is named on an IRM Note, or when they become an assignee of an IRM. There is an argument that the SHA, or at least part of it, is preempted because the National Bank Act and the Home Owners Loan Act, and their implementing regulations, give federally chartered lenders broad authority to make real estate loans without regard to state law limitations.
On its face, the SHA arguably applies to “operating subsidiaries” of national banks and federal savings banks and savings associations (“Op-Subs”). The question then becomes whether Op- Subs can take advantage of federal preemption to avoid the SHA’s requirements. Under federal law, any provisions of the SHA that would be preempted as to the parent federal bank would also be preempted as to the Op-Sub. As a result, precisely how the SHA might apply to an Op- Sub may depend on the extent to which the SHA would have been preempted had it applied to the parent bank itself.
New Jersey Constitution/Impairment of Contracts. Article IV, Section 7, paragraph 3 of the New Jersey Constitution specifically forbids the legislature from passing any law “impairing the obligation of contracts, or depriving a party of any remedy for enforcing a contract which existed when the contract was made.” While postponement of foreclosure may not in itself be considered sufficient impairment of the contract, an argument can be made that a law requiring modification to the payment terms of a mortgage impairs the obligation of that contract.
Penalties and Enforcement
The SHA establishes a penalty for willful violations of not more than $10,000 for the first offense and not more than $20,000 for the second and any subsequent offense. “Immaterial errors” in a notice do not constitute a violation. A creditor’s violation can trigger an action by an IRM borrower or the Attorney General “to enforce compliance by a summary proceeding” under New Jersey’s Penalty Enforcement Law. There does not appear to be any other enforcement avenue independent of the Penalty Enforcement Law, such as a private right of action. However, a borrower facing foreclosure that has not received either the 10-day Notice or the Judgment Notice could seek to derail the foreclosure proceeding.
The bottom line for readers: if your business is mortgage servicing, mortgage investing or mortgage foreclosure, the time to grapple with complicated SHA issues is now..