BILL ANALYSIS
SENATE COMMITTEE ON BANKING, FINANCE,
AND INSURANCE
Senator Michael J. Machado, Chair
AB 529 (Torrico) Hearing Date: June 4, 2008
As Amended May 27, 2008
Fiscal: No
Urgency: No
SUMMARY Would require entities responsible for collecting
payments of principal, interest, or both, on certain types of
residential mortgages to notify borrowers who hold those
mortgages in advance of certain events that are likely to change
the mortgage payments owed by the borrowers, as specified.
DIGEST
Existing federal law
1. Provides for the Truth in Lending Act (TILA; 15 USC 1601
et seq.), which was enacted in 1968 and is intended to
protect consumers in credit transactions, by requiring
disclosures of the key terms and costs of lending
arrangements. Regulation Z (12 CFR Part 226) implements
the provisions of TILA relating to the closed-end mortgage
transactions which are the subject of this bill;
2. Defines a variable-rate transaction as a closed-end loan
with a term greater than one year, in which the annual
percentage rate may increase after consummation, and which
is secured by the consumer's principal dwelling. Requires
specified disclosures to be provided to a consumer at the
time he or she applies for such loans or pays a
non-refundable fee in connection with the loan, whichever
is earlier (12 CFR 226.19(b));
3. Provides that an interest rate adjustment, with or
without a corresponding payment adjustment, in a
variable-rate transaction defined in 226.19(b), is an event
requiring new disclosures to the consumer, and requires the
following disclosures to be delivered or placed in the
mail, at least 25, but no more than 120, calendar days
before a payment at a new level is due (12 CFR 226.20(c)):
AB 529 (Torrico), Page 2
a. The current and prior interest rates;
b. The index values upon which the current and
prior interest rates are based;
c. The extent to which the creditor has foregone
any increase in the interest rate;
d. The contractual effects of the adjustment,
including the payment due after the adjustment is
made, and a statement of the loan balance;
e. The payment, if different from that described
in "d" above, which would be required to fully
amortize the loan at the new interest rate, over the
remainder of the loan term.
Existing law
1. Defines an adjustable-rate residential mortgage loan (ARM), for
purposes of Sections 1918.5, 1920, and 1921 of the Civil Code
(which collectively comprise Chapter 7.5 of Title 4 of Division
2 of the Civil Code), as any loan or credit sale that is
primarily for personal, family, or household purposes; which
bears an interest rate that is subject to change during the term
of the loan, and which is secured by residential real property
containing one to four dwelling unit (Civil Code Section 1921);
2. Defines a lender as any person, association, corporation,
partnership, limited partnership, or other business entity
making more than 10 loans or credit sales secured by residential
real property containing one to four dwelling units during any
12-month period (Civil Code Section 1921);
3. Requires all of the following with respect to ARMs covered by
Chapter 7.5 (Civil Code Section 1920):
a. Standards for the adjustment of interest rates or
monthly payments must consider factors that can reasonably be
deemed to affect the ability of borrowers to meet their
mortgage obligation;
b. No interest rate change is valid, unless:
i. The security document or evidence of debt
AB 529 (Torrico), Page 3
issued in connection with the security document includes
a statement authorized by the Secretary of Business,
Transportation, and Housing (Secretary), or his
designee, notifying the borrower that the mortgage may
provide for changes in interest, principal loan balance,
payment, or loan term;
ii. Before the due date of the first monthly
installment following each change in the interest rate,
notice is mailed to the borrower of all of the
following: the base index, the most recently published
index at the date of the change in the rate, the
interest rate in effect as a result of the change, any
change in the monthly installment, the amount of the
unpaid principal balance, and, if the interest scheduled
to be paid on the due date exceeds the amount of the
installment, a statement to that effect, and the amount
of the excess, and the address and telephone number of
the office of the lender to which inquiries may be made;
c. Borrowers must be allowed to prepay their loans in whole
or in part, at any time, without a prepayment charge. No fee
or other charge may be required by the lender of the borrower
as a result of any change in the interest rate, the payment,
the outstanding principal loan balance, or the loan term;
d. To the extent that any monthly installment is less than
the amount of interest accrued during the month with respect
to which the installment is payable, the borrower must be
notified of that fact in a form and manner prescribed by the
Secretary or his or her designee;
e. Lenders must provide full and complete disclosure to
borrowers, as specified by the Secretary or his or her
designee, regarding the nature and effect of the mortgage
payment instrument, prior to the execution of the mortgage by
the borrower.
This bill
1. Would require the entity responsible for collecting
payments of mortgage principal, interest, or both, to do all
of the following, with respect to first lien mortgage loans
that are secured by residential real property improved by
four or fewer units, and which were made between January 1,
2003 and December 31, 2007:
AB 529 (Torrico), Page 4
a. Notify the borrower no more than 120 days, and no
less than 90 days before either of the following:
i. The date on which a loan with an interest
rate that is initially fixed and then becomes
adjustable is scheduled to switch from the fixed
rate to an adjustable rate (these types of loans
will be referred to in the remainder of this
analysis as hybrid loans); or,
ii. The date on which a loan that allows the
borrower to select from among four payment amounts
each month is scheduled to reset to a fully
amortizing loan (these types of loans will be
referred to in the remainder of this analysis as
payment option loans);
b. To include all of the following in the notification
specified above in a:
i. The current monthly payment amount, in
the case of a hybrid loan, or the current minimum
payment, in the case of a payment option loan;
ii. The month and year in which the entity
responsible for collecting loan payments estimates
that a hybrid loan will switch from fixed to
adjustable, or that a payment option loan will
switch from non-amortizing to fully amortizing;
iii. The estimated monthly payment amount
expected to apply when the hybrid loan first becomes
adjustable, or when the payment option loan first
becomes amortizing;
iv. An indication of whether the monthly
payment amounts referenced in i and iii above
include real estate taxes, home insurance, or both;
v. A toll-free telephone number the borrower
may contact for additional information about the
terms of his or her loan;
vi. Statements that the information in the
notice is not a request for payment, is for
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informational purposes only, that the actual monthly
payment due in the month in which the loan is
expected to reset may be different than the amount
shown in the notice, and that the borrower will be
mailed a notification, pursuant to federal law, at
least 25 days prior to the loan reset, which will
indicate the actual payment that will be due when
the loan resets;
c. To deliver the notice either personally or by first
class mail to the borrower's last known address, as
contained in the lender's records;
2. Would provide that the notification required by the bill be
provided in addition to the notification required under 12
CFR Part 226 (i.e., pursuant to TILA).
COMMENTS
1. Purpose of the bill To provide borrowers with certain
types of mortgages that have recently been associated with
payment shock an early warning, before their mortgages
reset, in order to give them time in which to prepare for
their new monthly payments.
2. Background California is currently suffering the effects
of a severe housing crisis, which has not only negatively
affected borrowers who have lost their homes to foreclosure,
but has also had significant negative ripple effects on
housing values, local economies, and the state economy.
Although many other states across the United States have
been affected by what has colloquially become known as "the
subprime mortgage crisis," California is suffering more than
most others.
Statistics on the number of people who have been directly
affected by the mortgage problems gripping the state and the
country are available from RealtyTrac, DataQuick, First
American LoanPerformance, FirstAmerican CoreLogic, the
Mortgage Bankers Association, the HOPE NOW Alliance, the
Conference of State Bank Supervisors, the California
Department of Corporations, and others. Although the
statistics reported by each of these organizations differ
somewhat, depending on data collection methodologies and the
organizations surveyed, all of the data lead to the
AB 529 (Torrico), Page 6
following inescapable conclusions: Delinquencies and
foreclosure rates are at historically high levels in
California, and are growing. Subprime mortgages are
performing worse than Alt-A and prime mortgages, but
delinquencies and foreclosures among all three types of
mortgages are at historic highs. Many homes have lost a
significant amount of value since the mortgages issued to
fund their purchases were made, and historically high
numbers of homeowners owe more on their mortgages than their
homes are worth (i.e., are upside down). Most homeowners
who are upside down in their mortgages are unable to
refinance. Restrictions in the availability of credit and
high borrowing costs have made it difficult for even those
borrowers who are not upside down to refinance out of their
existing mortgages. Several of the hybrid and payment
option mortgages that are the subject of this bill were
underwritten based on borrowers' ability to pay the
introductory mortgage payments; they were not underwritten
based upon borrowers' ability to afford their mortgage
payments, after the mortgages reset. Poor mortgage
underwriting and inadequate consumer mortgage loan
disclosures have created a situation in which many subprime
borrowers are delinquent on their mortgages before their
first rate resets, and others become delinquent upon their
first rate resets.
AB 529 represents an attempt to help borrowers who hold hybrid
loans and payment option loans, and who either do not
understand that their loans will reset, or who understand in
concept that a reset will occur, but do not know when, nor
by approximately how much, their mortgage payments will
change. The bill is designed to provide borrowers that hold
the types of loans most commonly associated with payment
shock with early warning about their mortgage resets. The
author's logic is that, armed with the knowledge this bill
will give them, borrowers can either juggle their other
financial commitments to find the money necessary to afford
their new mortgage payments, or can reach out to their
lenders before the borrowers become delinquent on their
loans, in hopes of negotiating a loan modification or other
form of forbearance, and avoiding foreclosure.
The mechanics of hybrid and payment option loans are
sufficiently complicated that an explanation of both is
warranted, to provide a clear explanation of how and when
the notifications required by this bill would work.
AB 529 (Torrico), Page 7
Hybrid loans , which are also known as 2/28s and 3/27s, offer
borrowers an initial period of relatively low, fixed
payments, which last for either 24 months (in a 2/28 loan)
or 36 months (in a 3/27 loan). Once the introductory period
ends, the monthly payments adjust once every six months or
once annually, depending on the issuer and the mortgage
contract. The monthly payments applied after a hybrid loan
resets are calculated by adding a margin, specified in the
mortgage contract, to an index, also specified in the
mortgage contract. For example, a loan could use the London
Interbank Offered Rate (LIBOR), an index common to many
hybrid loans, and could apply an index of 7% (or another
margin; the margins on hybrids vary depending on when the
loan was issued and which lender originally issued it). In
this example, the monthly mortgage payment would equal LIBOR
plus 7%, multiplied by the loan principal, and amortized
over the remaining period of the loan (either 28 years in a
2/28 or 27 years in a 3/27). As LIBOR varies up and down,
so will the mortgage payment, although, as noted above, the
payment will typically reset only once semi-annually, or
once annually, depending on the mortgage contract.
Typically, mortgage contracts cap the amount by which the
semi-annual or annual payments may rise from one adjustment
to the next, but there is typically no cap on the amount by
which the mortgage payment can adjust between the initial
introductory rate period and the initial adjustable rate
payment, post-reset. These jumps between introductory rate
to first reset payment have been associated with payment
shock among borrowers who either did not understand that
their monthly payments would increase, or who understood,
but were unable to afford the new payments.
AB 529 would require entities that collect mortgage payments
from borrowers with hybrid loans to notify these borrowers
between 120 and 90 days before the change from the initial
introductory rate to the first, post-reset payment.
Subsequent notification of the borrower, other than the TILA
notification required under federal law, would not be
required.
Payment option mortgages offer borrowers a choice of four
payments each month: a minimum payment that does not
include any principal, and does not fully cover all of the
interest that is accruing on the loan; an interest-only
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payment that pays all interest as it accrues, but does not
pay down any principal; a payment that amortizes the loan
over 30 years (i.e., that pays down both principal and
interest as if the loan were a traditional 30-year loan);
and a payment that amortizes the loan over 15 years. The
minimum payment typically remains the same for one year,
then adjusts once annually. The other three payments vary
monthly, based on the index and margin of the loan.
Although some payment option mortgages issued during the
time period covered by this bill were fixed rate loans, the
vast majority of payment option mortgages were adjustable.
Furthermore, although most payment option mortgages require
borrowers to make payments on a monthly basis, some payment
option loans require bi-weekly payments.
As their name implies, payment option loans are intended to
give borrowers a choice about their monthly (or bi-weekly)
payments. However, over time, borrowers who make only the
minimum payment will accrue mortgage balances that exceed
the original amount borrowed. These minimum payments are
negatively amortizing (i.e., they increase the amount of
money the borrower owes), because a borrower's choice to
defer paying some of the interest he or she owes has the
effect of increasing the amount of money that must be paid
back later.
When the amount owed by the borrower reaches a trigger point,
established in the mortgage contract, the borrower must
begin to make payments that fully amortize the loan (i.e.,
payments that include both principal and interest). The
point at which a payment option loan converts from a choice
of four payments each month to a required, amortizing
payment is called the reset point.
Like most other elements of ARMs, the reset point for payment
option loans varies by lender, and is specified in the
mortgage contract. Some of the payment option loans offered
during the time period covered by this bill reset the
earlier of five years from the date the loan was made or
when the borrower owed 110% or 115% of the original loan
amount (different contracts specified different percentage
triggers). Other lenders offered payment option loans that
reset the earlier of ten years from the date the loan was
made or when the borrower owed 125% of the original loan
amount.
AB 529 (Torrico), Page 9
Generally speaking, if borrowers make only the minimum payment,
they will hit the 110%, 115%, or 125% trigger before they
hit the time trigger. If borrowers make a few interest-only
or fully amortizing payments and opt to pay the minimum
amount for most of their payments, they will hit the five or
ten year trigger before they hit the 110%, 115%, or 125%
trigger.
Under either scenario, borrowers who hit the reset point are
required to pay at least an amount each month (or every two
weeks, as applicable) that fully amortizes the accrued
principal and interest due. Depending on the lender and the
mortgage contract, this amount resets either monthly, or,
more commonly, semi-annually or annually.
AB 529 would require entities that collect mortgage payments
from borrowers with payment option loans to notify these
borrowers between 120 and 90 days before the loans are
expected to reset from non-amortizing (choice of four
payments each month) to amortizing. Subsequent
notification, other than the TILA notification required
under federal law, would not be required.
3. Discussion There are several ongoing initiatives intended
to assist borrowers who are having trouble making their
mortgage payments. For example, in November 2007, Governor
Schwarzenegger reached an agreement with several
state-regulated financial institutions to engage in
streamlined modifications of certain types of subprime ARMs.
The agreement has grown to include ten lender institutions.
As part of their commitment under the agreement, lenders
and servicers are required to reach out proactively to
borrowers before their loans reset.
In December 2007, President Bush and U.S. Secretary of the
Treasury Henry Paulson announced the HOPE NOW Alliance plan,
an industry-led initiative intended to facilitate
streamlined modifications of selected subprime ARMs.
Lenders and servicers who sign on to the HOPE NOW Alliance
also agree to attempt to contact at-risk borrowers 120 days,
at a minimum, prior to the initial ARM reset on all 2/28 and
3/27 loans.
Individual lenders are also taking it upon themselves to send
notices that go beyond the minimum expectations of the
voluntary foreclosure-avoidance alliances to which they
AB 529 (Torrico), Page 10
belong. For example, three lenders who have testified
before this Committee during informational hearings,
including Countrywide, Option One, and Wachovia, provide
multiple, detailed notification letters to borrowers prior
to rate resets, to warn them of upcoming payment changes,
and to provide borrowers with phone numbers they can call if
they have questions.
Furthermore, as noted above, both TILA and Civil Code Section
1920 require lenders that issue ARMs to notify borrowers
before the due date of each change in a mortgage's payment
amount, and to include considerably more information in
these notices than would be required by AB 529. Although no
court has specifically opined on whether Civil Code Section
1920 is pre-empted in its application to federally-chartered
financial institutions or their subsidiaries, there is no
question that TILA applies to both federal and state
lenders.
The discussion immediately above raises questions about the
extent to which the notifications required by this bill are
necessary, and will be helpful in helping mitigate
California's mortgage problems. However, there are also
reasonable counter-arguments that support the value of the
bill. The mortgages that are the subject of this bill can
be quite confusing, as the lengthy text above, attempting to
explain them, demonstrates. Requiring that a single letter
be mailed to a borrower three to six months before his or
her first mortgage payment reset, giving the borrower an
estimate of the amount by which his or her monthly payment
might increase, could provide the early warning necessary to
help avoid some delinquencies. Arguably, lenders who are
not already providing these notices have a moral obligation
to do so, to ensure that loans which were poorly
underwritten and inadequately disclosed do not trap
borrowers ignorant of their terms.
4. Support . The Center for Responsible Lending (CRL) is in
qualified support of the bill, and urges amendments to
clarify and strengthen the bill's requirements. CRL
describes the bill as "one positive piece in a larger
package of reforms and actions necessary to provide
borrowers with a real chance of saving their homes, and to
avoid or minimize problems in the future."
CRL believes that the May 28th amendments weaken the bill by
AB 529 (Torrico), Page 11
limiting the requirement to only one notice, from three in
the prior version. CRL would like to see the bill require
two notices, one early (120 to 90 days prior to reset) and
one closer to the date of reset.
CRL is pleased to see that the bill was amended to apply to
payment option mortgages, but would like the bill to be
amended to apply to "a loan that allows for negative
amortization, and allows the borrower to select one of
several payment amount options each month," because many
payment option mortgages provide a choice of three payment
amounts, rather than four.
CRL urges that the requirements of AB 529 be made permanent,
rather than applying only to loans originated before
December 31, 2007. Finally, CRL would like to require that
the notification required by the bill be sent to borrowers
in the language in which the loan was negotiated, or, if
that language is not known, in each of the languages
specified in Civil Code Section 1632 (Spanish, Vietnamese,
Korean, Tagalog, and Chinese).
5. Opposition The California Mortgage Bankers Association,
California Bankers Association, California Chamber of
Commerce, California Financial Services Association, and
California Independent Bankers, writing jointly, oppose AB
529, because the bill's provisions are still problematic and
are likely to cause consumer confusion, rather than provide
the intended assistance.
The trade organizations listed above are concerned that
projecting payment amounts three or four months prior to the
date of a payment reset would likely present an inaccurate
picture of the actual interest rate or payment at the date
of reset. They believe that the notifications required by
AB 529 will, at best, confuse consumers, and at worst,
unintentionally mislead them about what their actual payment
changes will be three or four months in the future.
The trade organizations are also concerned that AB 529 is
unclear about whether it would apply only to the initial
interest rate and payment reset. If the bill applies to
more than the initial reset, it would require lenders for
these types of loans to blanket the borrower with a
cascading number of notices that may or may not be accurate
depictions of the interest rate and payment, as of the date
AB 529 (Torrico), Page 12
of the actual interest rate reset.
The trade organizations note that TILA already requires
borrowers to be sent a notice about their new payment level
at least 25 days, and no more than 120 days, before a
payment at a new level is due. "This time-frame allows for
the lender or servicer to provide the actual interest rate
and payment changes because, as an example, the interest
rates are typically tied to an index that becomes available
30 or 45 days prior to the scheduled payment change. The
notice can therefore be sent during that 30 to 45 day
period."
6. Questions
a. Despite the existence of the voluntary
initiatives summarized above, and the requirements to
provide notifications pursuant to both TILA and Civil
Code Section 1920, mortgage delinquencies and defaults
continue to rise. Are delinquencies and defaults
rising, because borrowers are unaware that their
mortgages are about to reset, or for other reasons
unrelated to the knowledge of their mortgage resets?
b. Is an additional notification, such as the one
that would be required by this bill, necessary, given
all of the other requirements and initiatives in
existence?
c. Will this bill be binding on
federally-chartered financial institutions?
d. Will borrowers that are the target of this
bill open, read, and understand a notification mailed
to them pursuant to the requirements of the bill?
7. Suggested Amendments .
a. On page 3, line 20, the reference to
"lender's" records should be amended to "entity's"
records, consistent with the language of the measure.
b. The language in the bill that intends to refer
to hybrid loans would benefit from an amendment to
better achieve the author's intent. The following
language is suggested, in lieu of the language on page
AB 529 (Torrico), Page 13
2, lines 5 through 9: (1) In the case of a loan with
a payment amount that is fixed for a period of not
less than 24 months, nor more than 36 months, and
whose payment amount then becomes adjustable, the
notification required pursuant to this subdivision
shall be provided no more than 120 days, and no less
than 90 days, before the date on which the loan is
first scheduled to switch from the initial, fixed
payment, to an adjustable payment amount.
A conforming change is suggested on page 2, lines 21 and
22, to strike the words "an interest rate" and replace
them with "a monthly payment".
c. As noted above, CRL asserts that certain types
of payment option mortgages allow borrowers to choose
from three payments, rather than four.
8. Prior Legislation
a. SB 926 (Perata), 2007-08 Legislative Session:
Would have required mortgage payment notices similar
to, but more comprehensive than, those required by
this bill. Failed passage on the Senate Floor.
POSITIONS
Support
AFSCME
California ACORN
Center for Responsible Lending
Consumers Union
Oppose
California Bankers Association
California Chamber of Commerce
California Credit Union League
California Financial Services Association
California Independent Bankers
California Mortgage Bankers Association
Consultant: Eileen Newhall (916) 651-4102