Federal monetary and finance regulators aren't out to end so-called "nontraditional' mortgages, but they do want to make sure the loans are sound and come with terms that are fully disclosed to borrowers.
Since the end of March, federal agencies have been sorting through comments on proposed guidelines to reduce risk levels associated with some markets' preponderance of popular interest-only, payment-option, piggy-back, no-, low-down payment and certain adjustable rate mortgages (ARMs) known as "nontraditional" loans.
The feds also have begun to reassure lenders and the public the effort isn't designed to remove the loans from the market -- just the level of risk.
"What our proposed guidance seeks to do instead is to ensure that all nontraditional mortgage products are properly underwritten and disclosed. We believe this will help promote sound and sane practices in the mortgage market and thus serve the interests of the banking system and the general public," said Comptroller of the Currency John C. Dugan recently in a speech to the Conference on Bank Structure and Competition in Chicago.
Along with the Office of the Comptroller (OCC); the Board of Governors of the Federal Reserve System (FRS); Federal Deposit Insurance Corporation (FDIC); Office of Thrift Supervision (OTS); and the National Credit Union Administration (NCUA) helped author, "Interagency Guidance on Nontraditional Mortgage Products", which was published in the Federal Register on Dec. 29, 2005.
The rule proposal came with a 60-day public comment period originally due to expire Feb. 27, 2006, but at the request of financial institutions, the Feds extended the comment period to March 29, which has since ended.
"The agencies will now get together and go through the comments and determine the next step," said Susan Stawick, a spokeswoman for the Federal Reserve.
The comments on proposed guidance for nontraditional mortgages are available online to the public.
In some housing markets, especially high-cost and fast-appreciating markets, the "traditional" 20-percent-down, fixed-rate, 30-year mortgage just doesn't cut it.
Nontraditional loans have become de rigueur as purchase mortgages in many markets, because they give buyers more financial leverage and the ability to buy a home they might not other wise afford. The loans have also been used to help historically under served socioeconomic and ethnic segments of the population buy homes.
The trouble is, say federal money market regulators, the loans can push border line borrowers over the edge. In today's market, rising interest rates and flattening home prices exacerbate financial weakness and compound a household's financial woes.
"What happens if rates rise, or house prices fall, or both occur?" Dugan asked. "A borrower could easily be stuck with a mortgage that exceeds the value of his or her home, making it very difficult to refinance or sell the home."
Home owners with properties worth less than their mortgage because of falling values and rising rates and those with little or no equity stake, because of low down payments and interest-only payments, are more likely to walk when the going gets tough.
If lenders write too many risky loans they could be left holding the bag and that could have a snowballing effect on the cost of loans and the cost to the economy.
Dugan said there's a chance not one bank failure will result, but the potential is too great to ignore.
The proposed federal guidelines suggest, in part, that lenders:
- Take stock of borrowers' ability to repay the loan, including any balances added through negative amortization, at the fully indexed rate that would apply, not only initially, but also after the introductory period.
- Recognize that certain nontraditional mortgage loans are untested in a stressed environment and warrant strong risk management standards as well as appropriate capital and loan loss reserves.
- Ensure that borrowers have sufficient information to clearly understand loan terms and associated risks prior to making a product or payment choice.
"Knowing when to intervene in business of the banking system -- and to what degree -- will always demand the exercise of subjective judgment," Mr. Dugan said.
"I should emphasize that, while concentrations pose a known risk to safety and soundness, this risk can be effectively addressed if properly recognized and actively managed," Mr. Dugan said.
