Tougher Mortgage Guidelines Proposed
Federal regulators proposed tougher standards on nontraditional mortgage loans Tuesday, saying that expanded use of new interest-only and adjustable-rate loans had put both borrowers and the financial system at greater risk.
The proposed guidelines come amid growing concerns that many borrowers have signed up for mortgages they cannot afford, setting the stage for widespread defaults in coming years. Nationwide, mortgage debt has surged by about 70% since 1999 to nearly $8 trillion.
The widespread use of alternative loans -- combined with relaxed standards in evaluating the creditworthiness of borrowers -- presents “unique risks that institutions must appropriately measure,” the Federal Reserve said in a statement with other regulators.
To ease the dangers, the federal agencies proposed requiring lenders to assess the ability of borrowers to repay the full burden of loans after low-cost introductory periods had expired.
Lenders also would be required to give borrowers “clear and balanced information about the relative benefits and risks of these products.”
The affected loans include popular “payment option” adjustable-rate mortgages, in which borrowers get loans with low initial teaser rates that adjust higher over time, and so-called interest-only loans, in which borrowers don’t pay any principal for several years.
Industry observers worry that many of the new borrowers will be caught off balance when their payments shoot upward in the future. An analysis by Deutsche Bank found that $83 billion in loans with adjustable rates were subject to hikes this year. That amount will soar to $300 billion next year and $1 trillion in 2007.
Federal officials share that concern, noting that lenders also have relaxed standards for approving loans. Further, alternative loans often are marketed to people with weak credit histories “who may not fully understand the associated risks of nontraditional mortgages,” the Fed said in a joint statement with the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp., the Office of Thrift Supervision and the National Credit Union Administration.
The financial agencies proposed that lenders:
* Consider the ability of borrowers to repay their debts based on the fully indexed loan rate that kicks in after a cheaper introductory period ends, as well as the added costs of negative amortization, in which unpaid interest piles up.
* Set up reporting systems that warn of potential, or increasing, risks from nontraditional loans.
* Maintain sufficient reserves to cover potential losses from loans that go into default, recognizing that some of the new products have yet to be tested in times of financial stress.
The proposal was released for a 60-day public comment period. If approved, regulators would review lenders for compliance and could demand remedial action.
By improving standards and disclosure requirements, “financial regulators are acting prudently to mitigate the growing risks associated with these nontraditional products as their share of institutional portfolios grows,” Bryan Hubbard, a special advisor at the Office of the Comptroller of the Currency, said in a statement.
Debbie Goldstein, executive vice president at the Center for Responsible Lending, a consumer advocacy group, called the proposal “a good first start.” In particular, she said, the requirement that lenders consider the full payment burden of a loan would address “one of the most critical” problems.
Lenders were more cautious. An industry trade group representative pointed out that nontraditional loans have helped make homeownership possible for people who could only rent in the past.
“Our view is that innovation is a good thing,” said Doug Duncan, chief economist for the Mortgage Bankers Assn., who said his group would scrutinize the proposals. “We’ll be looking just to ensure that there isn’t a mind-set that will throw out the baby with the bathwater.”
