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Feds Again Warn Mortgage Lenders

Too Many "Creative" Mortgages Spell Trouble, Regulators Warn

By Martin H. Bosworth
ConsumerAffairs.com

December 21, 2005

Living in a Bubble? Mortgage Crisis? Act Now to Avoid Foreclosure • Avoiding Foreclosure Takes More Than Hope --- • Homes Lose More Value In Third Quarter • Home Prices Post Record Decline • Fed Throws $800 Billion Lifeline to Consumers • Existing Home Sales Drop in October • When in Doubt, Leave Nothing Out • Fannie Mae and Freddie Mac Suspend Foreclosures • Consumer Prices Plunge in October • Paulson Rejects Bailout Money for Detroit • Another Glimmer of Hope in The Housing Market • Buyers' Beware Market • FDIC Backs More Aggressive Loan Modification Plan • Housing 2009 Forecasts Mixed, But Mostly Grim • Foreclosures Up Five Percent in October • Feds Shift Gears On Bailout, Puts Focus On Consumers • More Homeowners Under Water in Third Quarter • Feds Mount New Effort to Help Struggling Homeowners • Lenders Embrace Workouts for Struggling Homeowners • Obama Can't Quickly Raise Homebuyers' Hopes • At Last: Bailout Trickling Down to Struggling Homeowners • New Home Sales Rise in September • How to Appeal Your Property Tax Bill • Existing Home Sales Rise in September • Administration Considers More Help for Homeowners • Foreclosure Activity Drops in September • Southern California Home Sales Surge 65 Percent in September • HOEPA: New Hope for Outlawing Abusive Mortgages • FDIC Chief: Not Enough Help for Homeowners --- • More ...

Federal banking regulators are warning lenders to ease up on issuing "creative" mortgages, including adjustable-rate mortgages (ARMs) and negative-option financing.

The guidance rules target both the increasing usage of "creative" mortgages, and the widening spectrum of borrowers making use of them, "including some who may not otherwise qualify for traditional fixed-rate or other adjustable-rate mortgage loans, and who may not fully understand the associated risks," the regulators said in a statement.

The rules counseled lenders to offer clearer explanations of nontraditional mortgage products and the risks involved in utilizing them.

"When an institution offers nontraditional mortgage loan products," the guidance said, "underwriting standards should address the effect of a substantial payment increase on the borrower's capacity to repay when loan amortization begins."

Borrowers who use ARMs for paying a home mortgage loan pay amounts of their choosing over a certain period, after which the mortgage rate changes. If the borrower is unable to meet the new mortgage payment, they risk default and foreclosure.

The latest shot across the bow is part of a series of "guidance" suggestions issued jointly by the Federal Reserve Board (FRB), the Office of the Comptroller of the Currency (OCC), the Federal Insurance Deposit Corporation (FDIC), the Office of Thrift Supervision, and the National Credit Union Administration. Taken together, the agencies regulate virtually every major mortgage lender in the country.

The OCC had previously mandated that credit card issuers raise the monthly minimum payments, in an effort to induce consumers to pay their debts faster.

As more cash-strapped borrowers put their money towards paying off their credit cards, there will be less money available to pay adjustable mortgage rates.

According to the latest guidance, lending institutions also need to exercise more "quality control" in who they lend to, and not enable consumers who already have high debt or previous financial problems to quickly get loans with little or no documentation to support their claims.

Making shaky loans may enable the borrower to make a profit from their home's appreciation, but it could also lead to even bigger financial problems if the borrow is not able to keep up the payments or is unable to realize a profit from the sale of the house.

"[A]n institution's qualifying standards should recognize the potential impact of payment shock, and that nontraditional mortgage loans often are inappropriate for borrowers with high loan-to-value (LTV) ratios, high debt-to-income (DTI) ratios, and low credit scores," said the report.

The agencies issued the guidance as a response to the economy's increasing reliance on skyrocketing home prices.

As long as the Federal Reserve continued to cut interest rates, home buying became the principal vehicle for investment by most Americans. With regional housing markets softening and prices dropping, the ability to "flip" properties and sell them quickly is becoming a thing of the past.

Although the Commerce Department issued a report today stating that the gross domestic product (GDP) was demonstrating greater economic growth, it noted that growth in housing spending was at 7.3 percent annually, a slightly lower estimate than had been previously forecast.

American consumers have become so reliant on home equity to pay expenses and other debts that they regularly take out home equity loans or lines of credit, effectively using their homes as ATMs in order to pay off other debt, such as credit card payments or medical expenses.

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