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Top Bank Regulator Worried by New Types of Mortgages

Initial Low Payments May Lure Buyers Unable to Make Higher Payments Later On

April 20, 2006

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Comptroller of the Currency John C. Dugan told a community development conference today that new types of mortgages aimed at making homes more affordable may offer low monthly payments initially, but will lead to significantly higher payments later, potentially harming those they are intended to help.

"After the limited initial period ends, the monthly payment for the holder of a nontraditional mortgage must increase – even if interest rates stay flat – and the size of that increase can be very substantial," Dugan said in a speech to the Greenlining Coalition's annual economic summit. "At its core, the 'bargain' in a nontraditional mortgage is that the borrower pays a lower monthly payment now in exchange for the near certainty of a higher monthly payment later."

That potential for payment shock got the attention of the regulatory agencies and led to a proposed guidance that is now under consideration, he said. The guidance addresses fundamental issues involving nontraditional mortgages, including the prospect of substantial increases in monthly payments that borrowers may not be able to afford and may not understand.

The increased monthly payments could put their homes at risk and lead to losses for lenders.

In the case of one such mortgage, the payment option ARM, homeowners with typically structured and priced loans could see their monthly payment double at the end of the initial period, which is usually about five years.

"Do borrowers that buy these products really understand the very real possibility of dramatically increased payments in the future?" Dugan asked.

The agencies looked at marketing materials used by lenders who offer non-traditional mortgages and found that the materials focused mainly on the initial low monthly payment, while giving relatively little attention to the likelihood of much higher payments later, Dugan said.

"Going through this exercise led regulators to conclude, at least initially, that nontraditional mortgages are relatively complex and that borrowers unfamiliar with them – which means most borrowers – would benefit greatly from improvements in both the content and timing of disclosures," he added.

Dugan said the agencies have by no means proposed a wholesale clamp-down on the use of these nontraditional products.

"Our proposed guidance makes clear that these products are perfectly appropriate if underwritten properly with meaningful disclosures," he said. Now that the comment period has closed, the agencies will be carefully reviewing comments over the coming days to determine whether adjustments to the proposal are called for, he added.

In his speech, the Comptroller highlighted the importance of homeownership in America and applauded community-based organizations for partnering with banks in efforts to help low-income families buy and retain homes. Homeownership, he said, is synonymous with building healthier communities and stronger economies.

"Increased homeownership means better school systems, reduced crime rates, and more civic-mindedness -- and, of course, stronger and more stable banks," he said.

Homeownership is also being helped by the community-based organizations around the country, including Los Angeles Neighborhood Housing Services, that work with local lenders to minimize the number of delinquent mortgages that go to foreclosure. "This is work that is every bit as important as helping people become homeowners in the first place," he said.

"With their deep-rooted community connections, these organizations can serve as trusted intermediaries, working with borrowers who might not be as comfortable turning to a bank for help when they get into trouble," he said. "We're also seeing evidence that banks can achieve cost savings by partnering with non-profits in this way."

Dugan also said that borrowers who are not able to qualify for prime rate loans deserve assurance that they will be treated fairly and will not be victimized by unfair or deceptive lending practices.

"The OCC has acted to guard against such potential abuses," he said. "While we have not seen evidence of predatory lending by national banks, we are taking preventive action to ensure that such lending does not occur. We are the only bank regulatory agency that has lending regulations specifically prohibiting unfair and deceptive practices in the mortgage lending process, and we have issued extensive mortgage lending guidelines to guard against predatory and abusive lending practices such as loan flipping and equity stripping."

Dugan said the OCC carefully monitors national banks through comprehensive examinations, "and we are prepared to take strong enforcement actions if they encounter evidence of predatory lending."

Dugan said that OCC District community affairs officers are working with national banks to help identify lending, investment, and service opportunities that can increase access to financial products and services for minorities.

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