Banks get nontraditional mortgage advice

AP Economics Writer

Federal regulators directed banks on Friday to properly explain the risks posed to borrowers from interest-only and other nontraditional mortgages.

The guidance was aimed at addressing the fear that consumers don't understand all the repayment risks involved in these mortgages, including rising interest rates which could greatly increase their monthly payments.

The regulators said that banks needed to make sure that the loans they made were "consistent with prudent lending practices, including consideration of a borrower's repayment capacity."

The new guidance will be used as a benchmark for audits of banks' operating procedures performed by the regulatory agencies.

There has been an explosion of nontraditional loans in recent years, raising worries about the risks to the financial system should there be a sizable number of defaults if borrowers are unable to meet rising mortgage payments.

"Mortgage delinquency rates are rising and foreclosure rates are also beginning to pick up. This could begin to affect the financial health of the banking system," said Mark Zandi, chief economist at Moody's

Howard Glaser, an industry analyst with the Glaser Group in Washington, said he believed the new guidelines reflected "deep concern by federal regulators not just about the impact of exotic mortgages on borrowers but also on bank risk."

But the Mortgage Bankers Association said that delinquency and foreclosure rates remained "well with the range of historical norms." The organization criticized the regulators' action.

"The guidelines propose a one-size-fits-all underwriting standard that will unnecessarily choke industry innovation and diminish consumer choice," said Regina M. Lowrie, chairman of the mortgage group. "We do not believe these products present unreasonable risk."

Interest-only mortgages require that the homeowner initially pay only the interest on the loan for a set period. Option adjustable rate mortgages give the homeowner flexibility to decide how much to pay each month. One of the options is a minimum payment that covers only a portion of the monthly interest.

These mortgages are appealing to people who need cash for other expenses or who in recent years have been struggling with rapidly rising home prices.

But these types of loans also expose borrowers to far greater risks. If housing prices drop, their loan could be worth more than their property. If interest rates rise, their loan will become expensive to pay.

Former Federal Reserve Chairman Alan Greenspan issued a number of warnings about these loans last year and other banking regulators have as well.

The Government Accountability Office told Congress last week that from 2003 to 2005, nontraditional mortgages rose from less than 10 percent of all mortgages to about 30 percent.

These mortgages were highly concentrated on the East and West Coasts, especially, California, the GAO said.

The new guidance was issued jointly by the Office of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corp., the Office of Thrift Supervision and the National Credit Union Administration.

"The marketing and use of nontraditional mortgage products — particularly interest-only and payment-option adjustable rate mortgages — have expanded rapidly to a wider spectrum of borrowers who may not otherwise qualify for more traditional mortgages of similar size," John C. Dugan, the comptroller of the currency, said in a statement.

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