Responding to a rise in delinquencies on subprime mortgage loans, Federal bank regulators are moving to tighten underwriting and disclosure standards for some adjustable-rate mortgages.
Like guidance issued in September for “exotic” interest-only and payment-option loans, the proposed guidelines for ARMs would direct federally chartered lenders to evaluate a borrower’s ability to repay a loan at the fully indexed rate, rather than an initial “teaser” rate.
Bank regulators also want lenders to provide “clear and balanced information about the relative benefits and risk of the products.”
The proposal follows a request by members of the Senate committee on Banking, Housing and Urban Affairs to extend the guidance for exotic loans to hybrid ARMs that carry initial teaser rates. Lending industry leaders who opposed the guidance for exotic loans have also objected to extending them to ARMs, saying they will restrict consumer choice.
The regulatory agencies proposing the new guidance for ARM loans are the Federal Reserve, Office of the Comptroller of the Currency, Federal Deposit Insurance Corp., the Office of Thrift Supervision, and the National Credit Union Administration. The agencies will accept comments for 60 days, and are particularly interested in whether they would “unduly restrict existing subprime borrowers’ ability to refinance their loans” and whether the guidelines should be applied beyond the subprime ARM market.
Regulators said they are concerned about ARM loans marketed to subprime borrowers with the following features:
- Offering low initial payments based on a fixed introductory or “teaser” rate that expires after a short initial period then adjusts to a variable index rate plus a margin for the remaining term of the loan.
- Approving borrowers without considering appropriate documentation of their income.
- Setting very high or no limits on how much the payment amount or the interest rate may increase (“payment or rate caps”) at reset periods, potentially causing a substantial increase in the monthly payment amount “payment shock.”
- Containing product features likely to result in frequent refinancing to maintain an affordable monthly payment.
- Including substantial prepayment penalties and/or prepayment penalties that extend beyond the initial interest-rate adjustment period.
- Providing borrowers with inadequate information relative to product features, material loan terms and product risks, prepayment penalties, and the borrower’s obligations for property taxes and insurance.
“Information provided to consumers should clearly explain the risk of payment shockand the ramifications of prepayment penalties, balloon payments, and the lack of escrow for taxes and insurance,” regulators said in the proposed guidance. “The agencies strongly encourage institutions that impose prepayment penalties to structure them in such a way that they do not extend beyond the initial reset period and, further, provide borrowers a sufficient window of time immediately prior to the reset date to refinance without penalty.”
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