Federal Financial Regulatory
Agencies Issue Final Guidance
on Nontraditional Mortgage
Product Risks
The
federal financial regulatory agencies today issued final guidance to address
the risks posed by residential mortgage products that allow borrowers to defer
repayment of principal and sometimes interest (Interagency Guidance on Nontraditional Mortgage Product Risks).
These
products, referred to variously as nontraditional, alternative, or exotic
mortgage loans (referred to below as nontraditional mortgage loans), include
interest-only mortgages and payment option adjustable-rate mortgages. These products allow borrowers to exchange
lower payments during an initial period for higher payments later.
While
similar products have been available for many years, the number of institutions
offering them has expanded rapidly. At
the same time, these products are offered to a wider spectrum of borrowers who
may not otherwise qualify for a similar-size mortgage under traditional terms
and underwriting standards. The agencies
are concerned that some borrowers may not fully understand the risks of these
products. While many of these features
exist in other adjustable-rate mortgage products, the agencies concern is
elevated with nontraditional products because of the lack of principal
amortization and the potential for negative amortization. In addition, institutions are increasingly
combining these loans with other features that may compound risk (risk
layering). These features include
making simultaneous second-lien mortgages and relying on reduced or no
documentation in evaluating an applicants creditworthiness.
The final guidance discusses the
importance of carefully managing the potential heightened risk levels created
by these loans. Toward that end,
management should:
·
Ensure that loan terms and underwriting
standards are consistent with prudent lending practices, including
consideration of a borrowers repayment capacity;
·
Recognize that many nontraditional mortgage
loans, particularly when they have risk-layering features, are untested in a
stressed environment. These products
warrant strong risk management standards, capital levels commensurate with the
risk, and an allowance for loan and lease losses that reflects the
collectibility of the portfolio; and
·
Ensure that consumers have sufficient
information to clearly understand loan terms and associated risks prior to
making a product or payment choice.
The
agencies published for comment proposed interagency guidance on Nontraditional
Mortgage Products on December
29, 2005. Comments were
received from financial institutions, trade associations, consumer and
community organizations, state and financial regulatory organizations, and
other members of the public. The
agencies made a number of changes to the proposal to respond to the commenters
concerns and to provide additional clarity.
The guidance is attached.
The agencies are issuing two
additional related documents Proposed
Illustrations of Consumer Information for Nontraditional Mortgage Products and
an addendum to the May 2005 Interagency
Credit Risk Management Guidance for Home Equity Lending.
The
agencies are also issuing an addendum to the May 2005 Interagency Credit Risk Management Guidance for Home Equity Lending
that provides additional guidance for managing risks associated with open-end
home equity lines of credit (HELOCs) that contain interest-only features. While HELOCs with these features may
provide flexibility for consumers, the agencies are concerned that consumers
may not fully understand the product terms and associated risks. This addendum
provides guidance addressing the timing and content of communications with
consumers obtaining interest- only HELOCs.
These consumer protection recommendations are similar to the guidance contained
in the Interagency Guidance on
Nontraditional Mortgage Product Risks referenced above.
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Media Contacts:
Federal Reserve Susan
Stawick (202) 452-2955
FDIC David
Barr (202) 898-6992
NCUA John
McKechnie (703) 518-6331
OCC Kevin Mukri (202) 874-5770
OTS Katie
Fitzgerald (202) 906-6677