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Federal Regulators Address Subprime Lending Risks
Addressing emerging risks associated with certain mortgage products and lending practices for subprime borrowers, the federal financial institution regulators on June 29 issued its "Statement on Subprime Mortgage Lending" that, among other things, will require lenders to use the fully indexed, fully amortized rate, instead of a “teaser” rate, when underwriting a subprime mortgage loan.
The agencies said that they were particularly concerned about the growing use of adjustable-rate mortgages (ARMs) “that provide low initial payments based on a fixed introductory rate that expires after a short period, and then adjusts to a variable rate plus a margin for the remaining term of the loan. These products could result in payment shock to the borrower."
In a footnote, the federal regulators cite the use of ARM products known as “2/28” loans, which feature a fixed-rate for two years and then adjust to a variable rate for the remaining 28 years. The fully indexed interest rate can typically range from a full three to six percentage points higher than the initial fixed interest rate.
These ARM products can have additional characteristics that heighten risks for lenders and borrowers, they said. These include qualifying borrowers based on limited or no documentation of income or imposing substantial prepayment penalties or prepayment penalty periods that extend beyond the initial fixed interest rate period.
“In addition,” they said, "borrowers may not be adequately informed of product features and risks, including their responsibility to pay taxes and insurance, which might be separate from their mortgage payments.”
In response to those concerns, the final statement from the agencies includes these provisions:
- Stated income and reduced documentation of income should only be accepted if there are “mitigating factors” that clearly minimize the need for verifying that the borrower has the ability to repay the loan. These factors might include situations where the borrower has substantial liquid reserves or assets that can be verified and documented by the lender.
- Borrowers should be able to refinance a loan within a minimum of 60 days of its reset period without incurring a prepayment penalty. However, this would not apply to prepayment penalties on existing loans.
- In a brief narrative format and through the use of examples based on hypothetical loan examples, the terms of the loan should be disclosed to the borrower. This should include the borrower’s responsibility for paying real estate taxes and insurance, which may be separate from their monthly mortgage payments.
“Fundamental consumer protection principles relevant to the underwriting and marketing of mortgage loans include approving loans based on the borrower’s ability to repay the loan according to its terms; and providing information that enables consumers to understand material terms, costs and risks of loan products at a time that will help the consumer select a product,” the statement says.
In written comments on May 7, NAHB said that it supported the supervisory approach taken in the proposed statement directing financial institutions “to have appropriate and prudent underwriting standards, risk management practices and consumer disclosures.”
NAHB also cautioned that an effort should be made “to avoid unnecessarily reducing the flow of mortgage credit, limiting consumer mortgage options or raising housing credit costs for qualified home borrowers."
“It is important,” NAHB’s comments added, “that efforts to ensure prudent mortgage lending and risk management practices as well as adequate consumer disclosures are comprehensive and uniform for all institutions and organizations that are involved in providing mortgage credit.”
For more information, e-mail Donna Ely at NAHB, or call her at 800-368-5242 x8529.
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 NAHB Kit Gives Builders Back-to-Basics Tips in Cooling Market
With the current cooling of the nation’s housing market expected to persist into next year, NAHB has developed a comprehensive online toolkit geared to providing association members with information that will help them prosper in today’s changing business environment.
To access the “Back to Basics” toolkit, you must be an NAHB member and have a login to www.nahb.org. To create a login, go to www.nahb.org/login or click on the log-in button on the main menu bar.
For assistance, call the NAHB Member Service Center at 800-368-5242.
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