Federal banking regulators Friday finalized rules for underwriting “exotic” mortgages, a move that the biggest U.S. lenders say will stifle the use of loans that make houses more affordable.
The Office of the Comptroller of the Currency, the Federal Reserve and other regulators kept intact a proposal that says banks must qualify borrowers for popular payment-option and interest-only loans at a “fully-indexed” rate — the highest rate that they could incur over the life of the loan.
Countrywide Financial Corp., Bank of America Corp. and Wall Street firms such as Lehman Brothers earlier this year told regulators the guidance was too strict and would hurt consumers who might not be able to afford a home without the mortgages, which cut payments by delaying repayment of principal, or the principal and a portion of the interest.
“The regulators have gone out there and restricted some of the marginal players,” said Paul Miller, a mortgage industry analyst at Friedman Billings Ramsey in Arlington, Virginia. ”But a lot of the guidance is already being done. Banks haven’t just been just waiting for the regulators.”
The “fully-indexed” rate on an interest-only or adjustable payment-option loan is the rate that kicks in after an initial period. The rules also tell banks to assume a payment-option borrower will let the balance of the loan grow for the maximum period, setting up a bigger shock.
Payment-option loans lower initial costs by allowing the borrower to defer principal and a portion of the interest in monthly payments for a set period. The unpaid interest is wrapped back into the loan, making the balance grow and worrying regulators as house prices have begun to fall.
The guidance is “aimed at ensuring these products are offered in a safe and sound manner and in a way that clearly discloses their risks and benefits to consumers,” Comptroller of the Currency John Dugan said in a statement.
The monthly payment of a $360,000 payment-option loan with an initial interest rate of 6 percent would rise to $1,600 from $1,200 in the first five years, even if underlying rates were unchanged, according to an example provided by Dugan earlier. Payments could jump to $2,500 in the sixth year.
The loans, often called “affordability products,” have become popular in higher-priced regions after the decade-long housing boom boosted house values faster than incomes. The median U.S. house price started to ease on a year-over-year basis in August after peaking at $230,000 in July, according to the National Association of Realtors.
“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,” regulators said in a joint statement. Regulators are concerned borrowers do not understand all risks, and that banks are also adding second-lien mortgages or approving loans without proof of the buyer’s ability to pay.
The OCC worked with the Fed, the Federal Deposit Insurance Corp., the National Credit Union Administration and the Office of Thrift Supervision to shape guidance that sparked more than 100 comment letters from lenders.
Wall Street analysts before the final guidance warned the rules would temper consumer demand for the “affordability products” that are also favored by investors in the $6.5 trillion market for mortgage-related securities.
Countrywide, the biggest U.S. lender, is also the largest issuer of payment-option ARMs with $39.5 billion originated in the first half of 2006. Including interest-only loans, nontraditional products were a third of its business.
“It seems likely the rules will have sufficient bite to cause some adjustments in the types of loans being offered in the mortgage marketplace,” analysts at UBS Securities LLC said in a Tuesday note. “That could have some serious repercussions for lenders, as well as for homeowners seeking to refinance their affordability loans.”
Regulators fearing homeowners weren’t fully informed of the risks that they faced in later years also prescribed guidance on disclosures to consumers.
David Schneider, president of Washington Mutual Inc.’s home loan group in a statement Friday declined to speculate on how the guidance will affect business, but said the bank already makes clear disclosures and the loans are an attractive product for borrowers. Washington Mutual is the second-most active seller of pay-option loans.
The OCC’s Dugan said in an April speech that regulators do not suggest “by any means” there should be a “wholesale clamp-down” on such mortgages.
Banks falling under the federal regulators have contended the guidance may put them at a competitive disadvantage to local lenders. But the Conference of State Bank Supervisors has confirmed its intent to issue similar guidance for lenders overseen by state agencies, the federal regulators said.
State authorities should “issue the same guidelines so that consumers receive consistent disclosures and lenders have an even playing field,” said WaMu’s Schneider.
