Feds Again Warn Mortgage Lenders

Too Many "Creative" Mortgages Spell Trouble, Regulators Warn

Federal banking regulators are warning lenders to ease up on issuing "creative" mortgages, including adjustable-rate mortgages (ARMs) and negative-option financing.

The guidance rules target both the increasing usage of "creative" mortgages, and the widening spectrum of borrowers making use of them, "including some who may not otherwise qualify for traditional fixed-rate or other adjustable-rate mortgage loans, and who may not fully understand the associated risks," the regulators said in a statement.

The rules counseled lenders to offer clearer explanations of nontraditional mortgage products and the risks involved in utilizing them.

"When an institution offers nontraditional mortgage loan products," the guidance said, "underwriting standards should address the effect of a substantial payment increase on the borrower's capacity to repay when loan amortization begins."

Borrowers who use ARMs for paying a home mortgage loan pay amounts of their choosing over a certain period, after which the mortgage rate changes. If the borrower is unable to meet the new mortgage payment, they risk default and foreclosure.

The latest shot across the bow is part of a series of "guidance" suggestions issued jointly by the Federal Reserve Board (FRB), the Office of the Comptroller of the Currency (OCC), the Federal Insurance Deposit Corporation (FDIC), the Office of Thrift Supervision, and the National Credit Union Administration. Taken together, the agencies regulate virtually every major mortgage lender in the country.

The OCC had previously mandated that credit card issuers raise the monthly minimum payments, in an effort to induce consumers to pay their debts faster.

As more cash-strapped borrowers put their money towards paying off their credit cards, there will be less money available to pay adjustable mortgage rates.

According to the latest guidance, lending institutions also need to exercise more "quality control" in who they lend to, and not enable consumers who already have high debt or previous financial problems to quickly get loans with little or no documentation to support their claims.

Making shaky loans may enable the borrower to make a profit from their home's appreciation, but it could also lead to even bigger financial problems if the borrow is not able to keep up the payments or is unable to realize a profit from the sale of the house.

"[A]n institution's qualifying standards should recognize the potential impact of payment shock, and that nontraditional mortgage loans often are inappropriate for borrowers with high loan-to-value (LTV) ratios, high debt-to-income (DTI) ratios, and low credit scores," said the report.

The agencies issued the guidance as a response to the economy's increasing reliance on skyrocketing home prices.

As long as the Federal Reserve continued to cut interest rates, home buying became the principal vehicle for investment by most Americans. With regional housing markets softening and prices dropping, the ability to "flip" properties and sell them quickly is becoming a thing of the past.

Although the Commerce Department issued a report today stating that the gross domestic product (GDP) was demonstrating greater economic growth, it noted that growth in housing spending was at 7.3 percent annually, a slightly lower estimate than had been previously forecast.

American consumers have become so reliant on home equity to pay expenses and other debts that they regularly take out home equity loans or lines of credit, effectively using their homes as ATMs in order to pay off other debt, such as credit card payments or medical expenses.

What are people saying about mortgages today:

Rates on 30-year mortgages edged down last week to a seven-month low. Mortgage-giant Freddie Mac reported Thursday that 30-year, fixed-rate mortgages fell to 6.3 percent, down slightly from 6.31 percent two weeks ago. It put rates at the lowest level since they were at 6.24 percent the first week of March.

Bank of Hawaii, Central Pacific Bank, Territorial Savings Bank and Wells Fargo Home Mortgages all cut their 30-year mortgage rates to 5.75 percent this week.

Most people think of a mortgage as a means to an end. After all, you buy a house, not a home loan. But a mortgage is much more than the path to homeownership. It is a financial instrument that must be managed, just like any other financial investment.