Final Subprime Guidance Issued

The final Statement on Subprime Mortgage Lending was jointly issued by the Office of the Comptroller of the Currency, the Federal Reserve System, the Federal Deposit Insurance Corp., the National Credit Union Administration, the Office of Thrift Supervision and the Department of the Treasury. It applies to all banks, bank holding companies, savings associations, savings and loan holding companies and credit unions — as well as subsidiaries of these companies.

While commenters on the proposed guidance requested a formal definition for subprime loans, the regulators determined that such a definition was already spelled out in the 2001 Expanded Guidance for Subprime Lending Programs.

The statement did clarify, however, that not all subprime mortgages are predatory. Among loans that were determined predatory were those where the lender ignored the borrower’s ability to repay a loan; mortgages that are repeatedly financed to generate high fees over and over; and loans where the borrower was lied to about the true terms of the loan.

Among the areas of concern identified in the report were teaser-rate payments and subsequent unlimited adjustments, limited or no income verification and prepayment penalties.

“The Agencies are concerned that these products, typically offered to subprime borrowers, present heightened risks to lenders and borrowers.,” the guidance said. “Often, these products have additional characteristics that increase risk. 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.”

Comments made to the agencies about the proposed guidance by mortgage bankers indicated aspects of the guidance will restrict the availability subprime credit, the report said.

“This is a strong statement that will help curb abuses, but will likely also constrain consumer credit choices,” John M. Robbins, chairman of the Mortgage Bankers Association, said in a statement immediately following the release of the guidance.

At the same time, the guidance indicated consumer-advocate groups stated the proposals didn’t go far enough — and recommended applying them to other mortgage products.

But MBA’s Robbins noted Congress should avoid legislation that imposes “rigid underwriting standards and litigation risk” on mortgage lenders and instead focus on legislation that improves transparency and accountability.

In underwriting borrowers with adjustable-rate mortgages, the statement indicated borrowers should be qualified at fully-indexed, fully-amortized payments.

Consumer groups had called for borrowers to be qualified at the highest possible monthly payment during the life of the loan. But mortgage industry advocates claimed teaser-rate loans “can be a useful credit repair vehicle or a means to establish a favorable credit history,” the regulators said. Additionally, mortgage bankers wanted subprime lenders to be allowed the flexibility to help borrowers refinance out of payments they can’t afford.

The federal agencies said stated-income or reduced-documentation borrowers should only be considered “if there are documented mitigating factors that clearly minimize the need for verification of a borrower’s repayment capacity.” Mitigating factors cannot include a higher interest rate.

Consumer groups wanted a reduction or prohibition of stated-income and reduced-documentation programs, the paper said.

Another requirement prohibits prepayment penalties that don’t allow borrowers to refinance the loan 60 days before the teaser rate increases. While lenders opposed such a measure — calling the fees “a legitimate means for lenders and investors to be compensated for origination costs when borrowers prepay prior to the interest rate reset,” some groups called for a complete abolition of the penalties.

Existing mortgages are exempt from the prepayment penalty prohibition.

The guidance addressed the lack of borrower awareness of loan terms that include escalating payments. Mortgage industry groups, however, suggested new disclosure requirements would cause consumer information overload.

One provision of the guidance suggests mortgage advertisements may begin to sound like pharmaceutical ads.

“Communications with consumers, including advertisements, oral statements, and promotional materials, should provide clear and balanced information about the relative benefits and risks of the products,” the regulators said. “Information provided to consumers should clearly explain the risk of payment shock and the ramifications of prepayment penalties, balloon payments, and the lack of escrow for taxes and insurance, as necessary.”

Mortgage bankers and consumer groups were both concerned that the proposed statement will not apply to all lenders, the regulators reported. Mortgage bankers indicated federally-regulated institutions would be placed at a competitive disadvantage. But the agencies noted a parallel statement subsequently announced by the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators subjects non-regulated originators to the same rules.

The agencies disagreed that a suitability standard is imposed by guidance — as lenders had claimed.

Sam Garcia worked in mortgage lending for twenty years prior to becoming publisher of MortgageDaily.com.

e-mail: mtgsam@aol.com