Groups Disagree About Subprime Hybrids

“Massive payment shocks built into these loans could cause a foreclosure crisis,” 80 national and local civil rights and housing groups wrote in a letter to Federal Reserve Chairman Ben S. Bernanke and the heads of five other agencies.

They asked that a supplement to last fall’s Guidance on Nontraditional Mortgage Product Risk be issued that would “clarify that subprime hybrid ARMs are subject to the same underwriting standards as non-traditional mortgages, particularly the requirement of underwriting at the fully-indexed rate.”

The letter, dated Thursday, was addressed to the chairs of the Federal Deposit Insurance Corp. and National Credit Union Administration, and to the Comptroller of the Currency, the Office of Thrift Supervision director and the head of the Conference of State Bank Supervisors, in addition to Bernanke. The signers included AARP, AFL-CIO, ACORN, Center for Responsible Lending, Consumer Federation of America, Consumers Union, Leadership Conference on Civil Rights, NAACP and Rainbow/Push.

“Subprime lenders,” they charged, “generally make hybrid ARMs without considering whether the borrower can afford the loan past the initial teaser rate.”

They also said it was “troubling” that some of the 2/28 and 3/27 loans were being made to older homeowners whose incomes would not rise.

Nearly one in five loans originated last year were subprime hybrid ARMs, the letter noted. Citing a Fitch Ratings report from mid-2006, the groups said 2/28 subprime ARMs carry an average built-in 29% payment shock, even if rates remain unchanged.

According to the Mortgage Bankers Association, 58 percent of all subprime loans originated are ARMs, but the trade group has no breakdown by type of ARM.

The trade group disagrees with the recommendation made in the letter, said Kurt Pfotenhauer, senior vice president, Government Affairs and Public Policy. “If followed, it would actually hurt the people it’s intended to help,” he told MortgageDaily.com.

The vast majority of 2/28 and 3/27 subprime ARMs are refinanced before they reset, with half of all subprime ARM borrowers refinancing into prime loans.

Pointing out that half of subprime ARM borrowers, when the time came for their loans to reset, went into prime loans, he said the two- or three-year fixed-rate period was used for credit repair.

“We’re not being an ostrich and saying there isn’t a problem, we’re just saying this isn’t the answer,” Pfotenhauer emphasized. “You’ve got a mortgage originator who’s not being honest or you’ve got a consumer who’s not informing themselves as to what’s going on in their transaction or who trusted somebody they shouldn’t have.

“Those are real issues,” he said, “but there are different kinds of solutions for those problems. You don’t necessarily have to eliminate access to the market by government fiat for a whole group of people because some people are abusing that product.”

The problem, Jim Wheaton, deputy director of non-profit Neighborhood Housing Services of Chicago, a HUD-approved counseling agency, told MortgageDaily.com, is “not the product in and of itself but other issues and factors that influence this.

“What’s really the problem and gets glossed over,” he said, “is that there are layers of risk being piled on the borrower,” only some of which are in the loans themselves. Property taxes continue to go up and income may be overstated on the loan application, he pointed out.

NHS was not a signer of the letter and takes no position on policy matters, Wheaton explained.

John Bellini, a senior vice president and general councel at Paramount Bank in Farmington Hills, Mich., which does originate the loans in question, told MortgageDaily.com that these loans can be “abused,” but that his bank makes sure they are underwritten at the fully indexed rate and that borrowers are “counseled appropriately.”

There is less of a problem with the loans themselves than with them being “abused” by “unscrupulous individuals out there in the market,” he said. “I think licensing and more monitoring and regulation applied to the mortgage broker industry would dampen this type of abuse out there,” he concluded.

Jerry DeMuth is an award winning journalist who has been reporting for four decades.

e-mail Jerry at demuth933@earthlink.net