On October 4, 2006, the Federal financial regulators published in the Federal Register, final guidance ("Guidance") concerning underwriting, risk management and consumer protection respecting nontraditional mortgage products covering interest only and payment option products. Under the Guidance, "nontraditional products" include mortgage products that allow borrowers to defer payment of principal or interest. The Guidance expressly includes interest-only (IO) and payment option adjustable rate mortgages (Option ARMs), but excludes home equity lines of credit (HELOCs) and reverse mortgages, as well as fully amortizing mortgages. The Guidance also clarifies that the regulators did not intend to establish a "suitability standard." The Guidance addresses three major areas: (1) Loan Terms and Underwriting Standards; (2) Portfolio and Risk Management Practices; and (3) Consumer Protection Issues. 1. The Loan Terms and Underwriting Standards provisions require that institutions maintain qualification standards for nontraditional products that include "a credible analysis of the borrower's capacity to repay the full amount of credit that may be extended considering principal and interest." Specifically, institutions should qualify borrowers at "the fully indexed rate assuming a fully amortizing payment including potential negative amortization amounts."
2. The Portfolio and Risk Management Practices provisions require that institutions establish strong risk management standards, appropriate capital levels and allowances for loan and lease losses (ALLL) that reflect the collectability of the portfolio. Institutions are to ensure risk management practices keep pace with portfolio growth and changing risks of nontraditional mortgage loans.
3. The Consumer Protection provisions require that institutions assure that communications with consumers, including advertisements, oral statements, promotional materials and monthly statements provide clear and balanced information about the relative benefits and risks of these products, including payment shock and the risk of negative amortization to help them make informed decisions about these products.
The Guidance applies to federally regulated institutions, including banks, thrifts and credit unions. Because it requires institutions to have strong systems and controls for establishing and maintaining relationships with third parties, it affects other originators and parties as well.
MBA believes that the availability of nontraditional mortgage products, hybrid ARMs and low documentation loans are positive developments. The growth of the U.S. homeownership rate to nearly 70 percent over the last 10 years is due in large part to innovations in the mortgage market. MBA maintains that if these products are properly underwritten and described to consumers, borrowers should continue to have access to them as important affordable financing options. While MBA believes the regulators' efforts to promulgate guidance in this area are well intentioned, the implementation of such guidance must not be unduly restrictive. It is particularly important that federal and state guidance on these products be consistent. An inconsistent patchwork will significantly increase compliance costs and lessen competition, increasing prices and limiting credit options to consumers.
MBA will pursue efforts to provide clearer guidance to consumers and to help member firms comply with the consumer protection concerns. MBA will continue to strongly advocate that Federal and any state guidance be consistent in order to avoid higher costs to consumers.
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