Proposed Guidance on Nontraditional Mortgages Stresses Risk Management
As consumers’ appetite for nontraditional mortgage loans has increased dramatically in recent years, many financial institutions have taken an innovative approach to the ways they make mortgage loans. The variety of residential mortgage products has helped many homebuyers who might not have qualified for conventional loans. The federal financial regulatory agencies are concerned, however, that these nontraditional loans, some of which allow borrowers to defer payment of principal and even interest, may increase the risks to both lenders and borrowers.
To address this potential risk, the regulatory agencies—including the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corp., and the Office of Thrift Supervision—have issued proposed guidance to mortgage lenders. This guidance addresses loan terms and underwriting standards, appropriate portfolio and risk management practices, and the need for consumers to understand the terms of these loans and the risks inherent in their mortgage decisions.
The period for public comment has been extended to March 29.
Managing risk levels
The proposed guidance emphasizes careful management of the heightened risk levels that nontraditional loans can bring. According to the guidance, such management should involve
• an assessment of the borrower’s ability to repay the loan at the interest rate that would apply after any lower rate used in the introductory period;
• recognition that certain nontraditional mortgage loans are untested during periods of housing weakness, warranting strong risk management standards and appropriate capital and loan loss reserves; and
• assurance that borrowers have enough information to understand the loan terms and the risks associated with choosing a certain type of loan product.
Customer communication, consistent practices are key
In the guidance, the regulatory agencies also recommend practices that can address the risks accompanying nontraditional mortgage products early in the lending process. These practices include clear communication with customers (including full product descriptions while the consumer is still shopping for a mortgage) and systems that ensure that institutions’ actual lending practices are consistent with stated policies and procedures.