Regulators To Issue Stricter Guidelines for Lenders
At a Senate Banking Committee hearing on "exotic mortgages", U.S. banking regulators promised that stricter lender guidance would be released in a few weeks, according to Market Watch. The term "exotic" is used to refer to mortgage loans that allow interest-only payments or eat into the equity in a home. Such exotic mortgages have increased in the past three years from less than two percent in 2000 to more than thirty percent in 2006. Moreover, in 2005, about half of such mortgages originated in California.
The Federal Deposit Insurance Corporation found that exotic mortgage loans were more prevalent in the housing markets with the biggest price increases.
At the hearing, the regulators testified that defaults and foreclosures on exotic mortgage loans remain very low. However, they also stressed that it is too early to tell what might happen if the economy slows, and interest rates and housing prices go up.
Mortgage Industry representatives at the hearing insist that they are responding to consumer demand. However, consumer advocates say that the consequences could be drastic as many borrowers do not fully comprehend what they are getting themselves into, as the loans allow them to buy a more expensive home by minimizing their initial payments. Because under some circumstances, the monthly payments could double or triple, many borrowers will not be able to keep up with their payments.
According to the Government Accountability Office, the disclosures made at closing of the loan are generally written in complex language, fine print or small and unreadable typeface, contributing to borrowers' lack of ability to understand the terms of their exotic loans. Accordingly, a large number of borrowers severely underestimate how much their payment could go up.
The soon to be released guidance will require greater disclosures to borrowers about the risk and benefits of exotic mortgage loans, and would recommend tighter credit standards for such loans, including forcing lenders to consider whether borrowers can afford full payment on the loan. Such standards are necessary because monthly payments could double or triple once the low initial payments expire.
The guidance will not cover a large part of the market that is not under federal bank supervision. However, state regulators say that they have moved to match federal efforts of making standards the same for all lenders.
Michael Calhoun, president of the Center for Responsible Lending, believes that the proposed guidance should be expanded to the sub-prime market, as he believes that the national economy is at great risk if sub-prime loans fail in great numbers, which he fears they will.