By Patrice Hill
THE
April 6, 2006
State regulators are moving to curb abusive tactics and
loose standards used by some mortgage lenders offering unconventional loans with
interest-only and multiple-payment options.
An
estimated 10 percent of the U.S. population, or 30 million people, are at risk
of falling into financial trouble because they used such easy-money loans with
no down payments to buy houses, leaving them with little or no equity in their
homes and vulnerable to sharply rising interest rates, according to the Federal
Deposit Insurance Corp.
The majority of mortgage
lenders in the
Lenders that are not banks or owned
by banks are regulated by states, but few states have set strict credit
standards or required disclosure of sharply higher monthly payments that occur
as loans are adjusted to include higher interest and principal payments.
Now, concern about the growth of aggressive and
deceptive practices by some lenders is prompting state regulators, like their
federal counterparts, to consider issuing rules or guidance to ensure that rogue
lenders do not continue to offer exotic loans in a regulatory vacuum.
Innovative loans with backloaded payment schedules
have "inherent risks," as they can multiply a borrower's debt load within months
or years, and even prevent the lender from accruing principal in a declining
market -- raising dangers for lenders and consumers alike, said Neil Milner,
president of the Conference of State Bank Supervisors.
"The risks associated with these products are
exacerbated by risk-layering," such as requiring no down payment or income
documentation to get the loans, he said, at a time when "residential real-estate
values are showing signs of peaking."
Problems with
the loans are starting to crop up now that the housing boom has shown signs of
ending and home sales and prices are turning down in some overheated areas.
Foreclosures in
In addition to structuring loans so that some
borrowers may never pay down principal and, thus, may be more inclined to go
into default, some lenders also have been offering risky loans to consumers with
little borrowing experience or histories of delinquency and bankruptcy. Such
borrowers are considered the most likely to go into default.
Nontraditional mortgages "may not be appropriate for
higher-risk borrowers and borrowers who might not otherwise qualify" to buy a
house without extremely liberal lending terms, Mr. Milner said.
The state banking group informed the Federal Reserve
in February that it is working with the American Association of Residential
Mortgage Regulators, the National Association of Consumer Credit Administrators
and other state agencies on a policy that they will apply to nonbank lenders
under their jurisdictions.
The state rules most
likely will closely follow the federal guidelines, Mr. Milner said, although
states are concerned that federal rules governing disclosure are becoming too
burdensome and complex and need to be streamlined to ensure that consumers are
getting the information they need to make informed decisions.
Disclosures need revision
Today's increasingly complicated loans often have
terms that change with economic conditions and payment schedules that vary with
each borrower, so they no longer fit into a framework of federal regulations
that were written decades ago when almost all loans had standard 30-year terms
with fixed interest rates.
"An entirely new
disclosure process is necessary to help consumers keep pace with an
ever-expanding array of mortgage-related products," Mr. Milner said.
Most importantly, consumers need to be informed
upfront, at the time that they apply for loans, of the pitfalls as well as the
advantages of various instruments, not at the time of settlement, which is when
most disclosures are required to be made under federal law, he said.
Consumers at loan closings typically are deluged
with disclosure forms that they must sign even though the forms may give them
little insight into their new loans. Often, borrowers do not even read the
forms, brokers say.
In any case, the end of the loan
process is too late for borrowers to reverse major decisions about loan terms or
shop for better deals, they say.
Mr. Milner said it
is important for states to act soon to prevent banks offering mortgages from
being disadvantaged by having to follow the strict federal guidelines while
their unregulated competitors continue to earn big profits and commissions by
offering abusive loans.
Bill Matthews of the
Conference of State Bank Supervisors said state regulation of the industry
likely will continue to vary. Currently under a "patchwork quilt" of state
regulation, many lenders are required to do no more than post surety bonds.
Two states,
Reflecting the patchy regulation, the state mortgage
regulators association has a volunteer staff and has confined itself mostly to
licensing mortgage brokers to ensure that they do not have criminal records, he
said.
Widespread problems with abusive loans have
not surfaced yet, Mr. Matthews said, because rapidly rising house prices and
quick turnover in the housing market in recent years enabled borrowers and
lenders to profit without suffering serious financial consequences.
Now that sales have slowed sharply and prices have
flattened or turned down in most markets, however, financial problems among
overstretched borrowers are likely to start cropping up, he said.
"The bodies will start to rise to the surface," he
said.