- The Washington Times - Thursday, May 25, 2006

The Federal Reserve, Federal Trade Commission and other regulators said yesterday that they will work to stamp out the fraudulent advertising and bad deals being offered by brokers marketing seemingly low-rate mortgages with backloaded payment schedules that put many consumers in debt over their heads.

By some estimates, one-third to one-half of all mortgages made in recent years are the kind the regulators are targeting.

Such mortgages include some loans with interest-only payments so that consumers accumulate no equity in their dwellings and some adjustable-rate mortgages with options to make minimal payments that do not pay down principal.

The loans have been particularly popular in Washington and other high-priced areas where borrowers need the lenient terms to afford houses.

Now that the housing market is cooling and home prices have flattened or declined, consumers who took out those loans are in danger of seeing their payments increase sharply — sometimes doubling within three years — at the same time they are unable to refinance with better terms and face losses if they have to sell their homes. They are the ones most likely to be driven to default, and many states report that foreclosures are rising.

In light of the high stakes for consumers and lenders alike, the Fed plans to revamp its Truth in Lending rules to ensure consumers get the facts they need about these risky loans when they are exposed to them instead of at the end of the loan process, as happens currently and when it is often too late for them to switch to safer alternatives, said Sandra Braunstein, director of the Fed’s consumer affairs division.

“We are overdue for a major review of credit and mortgage disclosures,” she said at a daylong conference organized by the FTC. She said the new regulations will follow the “guidance” the Fed and other bank agencies laid out in December, but will impose mandatory disclosures and other requirements on lenders, not just recommendations that they can choose to follow.

Ivy Jackson, a Department of Housing and Urban Development director, said she often hears from consumers who realized they got bad loans after the settlement. At that point, it is too late to do anything but sue the lender, she said.

Despite strong opposition from banks and brokers, who say overly strict regulations could stifle the mortgage market, Michael Bylsma, director of the Comptroller of the Currency’s consumer law division, said the regulators think it is important for the safety and soundness of banks that they follow conservative rules for determining whether consumers qualify for the loans.

Loans with low teaser rates that adjust to higher rates with added-in principal payments, for example, should be given only to consumers who qualify for the loans at the fully adjusted levels, he said.

That is not the case currently, with most lenders providing loans to home buyers who can afford to make only the minimum payments or interest-only payments and could not weather the “payment shock” if their payment schedules rise sharply, analysts say.

“These underwriting practices are causing concern,” Mr. Bylsma said. “Lenders have loosened their underwriting standards” in response to intense competition in the mortgage market, he said. “It’s no small problem, either, for the bank or borrower when their only option is to refinance or sell the home.”

Mr. Bylsma said regulators will require banks to oversee the activities of mortgage brokers they hire to market loans, to ensure the brokers also follow the rules. He said banks and lenders reacting to the December guidance objected to that requirement, because of the thousands of transactions, conversations and other exchanges brokers have each day.

“The marketing [by brokers] has really been the big issue of concern” among regulators, said April Breslaw, a Federal Deposit Insurance Corp. official. Millions of Internet ads, spam and direct-mail advertisements tend to “focus on short-term benefits and downplay the long-term risks of the loans,” she said.

The FTC’s primary role is to police deceptive or fraudulent advertising, and it has begun one case against a California broker, Chase Financial Funding Inc., which falsely advertised “fixed-rate, 30-year” loans with a 3.5 percent interest rate, when the loan terms were actually variable and risky, said Jesse Leary, assistant director of the FTC’s Bureau of Economics.

Surveys show that the riskiest loans in which the likelihood of payment shock is highest disproportionately go to Hispanic, black and other minority borrowers. Consumer advocates say these groups — as well as many non-minority borrowers — often do not understand the complicated and financially dangerous transactions they are entering.

“All of the risk falls on the borrower,” because in most cases the lender sells the loan to investors and no longer has a stake when the loan goes bad, said Stella Adams, executive director of the North Carolina Fair Housing Center.

For first-time minority home buyers, the realization that they have taken out unsuitable loans, are in debt over their heads and have built no equity can be devastating, she said.

“This is the biggest investment Americans ever make,” she said. “We’ve got to help give them an opportunity to build wealth, too.”

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