- The Washington Times - Friday, September 29, 2006

1:52 p.m.

Federal regulators directed banks today to properly explain the risks posed to borrowers from interest-only and other nontraditional mortgages.

The guidance was aimed at addressing the fear that consumers don’t understand all the repayment risks involved in these mortgages, including rising interest rates that could greatly increase their monthly payments.

The regulators said banks need to make sure that the loans they make are “consistent with prudent lending practices, including consideration of a borrower’s repayment capacity.”

The new guidance will be used as a benchmark for audits of bank operating procedures performed by regulatory agencies.

There has been an explosion of nontraditional loans in recent years, raising worries about the risks to the financial system should a sizable number of defaults occur if borrowers are unable to meet rising mortgage payments.

Interest-only mortgages require that the homeowner initially pay only the interest on the loan for a set period. Option adjustable rate mortgages give the homeowner flexibility to decide how much to pay each month. One of the options is a minimum payment that covers just a portion of the monthly interest.

These mortgages are appealing to people who need cash for other expenses or who have been struggling in recent years with rapidly rising home prices.

However, these types of loans also expose borrowers to far greater risks. If housing prices drop, their loan could be for more than the value of their property. If interest rates rise, such a loan will become more expensive to pay.

Former Federal Reserve Chairman Alan Greenspan issued a number of warnings about these loans last year, as have other banking regulators.

The Government Accountability Office told Congress last week that from 2003 to 2005, nontraditional mortgages rose from less than 10 percent of all mortgages to about 30 percent.

These mortgages were highly concentrated on the East and West coasts, especially California, the GAO said.

The new guidance was issued jointly by the Office of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corp., the Office of Thrift Supervision and the National Credit Union Administration.

“The marketing and use of nontraditional mortgage products — particularly interest-only and payment-option adjustable-rate mortgages — have expanded rapidly to a wider spectrum of borrowers who may not otherwise qualify for more traditional mortgages of similar size,” said John C. Dugan, the comptroller of the currency.

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