- The Washington Times - Friday, September 29, 2006

Federal regulators yesterday cracked down on risky mortgage lending that fueled a housing bubble in the first half of the decade, requiring banks for the first time to ensure that borrowers are able to make dramatically increased payments on mortgages after an initial low-payment period is over.

The tightened lending standards would apply to an estimated half of the mortgages made in the Washington area recently. The new breed of “interest-only” and variable-rate mortgages has been popular here as elsewhere because they keep payments low initially by permitting borrowers to opt out of paying principal and even some interest each month — at the cost of ballooning mortgage payments in future years.

The new rules are expected to make it more difficult to get such loans, and could add to recent pressures on home sales, prices and refinancings. But in the long run, analysts expect the regulatory crackdown to reduce defaults, foreclosures and the possibility of a broader financial crisis engulfing the banks.

The final rules for banks issued by the Federal Reserve, Federal Deposit Insurance Corp. and three other bank regulators also are designed to ensure that taxpayers do not end up picking up the tab for lax lending practices that proliferated during the housing boom, enabling people to purchase expensive homes often with no down payments, no proof of income, and even with a history of poor credit and bankruptcy.

While the new rules do not apply to the roughly half of mortgage lenders not attached to banks, state regulators have promised to adopt the federal guidance and issue similar rules for lenders and mortgage brokers they regulate. The Federal Trade Commission, which has jurisdiction over nonbank lenders, also is considering action.

“Some borrowers may not fully understand the risks of these products,” said the agencies, explaining why, in addition to tightening standards, they are requiring lenders to provide full, up-front disclosures to borrowers of the risks that their payments could double or triple as interest rates rise and principal payments are phased in.

A recent survey by RBC Capital Markets found that consumers remain largely in the dark, not only about the risks of nontraditional mortgages but also about the growing likelihood of a fall or stagnation in the market value of their homes, which would make it more difficult to refinance.

“Those who entered the end of the housing cycle with variable rate and interest-only mortgages are clearly at risk once their mortgages renew,” said Scot Ciccarelli, managing director at RBC.

“Many of them seem ill-equipped to handle the higher payments they will eventually incur,” he said, noting that 13 percent of the 1,003 consumers RCB surveyed “haven’t even considered the ramifications” of higher payments, while 40 percent of those who are aware their payments will rise are worried about whether they will be able to cope.

Included in the rules issued yesterday were examples of disclosures that banks should use to educate borrowers. They stress, for example, that if borrowers choose to make only minimum payments, they will increase the amount of interest and principal they owe and substantially increase payments in the long term.

Since many of the nontraditional loans were securitized by lenders and purchased by U.S. and foreign investors, the questionable credit quality of the loans poses risks to the financial markets and economy, as well as individual borrowers and banks, said Mark Zandi, analyst with Economy.com.

The reaction of foreign investors to any loan problems is a big hazard, he said, estimating that foreign investors own about $3 trillion of U.S. mortgage-backed securities, and could start dumping their holdings if delinquencies and defaults rise.

“At least some of the recent homeowners who have squeezed into a house by taking on an interest-only or option mortgage loan, with little in the way of a down payment, are at clear risk of difficulty in making their loan payment,” he said. “Given that many global investors are new to the U.S. residential [mortgage-backed securities] market, they may not be prepared. A financial market crisis of some form is a clear possibility.”

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