After hinting about new rules for months, on Dec. 27 federal banking regulators issued proposed guidance about nontraditional mortgages to lenders. The suggested rules—which won't go into effect until a 60-day comment period closes on Feb. 27 and an internal review of comments is made—advise more-stringent lending guidelines for interest-only and so-called payment option mortgages, which allow homeowners to choose monthly payments that result in negative amortization.

The proposed guidance comes as the popularity of nontraditional mortgages has skyrocketed. According to Loan-Performance, a subsidiary of First American Real Estate Solutions, interest-only loans accounted for just 1.9 percent of mortgage originations in 2000; through September 2005, that figure had climbed to 30.6 percent.

In a late October speech, John Dugan, the U.S. comptroller of the currency, described his concerns about growing risk in residential real estate and cautioned that such nontraditional products as payment option loans “have a legitimate use in the right hands, but they need to be handled with extreme care.”

ON THE WAY DOWN?: Total starts in December were down 13.2% from their peak in February, but early figures show that 2005 was another record year for starts. SOURCE: U.S. CENSUS BUREAU
ON THE WAY DOWN?: Total starts in December were down 13.2% from their peak in February, but early figures show that 2005 was another record year for starts. SOURCE: U.S. CENSUS BUREAU

The proposed guidance, issued jointly by his agency, the Office of Thrift Supervision, the Federal Reserve, the Federal Deposit Insurance Corp., and the National Credit Union Administration, details that extreme care. Among other things, it recommends that concentration limits be set for types of loans, to maintain diversification; that lenders perform stress tests on factors outside their control to better manage risk and that they underwrite mortgages based on buyers' income as well as credit scores; and that consumers are appropriately alerted to the risks associated with the loans.

“The agencies will carefully scrutinize institutions' lending programs, including policies and procedures, and risk management processes in this area,” the guidance states. “Remedial action will be requested from institutions that do not adequately measure, monitor, and control risk exposures in loan portfolios.”

Banking association groups including America's Community Bankers and the Mortgage Bankers' Association welcome the comment period. “I think it was a very conscientious attempt on the part of the regulators that they're offering guidance that helps clarify the market without disrupting the market,” says Tim Doyle, senior director of the Mortgage Bankers' government affairs group. “It sends a message that they're concerned about doing it right.”

HOLD UP: Both long- and short-term mortgage rates paused in January. Fixed 30-year rates even fell a bit. Economists forecast only a slight rise in fixed rates through 2006. SOURCE: FREDDIE MAC
HOLD UP: Both long- and short-term mortgage rates paused in January. Fixed 30-year rates even fell a bit. Economists forecast only a slight rise in fixed rates through 2006. SOURCE: FREDDIE MAC