A consortium of five federal regulatory agencies on June 29 issued new guidelines that impose tighter standards on the subprime mortgage review process and require lenders to allow borrowers to refinance out of ARMs before they reset, without penalty.
The guidelines were developed to "clarify how institutions can offer certain adjustable rate mortgage (ARM) products in a safe and sound manner, and in a way that clearly discloses the risks that borrowers may assume."They were issued in a joint statement by the Office of the Comptroller of the Currency, Treasury Department; Board of Governors of the Federal Reserve System; Federal Deposit Insurance Corporation; Office of Thrift Supervision, Treasury Department; and National Credit Union Administration.
The rules, which were based on an March statement made by the consortium, will require more than 8,000 federally regulated mortgage lenders to base loan approvals on a borrower's ability to pay not only under introductory rates for adjustable rate mortgages but on payments under subsequent increases in those introductory rates. The rules also give lenders 60 days to allow borrowers to refinance out of ARMs before the rate resets, without penalty.
The guidelines were met with statements of approval from the National Association of Realtors and disapproval from a coalition of consumer groups, which said the rules did not go far enough to protect borrowers.
The guidelines appear to effectively scotch stated-income loans to subprime borrowers except in unique circumstances. The joint statement said, "The Agencies believe that verifying income is critical to conducting a credible analysis of borrowers¹ repayment capacity, particularly in connection with loans to subprime borrowers. Therefore, the final statement provides that stated income and reduced documentation should be accepted only if there are mitigating factors that clearly minimize the need for verification of repayment capacity."
The statement continues, "The Agencies continue to believe that institutions should maintain qualification standards that include a credible analysis of a borrower¹s capacity to repay the loan according to its terms. This analysis should consider both principal and interest obligations at the fully indexed rate with a fully amortizing repayment schedule, plus a reasonable estimate for real estate taxes and insurance, whether or not escrowed."
Regarding the prepayment requirement, the corsortium said, "In light of the comments received, the Agencies revised their March statement to state that the period during which prepayment penalties apply should not exceed the initial reset period, and that institutions generally should provide borrowers with a reasonable period of time (typically, at least 60 days prior to the reset date) to refinance their loans without penalty. "However, it added, "There is no supervisory expectation for institutions to waive contractual terms with regard to prepayment penalties on existing loans."
Apparently responding to charges from some consumer activist groups that subprime lending is by its nature predatory, the federal regulators said, "The statement clarifies that subprime lending is not synonymous with predatory lending, and that there is no presumption that the loans to which the Statement applies are predatory."