State regulators are moving to curb abusive tactics and loose standards used by some mortgage lenders offering unconventional loans with interest-only and multiple-payment options.
An estimated 10 percent of the U.S. population, or 30 million people, are at risk of falling into financial trouble because they used such easy-money loans with no down payments to buy houses, leaving them with little or no equity in their homes and vulnerable to sharply rising interest rates, according to the Federal Deposit Insurance Corp.
The majority of mortgage lenders in the United States are not banks, so they are not covered by rules issued in December by the FDIC, the Federal Reserve and three other federal banking agencies to clamp down on the questionable lending practices, which have been encouraging homeowners to accumulate record levels of high-risk mortgage debt.
Lenders that are not banks or owned by banks are regulated by states, but few states have set strict credit standards or required disclosure of sharply higher monthly payments that occur as loans are adjusted to include higher interest and principal payments.
Now, concern about the growth of aggressive and deceptive practices by some lenders is prompting state regulators, like their federal counterparts, to consider issuing rules or guidance to ensure that rogue lenders do not continue to offer exotic loans in a regulatory vacuum.
Innovative loans with backloaded payment schedules have “inherent risks,” as they can multiply a borrower’s debt load within months or years, and even prevent the lender from accruing principal in a declining market — raising dangers for lenders and consumers alike, said Neil Milner, president of the Conference of State Bank Supervisors.
“The risks associated with these products are exacerbated by risk-layering,” such as requiring no down payment or income documentation to get the loans, he said, at a time when “residential real-estate values are showing signs of peaking.”
Problems with the loans are starting to crop up now that the housing boom has shown signs of ending and home sales and prices are turning down in some overheated areas.
Foreclosures in New Hampshire skyrocketed by 52 percent in the past seven months because “homeowners who financed with an interest-only, adjustable-rate or discounted-rate mortgage were unprepared when their mortgage payments increased anywhere from 20 percent to 40 percent,” said James Kenney, co-founder of ForeclosuresNH.com, a reporting service.
In addition to structuring loans so that some borrowers may never pay down principal and, thus, may be more inclined to go into default, some lenders also have been offering risky loans to consumers with little borrowing experience or histories of delinquency and bankruptcy. Such borrowers are considered the most likely to go into default.
Nontraditional mortgages “may not be appropriate for higher-risk borrowers and borrowers who might not otherwise qualify” to buy a house without extremely liberal lending terms, Mr. Milner said.
The state banking group informed the Federal Reserve in February that it is working with the American Association of Residential Mortgage Regulators, the National Association of Consumer Credit Administrators and other state agencies on a policy that they will apply to nonbank lenders under their jurisdictions.
The state rules most likely will closely follow the federal guidelines, Mr. Milner said, although states are concerned that federal rules governing disclosure are becoming too burdensome and complex and need to be streamlined to ensure that consumers are getting the information they need to make informed decisions.
Disclosures need revision
Today’s increasingly complicated loans often have terms that change with economic conditions and payment schedules that vary with each borrower, so they no longer fit into a framework of federal regulations that were written decades ago when almost all loans had standard 30-year terms with fixed interest rates.
“An entirely new disclosure process is necessary to help consumers keep pace with an ever-expanding array of mortgage-related products,” Mr. Milner said.
Most importantly, consumers need to be informed upfront, at the time that they apply for loans, of the pitfalls as well as the advantages of various instruments, not at the time of settlement, which is when most disclosures are required to be made under federal law, he said.
Consumers at loan closings typically are deluged with disclosure forms that they must sign even though the forms may give them little insight into their new loans. Often, borrowers do not even read the forms, brokers say.
In any case, the end of the loan process is too late for borrowers to reverse major decisions about loan terms or shop for better deals, they say.
Mr. Milner said it is important for states to act soon to prevent banks offering mortgages from being disadvantaged by having to follow the strict federal guidelines while their unregulated competitors continue to earn big profits and commissions by offering abusive loans.
Bill Matthews of the Conference of State Bank Supervisors said state regulation of the industry likely will continue to vary. Currently under a “patchwork quilt” of state regulation, many lenders are required to do no more than post surety bonds.
Two states, Alaska and Colorado, do not regulate mortgage lenders at all, he said, while others, such as California, regulate lending heavily.
Reflecting the patchy regulation, the state mortgage regulators association has a volunteer staff and has confined itself mostly to licensing mortgage brokers to ensure that they do not have criminal records, he said.
Widespread problems with abusive loans have not surfaced yet, Mr. Matthews said, because rapidly rising house prices and quick turnover in the housing market in recent years enabled borrowers and lenders to profit without suffering serious financial consequences.
Now that sales have slowed sharply and prices have flattened or turned down in most markets, however, financial problems among overstretched borrowers are likely to start cropping up, he said.
“The bodies will start to rise to the surface,” he said.
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