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On September 29, 2006, the ederal nancialinstitution regulators (the Agencies) issuedthe Interagency Guidance on NontraditionalMortgage Product Risks.1 The guidance was de-

veloped to clariy how institutions can oer nontraditionalmortgage products in a sae and sound manner, and in a waythat clearly discloses the risks that borrowers may assume.This article provides a brie summary o the guidance, butnancial institutions should reer to the guidance itsel ormore inormation, and should work closely with their regu-lator in developing or changing systems, policies, and pro-cedures in response to the guidance. Consumers and home-

ownership counseling organizations may nd this summaryuseul in understanding bank mortgage products as well asconsumer rights and responsibilities.

Background

The need or guidance on nontraditional mortgageproducts arose rom the increasing popularity o mortgageproducts that allow borrowers to deer payment o principaland, in some cases, interest. These products include interest-only loans and payment option adjustable rate mortgages(ARMs) and contain the potential or substantial paymentshock when the loans begin to ully amortize. Nontradition-

al mortgage products have been available or many years,but these products are now oered to a wider spectrum oborrowers by a much greater number o institutions.

The growth o these loans raises a series o pressing ques-tions or regulators, lenders, and consumers: Do these loanspose special risks to lenders, and how are those risks bestmanaged? Do consumers have enough inormation to makeinormed decisions about these products? Are consum-ers prepared or payment shocks when loans re-set, and dolenders appropriately account or payment shocks? Do theseloans help certain segments o the population become ho-meowners, and would increased regulation inappropriatelyrestrict access to credit? Alternatively, are these loans danger-

ous or some consumers, putting their dream o homeown-ership at risk, suggesting the need or more regulation?

Overview

In response to these questions and concerns, the Agen-cies issued guidance to nancial institutions to emphasizethe importance o developing sound underwriting standardsand portolio risk management practices, and to recommendpractices or consumer disclosure to ensure that borrowers

Nontraditional Mortgage GuidanceBy John Olson

are inormed about both the risks and the benets associ-ated with these products.

The guidance applies, in general, to all residential mort-gage loan products that allow borrowers to deer payment oprincipal or interest, including interest-only mortgages andpayment option adjustable-rate mortgages. The guidance as-serts that nancial institution management should:

Ensure that loan terms and underwriting standards areconsistent with prudent lending practices, includingconsideration o a borrowers repayment capacity;

Recognize that many nontraditional mortgage loans,particularly when they have risk-layering eatures, areuntested in a stressed environment; and

Ensure that consumers have sucient inormationto clearly understand loan terms and associated risksprior to making product choice.

The guidance is divided into three sections: Loan Termsand Underwriting Standards, Portolio and Risk Manage-ment Practices, and Consumer Protection Issues, as detailedbelow.

Loan Terms and Underwriting Standards

Qualifying borrowers: An institutions qualiying stan-dards should recognize the potential impact o paymentshock, especially or borrowers with high loan-to-valueratios, high debt-to-income ratios, and low credit scores.The criteria should be based upon prudent and appropri-ate underwriting standards, considering both the borrowerscharacteristics and the products attributes. For all nontradi-tional mortgage products, an institutions analysis o a bor-rowers repayment capacity should include an evaluation otheir ability to repay the debt by nal maturity and the ullyindexed rate.

Underwriting standards: Nontraditional mortgages canbe an eective nancial management tool or some borrow-

ers, but may not be appropriate or all borrowers. Whenqualiying borrowers or nontraditional mortgages, banksneed to make sure the borrower is able to repay the loan.The guidance states that loans should be underwritten at theully indexed rate, assuming a ully amortizing payment, in-cluding the additional payment burden rom any negativeamortization that can accrue.

Collateral-dependent loans: Institutions should avoidthe use o loan terms and underwriting practices that may

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heighten the need or a borrower to rely on the sale or re-nancing o the property once amortization begins. Loansto individuals who do not demonstrate capacity to repay, asstructured, rom sources other than the collateral pledgedare generally considered unsae and unsound.

Risk layering: Risk layering eatures such as limiteddocumentation and simultaneous second liens should be

accompanied by mitigating actors. Mitigating actors caninclude lower LTV and DTI ratios, higher credit scores, su-cient liquid assets or other credit enhancements.

Reduced documentation: Reduced documentationpractices should be used with caution. As the level o creditrisk increases, the Agencies expect an institution to morediligently veriy and document a borrowers income andpayment capacity.

Simultaneous second-lien loans: Loans with minimal orno owner equity should not have a payment structure thatallows or delayed or negative amortization without othersignicant risk mitigating actors.

Introductory interest rates: When developing non-

traditional mortgage product terms, an institution shouldconsider the spread between the introductory rate and theully indexed rate. Because a wide initial spread means thatborrowers are more likely to experience payment shock, in-stitutions should minimize the likelihood o payment shockwhen setting introductory rates.

Lending to subprime borrowers: Mortgage programsthat target subprime borrowers should ollow the applicableinteragency guidance on subprime lending.2 Institutionsshould recognize that risk-layering eatures in loans to sub-prime borrowers may signicantly increase risks or both theinstitution and the borrower.

Portfolio and Risk Management Practices

Institutions should ensure that risk management prac-tices keep pace with the growth and changing risk prole otheir nontraditional mortgage loan portolios and changesin the market. Active management o these risks is espe-cially important to institutions that have experienced, orproject, signicant growth or concentration levels. To meetthe Agencies expectations that institutions that originate orinvest in nontraditional mortgages adopt more robust riskmanagement practices, institutions should:

Develop written policies that speciy acceptable prod-uct attributes, production and portolio limits, sales

and securitization practices, and risk management ex-pectations;

Design enhanced perormance measures and manage-ment reporting that provide early warning or increasedrisk;

Establish appropriate Allowance or Loan and LeaseLosses (ALLL) levels that consider the credit quality othe portolio and conditions that aect collectibility;

Maintain capital levels that refect portolio character-istics and the eect o stressed economic conditionson collectibility; and,

Conduct stress tests on key perormance drivers suchas interest rates, employment levels and housing valuefuctuations. Stress testing results should provide directinput in determining underwriting standards, product

terms, concentration levels and capital levels.

Consumer Protection Issues

While nontraditional mortgage loans provide fexibilityor consumers, the Agencies are concerned that consumersmay enter into these transactions without ully understand-ing the product terms. Institutions should provide consum-ers with clear, balanced, and timely inormation concerningthe risks o nontraditional mortgage products, including therisks o payment shock and negative amortization. Clearinormation should be provided at critical decision times,such as when selecting a loan product or when choosing amonthly mortgage payment optionnot just upon submis-

sion o an application.Institutions that oer nontraditional mortgage products

must ensure that they do so in a manner that complies withall applicable laws and regulations. Applicable laws and reg-ulations include the Truth in Lending Act (Regulation Z),which governs disclosures that institutions must provide,and Section 5 o the Federal Trade Commission Act, whichprohibits unair and deceptive acts or practices. Other laws,including the air lending laws and the Real Estate Settle-ment Procedures Act, also apply.

Communications with consumers: Institutions shouldprovide consumers with inormation that is designed to helpthem make inormed decisions when selecting and usingthese products. Institutions should alert consumers to po-tential increases in payments or nontraditional mortgages,such as when an introductory rate expires or because o acap on negative amortization. Negative amortization and itsimpact on the consumers loan balance and home equityshould also be highlighted. I an institution oers loans withprepayment penalties or reduced documentation loans, theinstitution should highlight those eatures, including thepremium or a reduced documentation loan. I the institu-tion may impose a prepayment penalty, consumers shouldbe alerted to this act and to the need to ask the lender aboutthe amount o any such penalty.

Monthly statements on payment option ARMs: State-ments should enable consumers to make inormed choicesabout their payment options, explaining the impact o eachchoice on the loan balance.

Practices to avoid: Institutions should avoid practicesthat obscure signicant risks to the consumer. For example,i an institution emphasizes the comparatively lower ini-tial payments, it should also provide clear and comparablyprominent inormation alerting the consumer to the risks.

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Institutions should avoid promoting payment patterns thatare unlikely to occur. Institutions should also avoid makingone-sided representations about the cash savings or expand-ed buying power to be realized rom nontraditional mort-gage products, suggesting that initial minimum paymentswill cover accrued interest charges, and making misleadingclaims that interest rates or payment obligations or theseproducts are xed.

Control systems: Institutions should put systems inplace to ensure that their practices are consistent with theguidance. Among other things, institutions should not usecompensation programs that improperly encourage lendingpersonnel to direct consumers to particular products. Insti-tutions that make, purchase, or service loans through thirdparties should take appropriate steps to mitigate risks relat-ing to consumer protection discussed in the guidance. These

Box 4.1Comments on Interagency Guidance on Nontraditional Mortgages

On December 20, 2005, the Agencies issued or comment proposed guidance on nontraditional mortgage products. Thecomment period ended on March 29, 2006, and the nal guidance was issued on September 29, 2006. Over 60 com-ments were received by the Agencies, and comments letters are publicly available on the Federal Reserves website.1Comment letters rom several prominent organizations are highlighted below.

American Bankers Association (ABA)

While the ABA also pointed out that the consumer protections in the guidance would apply only to regulated nancial in-stitutions, it listed a number o its own concerns about the guidance. The ABA asserted that the proposed guidance over-

states the risks o these mortgage products, would be overly prescriptive, and would inappropriately combine saety andsoundness guidance with consumer protection guidance. The ABA also expressed concern that the guidance would resultin compliance problems by creating an additional layer o disclosure on top o what is required by Regulation Z and RESPA;it suggested that the Agencies agree on a generic consumer brochure explaining the risks o both interest-only and optionARMsand speciy a practical time when a lender should give the consumer the standard disclosure brochure.

California Reinvestment Coalition (CRC)

While generally supporting the proposed guidance, CRCs comment letter raised several areas o concern about the guid-ance and about the market or nontraditional loans. CRC would argue against combining stated income loans or loans withreduced income documentation with any nontraditional mortgages and/or subprime mortgages (emphasis in original).CRC also asked that the Agencies give greater guidance to secondary market participants because it believes that mucho the clamor or these products comes not rom borrowers but rom investors. CRC also advocated or a closer link be-tween the guidance and the CRA, citing a Federal Reserve analysis o HMDA data that showed that lending within banks

CRA assessment areas showed signicantly smaller race disparities than lending outside the assessment areas.

Mortgage Bankers Association (MBA)

The MBA expressed concern that the proposed guidance would be overly prescriptive, would introduce an inappropriatethird-party oversight standard or depository institutions, and that the guidance does not suciently use the authority o theFederal Reserve to improve consumer disclosure. The MBA stated that it is concerned that these deciencies will stifemortgage product innovation and hurt consumers access to homeownership nancing. While agreeing with the Agenciesrecommendation that borrowers should not be underwritten at a teaser rate, the MBA asserted that the proposed guid-ance goes too ar in detailing underwriting standards, and will orce lenders to apply credit policies inconsistent with risk.The MBA also expressed concerns in the consumer protection area, stating that guidance would create an even moreduplicative and ragmented system than the current one and will arguably add conusion rather than clarity.

National Consumer Law Center (NCLC)

NCLC called the proposed guidance a good beginning or what should be a major eort by the ederal nancial regulatorsto evaluate what changes need to be made in the regulation o the mortgage marketplace. The organization urged theAgencies to ocus on the risk to consumers inherent in these products, rather than the risk to lenders. The deciencies inthe guidance alleged by NCLC included the act that the guidance would not be enorceable by consumers seeking relierom a lender that had not conormed to the guidance; that the guidance would not apply to lenders that are not depositoryinstitutions; that the guidance would provide inadequate consumer protections; and that the guidance would ail to requiremeaningul underwriting (by not requiring ully indexed underwriting). While NCLC applauded the Agencies ocus on theneed or appropriate underwriting, it ound the proposed guidance to be inherently limited in its reach and strength.

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steps would include, or example, monitoring third partiescompliance with agreements and bank policy, and takingcorrective action i the third party does not comply.

Guidance for Non-bank Entities

As noted in several comments to the Agencies on theproposed guidance (See Box 4.1), while nontraditional mort-

gages are oered by a range o institutions, including manynon-bank lenders, the Agencies guidance applies only toinsured depository institutions. Since the issuance o theguidance, however, several other regulatory and supervisoryentities have issued similar guidance or other participants inthe nontraditional mortgage market.

State SupervisorsIn a comment letter responding to drat guidance, Neil

Milner, President and CEO o the Conerence o State BankSupervisors (CSBS), wrote: As the Interagency Guidance isdirected towards insured nancial institutions and their sub-sidiaries and their aliates, it appears that nonbank lenders,

most o which are licensed and regulated by state authoritiesand control a large share o the mortgage origination market,may not be subject to this proposal. CSBS will encourage itsmembers to determine the best course o action or distrib-uting this Guidance, or guidance that is similar in natureand scope, to the nancial service providers under their su-pervision.3 Indeed, the CSBS and the American Associa-tion o Residential Mortgage Regulators jointly distributedguidance to their state agency members that substantiallymirrors the ederal guidance.4

Fannie Mae and Freddie Mac

On December 13, 2006, the Oce o Federal HousingEnterprise Oversight (OFHEO) directed Fannie Mae andFreddie Mac to immediately take action to support prac-tices outlined in an interagency guidance on nontraditionalmortgage product risks.5 Director James B. Lockhart statedthat Fannie and Freddie adopting the principles o the guid-

ance into their risk management and business practices willenhance industry underwriting standards, risk management,and consumer protection. Fannie and Freddie are expectedto report progress on developing policies in line with theguidance by February 27, 2007.

Conclusion

The interagency guidance on nontraditional mortgagesis barely two months old. Consumers, lenders, and industryobservers will surely be sensitive to the impact o the guid-ance on the marketplace over the coming months and years.Bankers need to understand and conorm to the guidance,other lenders will surely be sensitive to the ongoing eort

by states and other entities to adopt the guidance, consum-ers need to understand and assert their rights under the lawand get the inormation they need to make good decisionsin the mortgage market, and industry observers will need tomonitor the impact o this guidance on the nontraditionalmortgage market. The concerted and collaborative eort othese groups, along with the Agencies, will help ensure anontraditional mortgage market that is sae, air, and prot-able on both sides o the table.

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Homeownership at High Cost: Recent Trends

in the Mortgage Lending Industry

1 Joint Center or Housing Studies o Harvard University (2006).

State o the Nations Housing 2006.2 Belsky, Eric and Mark Duda (2002). Anatomy on the Low-

Income Homeownership Boom in the 1990s. In Low-IncomeHomeownership: Examining the Unexamined Goal, NicolasRetsinas and Eric Belsky, eds. The Brookings Institution.

3 Doms, Mark and Meryl Motica (2006). The Rise inHomeownership. FRBSF Economic Letter, Number 2006-30.

4 U.S. Government Accountability Oce (2006). AlternativeMortgage Products: Impact o Deaults Remains Unclear, butDisclosure o Risks to Borrowers Could be Improved.

5 Joint Center or Housing Studies o Harvard University (2006).State o the Nations Housing 2006. and Avery, Robert, KennethBrevoort and Glenn Canner (2006). Higher-Priced Home Lendingand the 2005 HMDA Data. Federal Reserve Bulletin. FederalReserve Board.

6 Joint Center or Housing Studies o Harvard University (2006).State o the Nations Housing 2006.

7 Immergluck, Daniel and Marti Wiles (1999). Two Steps Back: TheDual Mortgage Market, Predatory Lending, and the Undoing oCommunity Development. Woodstock Institute.

8 Non-prime includes Alt-A low- and no-documentation loans

9 Board o Governors o the Federal Reserve System (2006).InterestOnly Mortgage Payments and Payment Option ARMSAre they or you? http://www.ederalreserve.gov/pubs/mortgage_interestonly/#comparison

10 Herbert, Christopher and Eric S. Belsky (2006). TheHomeownership Experience o Low-Income and Minority Families:A Review and Synthesis o the Literature. U.S. Department oHousing and Urban Development, Oce o Policy Development and

Research.11 Johnson, Hans and Amanda Bailey (2005). Caliornias Newest

Homeowners: Aording the Unaordable, Public Policy Institute oCaliornia.

12 Because many o the AMP loans originated in recent years have notyet reset, it is not yet clear how much o an impact these types opayment shocks are having on delinquencies and oreclosure rates.

13 Apgar, William and Mark Duda (2005). Collateral Damage: TheMunicipal Impact of Todays Mortgage Foreclosure Boom. Reportprepared or the Homeownership Preservation Foundation. Available:http://www.hponline.org/PDF/Apgar-Duda_Study_Final.pd

14 Immergluck, Daniel and Geo Smith (2005). There Goes theNeighborhood: The Eect o Single-Family Mortgage Foreclosureson Property Values. Chicago: Woodstock Institute. Available at:http://www.woodstockinst.org/publications/research_reports

15 Immergluck, Daniel and Geo Smith (2005). The Impact o Single-Family Mortgage Foreclosures on Neighborhood Crime. Paperpresented at the Federal Reserve System National CommunityAairs Research Conerence, Washington, D.C.

16 Mortgage Bankers Association. National Delinquency Survey,Second Quarter 2006.

17 Herbert, Christopher and Eric S. Belsky (2006). TheHomeownership Experience o Low-Income and Minority Families:A Review and Synthesis o the Literature. U.S. Department oHousing and Urban Development, Oce o Policy Developmentand Research., and Carr, James and Lopa Kolluri. (2001) Predatory

Lending: An Overview http://www.knowledgeplex.org/kp/text_document_summary/article/relles/hot_topics/Carr-Kolluri.pd

18 Loans are identied as high cost in the Home Mortgage DisclosureAct (HMDA) dataset i the spread between the interest rate on the

loan and the prime rate exceeded a specied amount (i.e. 3% orrst-lien loans and 5% or second-lien loans).

19 Avery, Robert, Kenneth Brevoort and Glenn Canner (2006). Higher-Priced Home Lending and the 2005 HMDA Data. Federal ReserveBulletin. Federal Reserve Board.

20 Carr, James and Lopa Kolluri. (2001) Predatory Lending: AnOverview http://www.knowledgeplex.org/kp/text_document_summary/article/relles/hot_topics/Carr-Kolluri.pd

21 Courchane, Marsha, Brian Surette and Peter Zorn (2004). SubprimeBorrowers: Mortgage Transitions and Outcomes, Journal of RealEstate Finance and Economics, 29:4, 365-392, 2004.

22 Bocian, Debbie, Keith Ernst and Wei Li (2006). Unair Lending:The Effect of Race and Ethnicity on the Price of SubprimeMortgages. Center or Responsible Lending., and U.S. GovernmentAccountability Oce (2006).

12th District Trends in Mortgage Lending Box 1.1

1 Nightmare Mortagages. (9/11/2006) BusinessWeek, onlineat http://www.businessweek.com/magazine/content/06_37/b4000001.htm

2 FDIC Outlook Summer 2006Breaking New Ground in U.S.Mortgage Lending. Federal Deposit Insurance Corporation (2006).http://www.dic.gov/bank/analytical/regional/ro20062q/na/2006_summer04.html

3 Ibid.

Predatory Lending Box 1.2

1 Loan fipping reers to lenders who encourage borrowers to rapidlyrenance loans; loan fipping may result in equity-stripping becauserenancing costs money and oten these charges are renanced

into the amount o the loan.

Foreclosure Risk in California Box 1.3

1 This research ocuses on a subset o the subprime marketloansthat are high cost. For the rst time in 2004, loans are identied ashigh cost in the Home Mortgage Disclosure Act (HMDA) dataset ithe spread between the interest rate and the prime rate exceeded aspecied amount (i.e. 3 percent or rst-lien loans and 5 percent orsecond-lien loans).

2 According to a recent study by the Public Policy Institute oCaliornia, orty percent o households with mortgages in the state,and 52 percent o recent homebuyers pay more than the HUDrecommended guideline o spending 30 percent o their incomeon housing costs. Twenty percent spend more than hal o theirincome on their housing costs. Among low-income households,the percentages o those spending the majority o their incomeon housing costs is even higher. Baldassare, M. Statewide SurveyNovember 2004: Special Survey on Caliornians and Their Housing,Public Policy Institute o Caliornia. Available at: http://www.ppic.org/content/pubs/survey/S_1104MBS.pd

3 Notices o Deault are not a perect indicator o oreclosure riskbecause many households that have home loans they cannot aorddo not ever get to the point where they receive a notice o deault.Some homeowners are able to renance or sell their home beorereceiving this ocial warning. Here, the term oreclosure risk is usedas shorthand to describe areas in which households have receivednotices o deault. Areas are described as having a higher level ooreclosure risk i they have a higher rate o notices o deault.

Endnotes

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Preventing Foreclosure: Initiatives to

Sustain Homeownership

1 Mortgage Bankers Association (2005). National DelinquencySurvey, First Quarter 2005 Fourth Quarter 2005.

2 Cutts, A C. & Green, R. K.. (2005). Innovative Servicing Technology:Smart Enough to Keep People in Their Houses?. in Building Assets,Building Credit: Creating Wealth In Low-Income Communities,Retsinas, N. & E. Belsky, eds. Brookings Press. 348-377.

3 Apgar W.C. & Duda M. (2005). Collateral Damage: The Municipal

Impact of Todays Mortgage Foreclosure Boom. HomeownershipPreservation Foundation Minneapolis, Minnesota rom www.hponline.org.

4 Immergluck, D. & Smith, G.. (2005). The Impact of Single-FamilyMortgage Foreclosures on Neighborhood Crime. Federal ReserveCommunity Development Conerence, Washington, DC romwww.chicagoed.org/cedric/les/ 2005_con_paper_session1_immergluck.pd

5 Apgar W.C. and Fishbein A.J. (2005). Changing IndustrialOrganization o Housing Finance and Changing Role o Community-Based Organizations, in Building Assets, Building Credit: CreatingWealth In Low-Income Communities, Retsinas, N. & E. Belsky, eds.Brookings Press. P. 107-137.

6 Courchane, M., Surette B., and Zorn, P. (2004). Subprime Borrowers:Mortgage Transitions and Outcomes, Journal of Real EstateFinance and Economics 29 (4): 365-92.

7 Apgar W. C. and Fishbein, A.J. (2005). Hilgert, M.A., Hogarth J.M.,& Beverly S.. (2003). Household Financial Management: TheConnection between Knowledge and Behavior. Federal ReserveBulletin, 89 (7) 309322. M. Wiranowski, 2002, Sustaining HomeOwnership Through Education and Counseling. Joint Center orHousing Studies, Harvard University.

8 Hilgert, M.A., Hogarth J.M., & Beverly S. (2003).

9 Hirad, A. and Zorn, P. (2001). A Little Knowledge is a GoodThing: Empirical Evidence of the Effectiveness of Pre-PurchaseHomeownership Counseling. Hartarska, V., Gonzalez-Vega, C., andDobos, D. (2002). Credit Counseling and the Incidence of Defaulton Housing Loans by Low-Income Households.

10 For a list o organizations and agencies that provide HUD certied

homeownership counseling in your state, visit http://www.hud.gov/oces/hsg/sh/hcc/hcs.cm.

11 Emerging markets are dened as households o color, non-Englishspeaking households, and households in which English is a secondlanguage.

12 Todd, R. and Grover, M. (2005). A Case or Post-Purchase SupportPrograms as Part o Minnesotas Emerging Markets HomeownershipInitiative, Federal Reserve Bank of Minneapolis Community AffairsReport No. 2005-1.

13 For more inormation on EMHIs goals and participatingorganizations, see the EMHI Business Plan at www.mha.state.mn.us/about/EMHI_Business_Plan.pd.

14 W. Pitco (2006), Homeownership Rescue, Shelterforce OnlineIssue Number 147. National Housing Institute.

15 Neighborhood Housing Services o Chicago (2006). HomeOwnership Preservation Initiative: Partnership Lessons & Results,Three Year Final Report.

16 For more inormation on ACORNs HFC Foreclosure AvoidanceProgram, please visit http://acornhousing.org/TEXT/ap.php.

17 D. Sheline (2006). Sustaining Homeownership and Communities,Community Developments Online, Spring 2006. Oce o theComptroller o the Currency.

18 Silver J. and Williams M. (2006), Asset Preservation: Trends andInterventions in Asset Stripping Services and Products, NationalCommunity Reinvestment Coalition and The Woodstock Institute.

19 Barr, M.S. (2005). Modes o Credit Market Regulation, in BuildingAssets, Building Credit: Creating Wealth In Low-IncomeCommunities, Retsinas, N. & E. Belsky, eds. Brookings Press. P.206-236.

20 Barr, M.S. (2005).21 Engel, K.C. and. McCoy, P.A. (2001). A Tale Of Three Markets: The

Law And Economics Of Predatory Lending. Cleveland-MarshallCollege o Law, Cleveland State University.

22 Engel, K.C. and. McCoy, P.A. (2001).

23 United States Government Accountability Oce (2006). AlternativeMortgage Products: Impact on Defaults Remains Unclear, butDisclosure of Risks to Borrowers Could be Improved. GAO-06-1021.

24 S.F. Braunstein (2006). Nontraditional mortgage products.Testimony beore the Subcommittee on Housing and Transportationand the Subcommittee on Economic Policy, Committee on Banking,Housing, and Urban Aairs, U.S. Senate, September 20, 2006.

25 For an analysis o the dierences between HR 1182, Prohibit

Predatory Lending Act (Miller-Watt-Frank) and HR 1295,Responsible Lending Act (Ney-Kanjorski), the two pieces olegislation introduced during the 109th Legislative Session, visithttp://www.responsiblelending.org/issues/mortgage/policy/page.jsp?itemID=29837365

26 Quercia, R.G., Stegman, M.A., and Davis, W.R. (2004). Assessing theImpact o North Carolinas Predatory Lending Law, Housing PolicyDebate 15(3): 573-601.

27 Other states with predatory lending laws include Arkansas, Colorado,Connecticut, the District o Columbia, Florida, Georgia, Illinois,Indiana, Kentucky, Maine, Maryland, Massachusetts, New Hampshire,New Jersey, New Mexico, New York, North Carolina, Ohio, Oklahoma,Pennsylvania, Rhode Island, South Carolina, Tennessee, Texas, andWisconsin.

28 Inormation relating to state and local laws and their provisions is

rom a database maintained by Butera & Andrews, A Washington,D.C., law rm that tracks predatory lending legislation, and is currentas o September 8, 2006.

29 Elliehausen, G. and Staten, (2002) Regulation of SubprimeMortgage Products: An Analysis of North Carolinas PredatoryLending Law, Credit Research Center, Georgetown University.

30 For a review o these studies, see Quercia, R.G., Stegman, M.A., andDavis, W.R. (2004).

31 Quercia, R.G., Stegman, M.A., and Davis, W.R. (2004).

The Consumer Rescue Fund Box 2.1

1 For a more detailed description and analysis o the ConsumerRescue Fund, see Josh Silver and Marva Williams (2006), AssetPreservation: Trends and Interventions in Asset Stripping Servicesand Products, National Community Reinvestment Coalition and TheWoodstock Institute.

2 The name o the consumer has been ctionalized or privacyreasons.

3 Alabama, Arizona, Caliornia, Florida, Georgia, Illinois, Indiana,Maryland, Massachusetts, Nevada, New York, North Carolina, Ohio,Pennsylvania, Rhode Island, Texas, and Wisconsin.

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Calculated Risk:

Assessing Nontraditional Mortgage Products

1 This article was adapted rom testimony that was given in September2006 beore the Senate Committee on Banking Housing and UrbanAairs. The ull text is available at: http://www.responsiblelending.org/policy/testimony/page.jsp?itemID=30380832

2 Inside B&C Lending, 9/1/2006; See also Inside Mortgage FinanceMBS Database, 2006.

3 54.7 percent o Arican-Americans who purchased homes in 2005

received higher-rate loans. 49.3 percent received such loans torenance their homes.

4 46.1 percent o Latino white borrowers received higher-ratepurchase loans. 33.8 percent received higher-rate renance loans.For the purpose o this comment, Latino reers to borrowers whowere identied as racially white and o Latino ethnicity.

5 Hudson, Mike and E. Scott Reckard, More Homeowners with GoodCredit Getting Stuck in Higher-Rate Loans, L.A. Times, p. A-1(October 24, 2005).

6 Ibid.

7 In 2nd quarter o 2006, 80.7 percent o subprime loans wereadjustable rate loans. This gure based on Mortgage BackedSecurities through the 2nd quarter o 2006, see Inside MortgageFinance MBS Database, 2006.

8 Ibid.9 Laing, Jonathan R. Coming Home to Roost, Barrons (New York,

NY), Feb. 13, 2006, at 26.

10 For example, a recent prospectus shows that a large subprimelender, Option One underwrites to the lesser o the ully indexed rateor one percentage point over the start rate. For a loan with a typical2/28 structure, the latter would always apply. See Option OneProspectus, Option One Mtg Ln Tr Asset Bk Ser 2005 2 424B5May 3 2005, S.E.C. Filing 05794712 at S-50.

11 See, eg., Chase Home Finance Subprime Lending marketingfier, Attractive Underwriting Niches, at www.chaseb2b.com(available 9/18/2006) stating Taxes and Insurance Escrows areNOT required at any LTV, and theres NO rate add! (suggestingthat ailing to escrow taxes is an underwriting highlight that isbenecial to the borrower).

12 See, eg., B&C Escrow Rate Called Low (February 23, 2005)Mortgage Servicing News Bulletin, July 23, 2005 Servicers osubprime mortgage loans ace a perplexing conundrum: only abouta quarter o the loans include escrow accounts to ensure paymento insurance premiums and property taxes, yet subprime borrowersare the least likely to save money to make such payments.NigelBrazier, senior vice president or business development and strategicinitiatives at Select Portolio Servicing, said only about 25 percent othe loans in his companys subprime portolio have escrow accounts.He said that is typical or the subprime industry.

13 Mortgage Asset Research Institute, Inc, Eighth Periodic MortgageFraud Case Report to Mortgage Bankers Association, p. 12,available at http://www.mari-inc.com/pds/mba/MBA8thCaseRpt.pd (April 2006).

14 Figure based on Mortgage Backed Securities through the 2nd quartero 2006, see Inside Mortgage Finance MBS Database, 2006.

15 See Steep Increase in Caliornia Foreclosure Activity, DataQuickNews, October 18, 2006, http://www.dqnews.com/RRFor1006.shtm and National Foreclosures Increase 17 Percent In ThirdQuarter Press Release rom RealtyTrac, November 1, 2006,http://www.realtytrac.com/ContentManagement/PressRelease.aspx?ItemID=1362.

16 Quercia, Roberto, Michael Stegman and Walter Davis, The Impactof Predatory Loan Terms on Subprime Foreclosures: The SpecialCase of Prepayment Penalties and Balloon Payments, Center orCommunity Capitalism, University o North Carolina at Chapel Hill(January 25, 2005) at 30 and 24.

17 CRL conducted an OLS regression o state-level changes in housingprices and oreclosure rates among subprime loans originated in2000 (based on perormance through May 2005), which shows ahighly signicant relationship (p < 0.01) with an adjusted r-squaredo 0.57 and coecient o -0.92. In other words, or every percentagepoint decrease in appreciation rates, the model predicts a 0.92percentage point increase in oreclosure rates. Mean oreclosurerate=13.57 percent, N=51.

18 Knox, Noelle and Barbara Hansen, More Fall Behind on Mortgages,USA Todayat B1 (September 14, 2006). The USA Todayguresreer to total delinquency gures (30 days + delinquent throughoreclosure).

19 See MBA survey cited in Noelle Knox and Barbara Hansen, MoreFall Behind on Mortgages, USA Todayat B1 (September 14, 2006).

20 Income verication could include nontraditional methods includingbank accounts, records o consistent bill paying that are notrecorded by standard credit agencies or other methods that willreasonably veriy income to meet mortgage requirements.

Nontraditional Mortgage Guidance

1 The guidance was issued by the Board o Governors o theFederal Reserve System, the Oce o the Comptroller o the

Currency, the Federal Deposit Insurance Corporation, and theNational Credit Union Administration. The guidance is availableonline at http://www.ederalreserve.gov/boarddocs/press/bcreg/2006/20060929/attachment1.pd.

2 Interagency Guidance on Subprime Lending, March 1999.http://www.ederalreserve.gov/boarddocs/srLETTERS/1999/sr9906a1.pd

3 February 14, 2006 letter to the Agencies. http://www.ederalreserve.gov/SECRS/2006/February/20060224/OP-1246/OP-1246_10_1.pd

4 See http://www.csbs.org/AM/Template.cm?Section=Press_Releases&Template=/CM/ContentDisplay.cm&ContentID=9010.

Comments on Interagency Guidance on

Nontraditional Mortgages Box 4.1

1 See http://www.ederalreserve.gov/generalino/oia/index.cm?doc_id=OP%2D1246&doc_ver=1&ShowAll=Yes.

Glossary

1, 2, 6, 7, 19: Consumer Handbook on Adjustable Rate Mortgages(2005). Board o Governors o the Federal Reserve System:http://www.ederalreserve.gov/pubs/arms/glossary_english.htm.

13, 29: Board o Governors o the Federal Reserve System: http://www.ederalreserve.gov/events/publichearings/hoepa/2006/deault.htm

12: Frequently Asked Questions about the New HMDA Data (2006).Board o Governors o the Federal Reserve System: www.ederalreserve.gov/boarddocs/press/bcreg/2006/20060403/attachment.pd

3, 4, 5, 11, 16, 23, 25, 27, 30-33: Center or Responsible Lending: http://

www.responsiblelending.org/glossary.html8, 9, 10, 15, 18, 24: Fannie Mae: http://www.anniemae.com/tools/

glossary.jhtml

14, 21, 22, 28: Overview o Nonprime Mortgage Lending andNontraditional Mortgage Product Terms. In FDIC Outlook Summer2006Breaking New Ground in U.S. Mortgage Lending. FederalDeposit Insurance Corporation: http://www.dic.gov/bank/analytical/regional/ro20062q/na/2006_summer04.html

17, 20, 27: U.S. Department o Housing and Urban Development:http://www.hud.gov/oces/hsg/sh/buying/glossary.cm

27December 2006

non traditional mortgages

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