Residential mortgage lenders should ramp up their existing risk-management and consumer-protection practices to adequately address borrower risk when offering nontraditional mortgage products--that's the latest marching orders under final guidance issued jointly by the Office of the Comptroller of the Currency (OCC), the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), the Office of Thrift Supervision (OTS) and the National Credit Union Administration (NCUA).
The final guidance, Interagency Guidance on Nontraditional Mortgage Product Risks, addresses mortgage products such as interest-only mortgages and payment-option adjustable-rate mortgages (option ARMs).
In the final guidance, regulators reiterate their concern, first expressed in the proposed guidance released late last year, about the nature and the use by lenders of nontraditional mortgage products (see Mortgage Banking February 2006, p. 9).
"While similar products have been available for many years, the number of institutions offering them has expanded rapidly," the joint statement pointed out. "At the same time, these products are offered to a wider spectrum of borrowers who may not otherwise qualify for a similar-size mortgage under traditional terms and underwriting standards. The agencies are concerned that some borrowers may not fully understand the risks of these products."
The final guidance discusses the importance of carefully managing the potential heightened risk levels created by these loans. Toward that end, lenders are directed to do the following:
* Ensure that loan terms and underwriting standards are consistent with prudent lending practices, including consideration of a borrower's repayment capacity.
* Recognize that many nontraditional mortgage loans, particularly when they have risk-layering features, are untested in a stressed environment. These products warrant strong risk-management standards, capital levels commensurate with the risk, and an allowance for loan and lease losses that reflects the collectibility of the portfolio.
* Ensure that consumers have sufficient information to clearly understand loan terms and associated risks prior to making a product or payment choice. …