Final regulatory guidance for federally chartered bank lenders on so-called non-traditional mortgage products came forth to a relatively receptive market late last month. The guidelines were little changed from those proposed last December.
One particular aspect of the regulations that are expected to bear most heavily on the market, however, is the possibility that lenders will no longer be able to qualify interest only and option ARM borrowers on their ability to pay a product's low introductory rate - a practice that has helped shoe horn a number of borrowers into homes, and one that will now not be available to financially exhausted borrowers in coming years, some speculated.
The Office of the Comptroller of the Currency, the Treasury Department, the Federal Reserve Board and the Federal Deposit Insurance Corp. jointly published the guidelines, called Interagency Guidance on Nontraditional Mortgage Product Risks, in final form on Sept. 29. The nonbinding guidelines only apply to federally chartered banks, but state bank and non-bank regulators are widely expected to eventually adopt them. Of course, when and if the guidance reaches non-bank lenders, and how it is actually implemented "on the ground" will gauge its real impact, sources said.
While some had voiced concern that the federal regulators would stamp out particular products completely, they chose instead to focus on what many would call a more pertinent issue within the mortgage-lending sector - the layering of risk. Consequently, the regulations are expected to primarily affect those borrowers that need a high debt-to-income, loan-to-value, stated income and silent second Frankenstein of a product just to squeeze into a mortgage. And, luckily for the subprime lending market, the guidance pertains specifically to interest only and option ARM issuance. This leaves ARMs and hybrid ARMs - including the popular 2/28 and 3/27 - relatively untouched, UBS pointed out last week.
"This is what regulations are good for, to prevent this competitive race to the bottom," said Gyan Sinha, a senior managing director at Bear Stearns during a conference call on the matter last week. "I don't think these are ever going to be hard-and-fast rules." Instead, he said, adding that regulators are more interested in checking that lenders are "following the spirit of the guidelines." Sinha, along with a number of other analysts last week, said he thought the most likely effect of the regulations might be a small drop-off in issuance from those lenders using unfavorable underwriting standards for the named products. Any slow-down in origination would be in the neighborhood of the low single-digits, he said.
Under the new guidelines, for both option ARM and IO loans, lenders will need to qualify borrowers using the fully indexed, fully amortizing rate of the product, instead of the low introductory rate and payment. While most prime and Alt-A lenders already did this, a number of subprime lenders have, at some point, squeezed borrowers into homes by using the low introductory rate, according to UBS. The practice, however, has been curbed recently, and also muted by the surge in such products as the 40-year mortgage. But, UBS says, "it will remove one of the lowest monthly payment loans from the subprime arsenal, and that will have an impact, if only at the margin." Sinha questioned last week whether this would hinder the ability of a number of subprime borrowers to refinance out of an unaffordable product.
The guidance also warns that second lien loans and reduced documentation loans entail "extra risk" when they are used along with non-traditional lending products, but does not exactly spell out how the lenders should calculate or curb that additional risk.
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