Subprime under scrutiny

From the AP:

Fed: Use Caution in Subprime Mortgages

Federal bank regulators, worried about a surge in defaults on high-risk home mortgages, on Friday called on lenders to exercise caution in making subprime loans and closely evaluate borrowers’ ability to repay them.

The proposed guidance issued by the Federal Reserve and the other four federal agencies that regulate banks, thrifts and credit unions, comes in increasingly troubled market for subprime mortgage loans. Home-mortgage delinquencies and foreclosures are spiking, especially for people who took out subprime mortgages _ higher-interest loans for those with blemished credit records or low incomes who are considered higher risk _ during the sizzling housing boom that waned in the second half of 2005.
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In their notice putting out the guidance for public comment, the banking regulators noted concerns that borrowers “may not fully understand the risks and consequences” of taking out subprime mortgages, and that the mortgages “may pose an elevated credit risk to financial institutions.”

Adjustable-rate mortgages are especially prevalent in the subprime market. They are considered higher-risk loans because they typically draw borrowers in with an initial low, or “teaser” interest rate, which can rise markedly over time. The proposed guidelines direct banks to base their lending decisions on borrowers’ ability to repay home loans at the full final rate, as opposed to the teaser rate.

In addition, the guidelines say that banks should provide consumers “clear and balanced information about the relative benefits and risks” of subprime mortgages.
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In addition to the Fed, the agencies issuing the proposed guidance are the FDIC, the National Credit Union Administration, and the Treasury Department’s Office of the Comptroller of the Currency and Office of Thrift Supervision. The guidelines could be formally adopted sometime after the 60-day public comment period.

From the Federal Reserve:

Agencies Seek Comment on Subprime Mortgage Lending Statement

The federal financial regulatory agencies today issued for comment a proposed Statement on Subprime Mortgage Lending to address certain risks and emerging issues relating to subprime1 mortgage lending practices, specifically, particular adjustable-rate mortgage (ARM) lending products.

The proposal addresses concerns that subprime borrowers may not fully understand the risks and consequences of obtaining these products, and that the products may pose an elevated credit risk to financial institutions. In particular, the proposed guidance focuses on loans that involve repayment terms that exceed the borrower’s ability to service the debt without refinancing or selling the property.

The statement specifies that an institution’s analysis of a borrower’s repayment capacity should include an evaluation of the borrower’s ability to repay the debt by its final maturity at the fully indexed rate, assuming a fully amortizing repayment schedule. The statement also underscores that communications with consumers should provide clear and balanced information about the relative benefits and risks of the products. If adopted, this statement would complement the 2006 Interagency Guidance on Nontraditional Mortgage Product Risks, which did not specifically address the risks of these ARM products.