Testimony on Non traditional Mortgage Products to FDIC Resource
Web Site Here
March 27, 2006 The Warnings
were first sent out - BEWARE EXOTIC
MORTGAGE PRODUCTS
No money down, interest only loans, etc. One year later
that news is affecting the Stock Market
Exotic Loan Programs may become a serious concern when made to the unsophisticated
borrower. The market today is flooded with exotic mortgage products: interest-only loans,
option adjustable-rate mortgages (ARMs), adjustable rate mortgages, no documentation
mortgages, no down payment mortgages, pick your payment options, and so forth. These
products are already becoming main stream.
Washington Post reports that in 2005, 63% of new mortgages were
interest-only and adjustable-rate mortgages. New York Times reports that over an 18-month
period in 2004 and 2005, approximately one-third of homebuyers did not put any money down
for their loan. These products are unsuitable to the unsophisticated borrower who can not
comprehend the potential payment shock, negative amortization, loss of equity and
theultimate risk of losing the home. We believe that borrowers' repayment capacity must be
conservatively assessed through carefully reviewing loan-to-value (LTV) and debt-to-income
(DTI) ratios, credit scores and borrowers' income levels. In addition, lenders should
conduct stress tests that include assessing borrower ability to repay at interest rates
higher than the fully indexed rate.
Minimum Payments - We agree that lenders must underwrite loans involving minimum payments
with extreme caution. This option is like buying a home with a credit card. Even if it may
make sense for some borrowers, the minimum payment has to be sufficient enough to make
sense. After all the agencies have recommended that credit card lenders raise the minimum
payment required of all borrowers! Lenders need to assume that large and increasing
outstanding balances will confront borrowers who choose minimum payments. We agree that
the lending industry must underwrite these loans as if at some point in the near future
there will be a large outstanding balance for loans with minimum payments. In addition, we
ask the regulators to set a limit on the amount the outstanding loan balance can increase
as the loan negatively amortizes. We suggest that outstanding balances be capped at 105%
of the original loan amount for loan products that permit negative amortization.
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Stated Income - We do not see any benefits to combining stated income loans or loans with
reduced income documentation with any non traditional mortgage and/or with any sub
primemortgage. If this product is allowed, 1)It should not be offered in combination with
any other risky product. 2)It should not rely solely on credit scores as a substitute for
income verification. 3)It should require low LTV, low DTI ratios, and high credit scores.
Consideration of Future Events Future events should only be considered in borrowers'
ability to repay to the extent that they are predictable, likely, and relevant. Estimating
future incomes, for example, should not be considered in this calculation as it is not a
reliable, foreseeable or necessarily likely event. If at all, given the realistic
environment of globalization, downsizing, and real loss in incomes, projections of future
incomes should be conservative. Estimating future debt should be in the context of our
recent experience. For example, we could barely handle a rate shock of $3/gallon gasoline!
Delawareans are poised for a rate shock of 59% increase in utility bills. Future interest
rates should be a consideration in an environment where we are poised for the 15th
straight rate hike. When ARMs first came out in the 1980s, lenders protected themselves
and borrowers from risk by calculating some extra cushion into the analysis of the
borrower's ability to repay. Lenders should continue this responsible lending effort by
assessing borrowers' ability to repay at 2 percentage points beyond the fully indexed rate
or at the cappedrate, whichever is greater. Underwriting Standards We are pleased with
several of the proposed guidelines to set higher industry standards on underwriting,
consumer protections, and portfolio management practices. We agree with your proposals
that: *Lenders should avoid making unrealistic loans that effectively force borrowers to
refinance or sell their homes once amortization begins. *Lenders should be curbed from
making simultaneous second-liens that allow for negative amortization when there is
minimal or no invested equity. page three
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*Lenders should sufficiently compensate for risk layering and to carefully come up with
ways to minimize impending payment shock for borrowers with low introductory rates.
*Lenders should compensate for risk layering through a combination of higher credit
scores, lower LTV and DTI ratios, and credit enhancement. *Lenders must develop strategies
for managing the payment shock by eliminatinglarge disparities between low introductory
rates and adjustable rates.
Managing Portfolio Practice - We support: *The requirement that lenders monitor their
third-party relationships to ensure that these agents follow lenders' policies and
procedures. *Lenders must immediately sever ties with third-party originators if harmful
lending practices are discovered. We recommend that regulators review lenders on their
compliance with these guidelines during their fair lending and safety and soundness
reviews.
Consumer Protection Issues - We appreciate the clarification that lenders should provide
clear, balanced and timely communication, explain available options and their associated
increases and impacts in monthly payments, and specifically describe features such as
payment shock, negative amortization and prepayment penalties. Even the best disclosure
requirement is simply not enough. We urge you to augment strong consumer disclosure
requirements with tough regulations and enforcement. Thank you for reminding lenders about
their continued legal responsibilities to borrowers, even after loans are sold or
securitized. Sub Prime Borrowers Non traditional mortgages pose heightened risk to
subprime borrowers. Already starting with higher interest rate loans, subprime borrowers
are often more sensitive to rate fluctuations than prime borrowers. Yet, lenders
inappropriately target subprime borrowers for these risky products. We urge you to
prohibit lenders from offering risky non traditional mortgages to subprime borrowers that
allow for negative amortization, risk layering or similarly dangerous features.
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Community Reinvestment Act - We urge you to incorporate the Community Reinvestment Act
(CRA) into the proposed guidance. CRA mandates lenders to respond to credit needs in a
safe and sound manner. The guidance must therefore stipulate that issuing non traditional
mortgages in an unsafe and unsound manner violates CRA. Lenders must be penalized via
lower ratings on their CRA exams for making exotic mortgages that are unsafe and unsound.
The recent changes to the CRA regulation include a new provision that penalizes lenders
for discriminatory, illegal and abusive loans. Therefore, regulators must ensure that
lenders are not targeting minorities and other protected classes with dangerous and
ill-suited exotic mortgages. Lenders targeting minorities, women, elderly, or low-income
borrowers with exotic mortgages must be given a lower rating on their CRA exams and
reported for violations of fair lending and equal credit opportunity laws. We remain
concerned that risky non traditional mortgages are becoming commonplace for the average
borrower, and too common for low- and moderate-income and sub-prime borrowers who are
extremely vulnerable to risky products. We sincerely appreciate your efforts to gain
control of the ever-growing trend of risky non traditional mortgage products and request
that you keep borrowers' best interests inmind when finalizing the guidelines. Thank you
for the opportunity to comment on this proposal. If you have any questions,please do not
hesitate to contact us at (302) 654-5024. Sincerely, Rashmi Rangan
NEWS SOURCE- on comments to the FDIC March 27, 2006 Full
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