By Kirstin Downey
Washington Post Staff Writer
Thursday, September 21, 2006

At a Senate Banking Committee hearing yesterday, legislators and consumer advocates prodded federal banking regulators to move more quickly to put restrictions on non-traditional mortgage lending, because, they said, the new kinds of mortgages may place borrowers and lenders at financial risk.

"It seems to me there's been a race to the bottom" in lending standards, said Sen. Jim Bunning (R-Ky.). He said that consumers don't seem to understand the new products, and that if real estate values continue to fall, the market "pullback" could become "a prelude to a crash."

"There's a plethora of new products that are destroying the lives of a whole lot of people," said Sen. Charles E. Schumer (D- N.Y.). "These were intended for rich, sophisticated buyers but they have been sold to the least sophisticated and most vulnerable."

The popular loans, which include various adjustable-rate mortgages, interest-only loans and what are called "option" adjustables, share a common feature in that they allow borrowers to pay less money now but require them to pay more, sometimes much more, later. Monthly payments could double or triple when borrowers are required to pay the full interest and principal on the loan, several years down the road. About half of all non-traditional loans now require borrowers to pay a hefty fee, known as a prepayment penalty, if they try to sell the home or refinance to get better terms, according to George Hanzimanolis, a mortgage broker who spoke at the hearing.

The lending industry has defended non-traditional loans as a key reason that homeownership has reached a near-record high despite steep home prices. They say the loans can be tailored to meet individual needs, rather than the one-size-fits-all loans of past decades. But consumer advocates and an increasing number of legislators have questioned whether borrowers really understand what they are doing.

Last year, federal banking regulators said they intended to issue a regulatory "guidance," which is a kind of warning, to tell lenders to be more careful in making these loans and to make sure consumers understood them. At yesterday's hearing, the regulators said the guidance was still a few weeks away, something they have been telling legislators for several months.

Sen. Wayne Allard (R-Colo.) pushed the bank regulators appearing before the committee to say when, exactly, the guidance would be issued. Regulators from the Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency said "soon" or "in a matter of weeks, not months."

"We were hoping for something more specific," Allard said.

Until recently, the lending industry had said the loans were being marketed to people with only the strongest financial records. But a report released yesterday by the Government Accountability Office found that about three-quarters of people whose option-ARM loans were packaged into securities in the first half of 2005 were not required to fully document their income.

The mortgage market has changed quickly, and senators and banking industry regulators and officials grappled yesterday with the ramifications. Only six years ago, most borrowers had either simple fixed-rate or adjustable-rate loans, but now more than one-third, particularly people in high-cost areas such as the District and California, have opted for the new variants, which are typically originated by mortgage brokers on behalf of lenders, who then sell the loans on the secondary market as securities. Traditionally, banks made loans to people they thought were good credit risks and held the loans or sold them to government-backed entities such as Fannie Mae and Freddie Mac, which resold many of them. But now many are sold as securities to other investors who appear to have a much higher risk tolerance.