States Swift to Warn Mortgage Lenders
Tuesday, January 2, 2007
Nineteen states and the District of Columbia have moved quickly to warn state-regulated lenders about the hazards to consumers from nontraditional mortgages.
Tens of thousands of state-licensed lenders and mortgage brokers are affected by the advisories, also known as a "guidance." Such loans include interest-only mortgages and other arrangements where the borrower cuts monthly costs by paying back less than full interest and principal.
The states are following closely behind federal banking regulators, who issued a sternly worded advisory in late September to the lenders they supervise, telling them they should not make these loans to borrowers who may be unable to repay them. Within 24 hours of the federal guidance's release, six states had issued similar warnings to their own lenders, a notable flurry of activity in a field known for its slow-moving bureaucracies.
"They were ready for this; they wanted it," said Mike Stevens, senior vice president for regulatory affairs at the Conference of State Bank Supervisors, who said it was the fastest state-by-state regulatory rollout he had ever seen. "We had a national need to do this."
In the District, the guidance covers about 1,200 licensed mortgage brokers and lenders. It was adopted Dec. 5.
"We see a need to protect consumers who were not too savvy," said Lily Qi, a spokeswoman for the D.C. Department of Insurance, Securities and Banking. "They didn't understand what they signed when they signed on the bottom line. Some companies can be very aggressive in their marketing, and it can be misleading."
Officials in Maryland and Virginia are considering introducing the new lending guidelines.
Edward Joseph Face, Virginia's commissioner of financial institutions, said he was hopeful the state corporation commission would decide on some version of it within the next month. In Virginia, such a guidance would affect about 2,800 mortgage lenders and brokers.
"I don't think we've ever seen this many adjustable interest-only loans on the books in all of history," Face said. "I am concerned. . . . There are so many out there, and when the rates start adjusting, it's not clear that borrowers will have prepared themselves."
Nontraditional loans, also known as exotic mortgages and which were once marketed to the wealthy as a cash-management tool, have expanded to the mass market because they allow borrowers to pay only the interest on a loan, or a partial monthly payment, without paying down the principal. In 2003, just 10.6 percent of new loans tracked by First American LoanPerformance, a San Francisco-based real estate information service, were nontraditional mortgages, but during the first nine months of 2006, about 34.1 percent of all borrowers used these loans to buy or refinance homes. In the Washington area, where housing prices have skyrocketed in the past five years, about 47.7 percent of loans originated in 2006 were nontraditional, compared with 10.7 percent in 2003.
These loans became popular because they let borrowers stretch to afford homes. The concern is that some borrowers may not fully understand they face payment "resets," or upward adjustments after a set period, often three to five years.
Regulators have noted that many consumers are unaware that their payments could double or even triple when they reset. At a recent Consumer Bankers Association conference, some lenders marketing fixed-rate loans to borrowers with nontraditional mortgages said that 30 to 50 percent of the borrowers seemed unaware of the resets looming.
Many economists now say the surge in these loans contributed to the real estate boom of the last few years. Regions that had the highest rates of nontraditional lending were also those areas where housing prices rose most quickly.
Regulators and consumer activists also say these loans increase the risk of foreclosure, particularly if monthly payments jump at a time when home prices are stagnant, making it more difficult to sell homes or refinance into other loans.
The Conference of State Bank Supervisors put out a model set of guidelines based on the federal guidance. It spells out that lenders must take into account whether borrowers will be able to afford to pay when the loans reset and must explain the loans more explicitly.
The warnings vary by state, as does the universe of mortgage lenders covered by each state. Some state regulators have proposed the guidance but are awaiting final approval. The federal guidance covers institutions that have federal deposit insurance; these state warnings will encompass lenders who do not also accept deposits. In Kentucky, the guidance covers about 525 enterprises, including mortgage brokers and lenders; in Indiana, it covers 350 licensed second-mortgage brokers; in Connecticut, it covers more than 3,800 licensed mortgage companies; in Iowa, it covers 342 state-chartered banks, 110 loan companies and 737 mortgage brokers or lenders.
Many federally supervised lenders opposed the federal government's decision to issue a guidance on nontraditional lending, saying that they thought it was overly prescriptive and that restrictions might block consumers from receiving loans. They also expressed concerns that they would be subject to federal restrictions while state-regulated lenders would be unaffected.
"The idea is to get as much consistency as possible out there for all the players," said Mark Tarpey, division supervisor for consumer credit for the Indiana Department of Financial Institutions.