Nontraditional Lending Hearings

“The term ‘nontraditional mortgage products’ encompasses a variety of financing options developed by an industry to increase the ability of borrowers to manage their own money and wealth,” Robert Broeksmit reportedly testified at the Senate’s Subcommittee on Housing and Transportation and Subcommittee on Economic Policy.

“Borrowers have used these products to tap their homes’ increased equity to meet an array of needs ranging from education to health care to home improvement and to purchase homes in markets where homes are quickly appreciating,” Broeksmit, representing the Mortgage Bankers Association, said, according to a transcript of his testimony.

Since mortgage lenders have been successful in addressing the nation’s credit needs, particularly those of previously underserved borrowers, debate has shifted away from concerns about the availability of credit to whether some of the many credit options are appropriate for borrowers, he testified.

“Some have even suggested that the industry should take on an undefined responsibility to determine the suitability of products for particular borrowers,” he added.

Creation of an unspecific suitability requirement would not serve borrowers well, as it would increase lenders’ liability and borrowers’ costs, MBA said.

Currently, over a third of households own their homes outright. Out of the remaining 66 percent households, three quarters have fixed-rate mortgages and the rest are in adjustable-rate mortgages. Many of these ARMs are jumbo loans, or loans indicating that they are wealthier borrowers, MBA noted.

Nontraditional loans, which have often been characterized as “new” even though many predate long-term fixed-rate mortgages, have been used to finance a relatively small portion of the nation’s housing, he added.

As with all other mortgages, lenders must underwrite nontraditional loans in a sound manner and appropriately manage their risks, and provide adequate explanations of the loans and their terms for borrowers to make an informed choice. Data demonstrates that the mortgage market works and is serving more borrowers, he added, noting that everybody loses when a loan goes into default and the home must foreclose.

“I strongly believe that the market’s success in making these ‘nontraditional’ products available is a positive development, not cause for alarm,” Broeksmit said in the testimony.

Sandra F. Braunstein, director of the Federal Reserve’s division of consumer and community affairs, testified on how loan cost disclosures provided to consumers under the Truth in Lending Act apply to nontraditional mortgage products, including interest-only loans and option ARMs.

“These loan products are not appropriate for everyone,” she said. “When monthly payments increase, sometimes substantially, consumers may face ‘payment shock.’ Thus, it is important for consumers to have the information necessary to understand the features and risks associated with these types of mortgages.”

TILA has been revised over the years to require creditors to provide borrowers with detailed, specific, information about loans with adjustable rates. But the Fed recognizes that information overload can impair the effectiveness of consumer disclosures, and that the disclosures describing the complex products are also complex and can be difficult for some consumers to understand.

To address this issue, Braunstein noted the Fed is focusing on how to improve disclosures for alternative mortgage and how to make disclosures more readable and easier for consumers, and that it is pursuing other opportunities, such as consumer education publications and interagency regulatory guidance that will include recommended best practices for depository institutions.

A “wider spectrum of borrowers that are now using [alternative mortgage products] may not fully understand their risks,” Orice Williams testified on behalf of the Government Accountability Office. This is because these loans often have complicated terms and features, advertising sometimes emphasizes their benefits over the risk, disclosures may be hard to understand, and because current federal disclosure requirements do not require lenders to address terms and risks specific to these products.

Furthermore, alternative mortgage product lending has “tripled over a 3-year period, and many borrowers were using interest-only or payment-option adjustable-rate products to purchase homes in high-priced markets,” Williams said. This type of lending “has been concentrated in the higher-priced regional markets on the East and West Coasts in states such as California, Washington, Virginia, and Maryland.”

While “it is too early to determine the extent to which high foreclosure rates will result or whether lenders will be affected,” Williams added that “lenders may have increased risks to themselves and their customers by relaxing underwriting standards and through “risk-layering,” which includes combining [alternative mortgage products] with less stringent income and asset verification requirements or lending to borrowers with lower credit scores and higher debt-to-income ratios.”