Feds ask: Is that mortgage really right for you?
By Holden Lewis • Bankrate.com

Imagine that mortgages were automobiles, and you had the power to witness every sale. Every day, you would watch, dumbfounded, as pizza deliverers passed up Priuses and bought Hummers instead. You would cringe as 16-year-olds screeched off the lot in souped-up cars, destined to die young.

If mortgages were cars, you would see people making these mistakes all the time. Too often, consumers get home loans that are inappropriate or too risky.

Regulators are wrestling with the question of what to do about it. Whose job is it to decide that a particular loan is unsuitable for a specific customer?

"Who am I to tell you that you're eligible for this kind of loan, but you're not suitable for it?" banker Robert Broeksmit asked at a recent Federal Trade Commission workshop.

A consumer advocate retorted in an interview: "It can be boiled down to this: Don't offer things that people can't pay and really are rip-offs."

'Nontraditional' mortgages surge
The argument is about what federal regulators call "nontraditional" mortgages -- home loans in which the borrower is required to pay only interest, and not principal, for the first few years. About one-quarter of new mortgages are nontraditional loans, up from a negligible market share just five years ago. That worries regulators, because these loans are considered riskier. Some nontraditional loans, called payment-option adjustable-rate mortgages, don't even require the borrower to pay the interest accrued: The amount owed can increase every month.

Regulators have proposed a "guidance" asking lenders to step cautiously when underwriting nontraditional loans. A guidance is a recommendation -- not as binding as a regulation, but stronger than a mere suggestion. The proposed guidance says lenders should avoid loans "that may result in the borrower having to rely on the sale or refinancing of the property," once the borrower has to start paying principal as well as interest.

In other words, don't give a mortgage to someone who can't afford to pay principal and interest, even if it's an interest-only loan.

Regulatory agencies jointly proposed such guidance in December and asked for written comments. In late May in Washington, D.C., the FTC held the workshop on behalf of itself and other agencies so regulators could ask questions and get answers in a more informal setting.

Added risk for consumers, lenders
Regulators worry about interest-only and payment-option mortgages, because payments can rise abruptly after a few years. In unlikely worst-case scenarios, monthly payments can more than double in one traumatic leap. A lot of borrowers don't make down payments or document their income -- additional risk factors that increase the odds of eventual foreclosure.

Interest-only mortgages have been around for decades, and they were originally marketed to two types of customers: wealthy people who can afford volatile payments, and workers with unpredictable incomes, such as business owners, salespeople on commission and executives whose income mostly comes from annual bonuses. But now a lot of homeowners get these loans because they offer the only way to afford an acceptable house in pricey markets.