Stop giving risky mortgages to people who won't be able to afford the payments in two or three years, federal regulators are telling lenders.
At issue: so-called 2/28 and 3/27 subprime mortgages.
These hybrid adjustable-rate mortgages are intended for people with flawed credit.
They have interest rates that can jump sharply after two or three years. House
Democrats call them "high-risk 'payment shock' loans." Defenders call
them "credit improvement vehicles" that allow people to become homeowners
while they clean up their personal finances.
have introductory interest rates that last for two years (on 2/28 loans) or three
years (on the less-common 3/27s). After that, the interest rate is adjusted upward
or downward every six or 12 months. It's possible for monthly payments to skyrocket
by 50 percent or more.
|Terms of a hypothetical subprime hybrid ARM
In this hypothetical 2/28 ARM, the introductory rate is 7 percent. The fully indexed rate is the London Interbank Offered Rate (LIBOR) plus 6 percent. If the LIBOR is 5.5 percent at the end of the loan's second year, the rate would rise to 11.5 percent -- and the monthly principal and interest charges would rise 47 percent.
Regulators say lenders should qualify
borrowers at the highest possible rate. That way, there's more certainty that
the borrower can afford the maximum possible monthly payment, making foreclosure
less likely. The proposal says the agencies "are concerned that subprime
borrowers may not fully understand the risks and consequences of obtaining certain
adjustable-rate mortgage (ARM) products." They recommend better disclosures
The proposed guidelines please consumer advocacy
groups, including the Center for Responsible Lending, which said in a statement:
"The devastating reign of 'exploding' adjustable-rate mortgages (ARMs) in
the subprime market may soon be over. Today federal banking and credit union regulators
proposed to clamp down on these risky loans by requiring depository institutions
to do more careful assessments before approving these loans for credit-strapped
Critics say the regulators are focusing on the wrong
problem, are taking action too late and might harm more people than
they help. And anyway, some big mortgage lenders are free to ignore
the federal guidelines if they want.
Subprime mortgages are home loans
to people with flawed credit. Generally, the line is drawn at a credit score of
620 or 660. Between 15 percent and 20 percent of mortgage borrowers got subprime
loans last year. A lot of those 2006 subprime customers fell behind on their payments
within the first three months. That threw the subprime industry into turmoil,
with major lenders going out of business or seeking bankruptcy protection in the
last four months.
Sharp-eyed readers will notice that the feds aren't
addressing the current problem. Borrowers are falling behind on
their payments immediately and the regulators are taking steps to
ensure that they don't fall behind in two or three years. It's like
trying to lower the infant mortality rate by improving health care
for the elderly.