Federal Agencies Issue Final Guidance On Subprime Mortgages

The Federal Reserve Board released the final statement of federal regulatory agencies on subprime mortgage lending recently. The release was done on behalf of the Federal Reserve's Board of Governors, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, Office of Thrift Supervision, and the National Credit Union Administration (the Agencies.)

The guidelines were first published for comment in March of this year. The proposed statement provided guidance on the measures lenders should use in assessing a borrower's ability to repay a loan and advice to consumers to protect them from unfair, deceptive, and other predatory loan practices and to insure that consumers are provided with clear and balanced information about the risks and features of these loans. The Agencies specifically requested comment about whether subprime products always present inappropriate risks to institutions and/or consumers; whether the proposed guidelines would unduly impinge on the ability of subprime borrowers to refinance their existing loans; whether the principals of the statement should be applied beyond the subprime adjustable rate mortgage (ARM) market; and whether it was appropriate to limit the use of prepayment penalties.

During the public comment phase the five agencies collectively received 137 unique comments from financial institutions, industry groups, consumer and community groups, government officials, and members of the general public.

While the Federal Reserve described the comments as "generally supportive of the Agencies' efforts to provide guidance", many financial institutions were concerned that the proposed guidelines were too restrictive while consumer and community groups stated that they did not go far enough in addressing their concerns about subprime products.

Specifically financial institutions and their trade associations objected to a requirement that ARMs be underwritten at a fully indexed rate with a fully amortizing repayment schedule on the basis that these loan products are not always inappropriate and can be useful as a way to repair or establish a credit history. These lenders and industry group responders also objected to the lack of clarity in the scope of the statement and the definition of subprime in fear that the restrictions might creep into the non-subprime market. Lenders were also concerned that the statement came to close to equating the term "subprime" with the concept of predatory lending.

Another concern among the financial institutions was that the consumer disclosure requirements of the proposed guidelines might cause borrowers to suffer information overload and would put federally regulated institutions at a competitive disadvantage. This concern was mirrored by consumer and community groups who felt that the proposed statements and disclosures should apply to all lenders, not just the federally regulated institutions. Both complaints may be moot as both the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators have stated their intent to develop "a parallel statement for state supervisors to use with state-supervised entities."

Financial institutions and consumer groups differed over portions of the proposed statement dealing with subprime borrowers' ability to refinance with consumer groups stating that allowing borrowers to refinance into another unaffordable ARM was not acceptable while lenders commented that the proposed statement would unduly restrict borrowers' ability to refinance.

Consumer groups were also concerned that the rules regarding reduced documentation or stated income loans did not necessarily encourage lenders to allow borrowers to document income and thereby pay a lower interest rate and were an invitation for fraud. Financial institutions argued that the rules should allow for mitigating factors where borrowers were hard pressed to provide full documentation.

In response to these comments the agencies have taken the following steps in issuing the final statement:

• The final statement retains a focus on subprime borrowers while noting that institutions should look to the statement principles in offering ARM products to non-subprime borrowers.
• The statement clarifies that subprime lending is not synonymous with predatory lending.
• The general guideline of qualifying borrowers at the fully indexed rate at a fully amortizing payment schedule remains in the final statement, but additional information to clarify how institutions should assess borrowers' repayment capacity is included.
• Stated income and reduced documentation should be accepted only in the face of mitigating factors that clearly minimize the need for verification of repayment capacity.
• To address concerns about workout arrangements and refinancing the Agencies have incorporated a section on such arrangements in the final text of the statement.
• The Agencies revised the statement to address prepayment penalties, stating that the period during which these apply should not exceed the initial reset period and that borrowers should be allowed a reasonable period of time prior to the reset date to refinance their loans without penalty.
• The Agencies are working on illustrations of the type of consumer information it feels appropriate which will not be burdensome to financial institutions or to the consumer.

The complete final statement can be read here.