Hybrid adjustable-rate mortgages like the 2-28, which carries a fixed “teaser” interest rate for two years and then fluctuates with market interest rates, should be subject to the same underwriting and disclosure requirements as so-called “exotic” mortgages, a group of influential U.S. senators says.
The Mortgage Bankers Association is fighting the proposal, saying it would reduce the number of borrowers able to finance homes and contribute to downward pressure on home prices.
Federal banking regulators issued new guidance in September that applies to mortgage lenders offering payment-option ARM and interest-only loans. The guidance requires federally chartered banks that offer such nontraditional or exotic loans to disclose the risk of payment shock, and assess a borrower’s ability to repay a loan at the fully indexed rate. Since that time, 23 states have adopted their own version of the federal guidance, subjecting all mortgage lenders to the same rules.
Six members of the Senate committee on Banking, Housing and Urban Affairs — including Chairman Christopher Dodd, D-Conn. — last month wrote banking regulators, saying the guidance should also apply to hybrid ARMs.
In their letter, the senators cited Michael Calhoun, president of the Center for Responsible Lending, who testified at a Sept. subcommittee hearing that borrowers using hybrid ARMs can see their monthly payments increase by 40 percent to 50 percent when the teaser rate expires.
The letter claimed that most subprime 2-28 mortgages have prepayment penalties making it “extremely costly” to refinance to a loan with a more stable payment, and that many such loans have been made on the basis of stated income or reduced borrower documentation, increasing the risk of default.
“It is our view that these mortgages have a number of the same risky attributes at the interest-only and option-ARMs and, therefore, should be covered by the new guidance,” the letter said. The Dec. 7 letter was signed by Dodd and Jack Reed, D-R.I.; Charles Schumer, D-N.Y.; Wayne Allard, R-Colo.; Jim Bunning, R-Ky.; and Paul Sarbanes, D-Md. (Sarbanes has since retired from the Senate).
In a letter to Sen. Dodd last week, MBA Chairman John Robbins took issue with characterizations of hybrid ARMs as “exploding mortgages.” On average, Robbins said, interest rates increase by no more than 2 percent to 3 percent when the introductory period expires.
Few hybrid ARMs see any adjustment at all, Robbins said, because most such loans are refinanced early in their terms. Of nonprime loans originated in 2003, he said, only 22 percent remain in effect today, and only 12 percent of subprime loans originated in 2002 are still in effect.
Making hybrid ARMs subject to the guidance and its tighter underwriting guidelines “will unnecessarily disqualify borrowers from home ownership and affordable credit,” the MBA chairman said in the Jan. 8 letter. Hybrid ARMs, he said, “are frequently underwritten using more flexible guidelines based on reasonable repayment expectations. This difference makes many more borrowers eligible for these loans.”
Robbins said a “significant portion” of recent gains in home ownership are attributable to hybrid ARMs. In the first half of 2006, he said, 67 percent of new subprime loans were ARMs, and 52 percent of nonprime ARMs were hybrids.
The delinquency rate for subprime loans in the third quarter of 2006 was 12.56 percent, including a 9.56 percent delinquency rate for subprime fixed-rate loans and 13.22 percent for subprime ARMs, Robbins said.
With ARM loans now comprising 25 percent of the overall mortgage market, tightening underwriting and disclosure standards “would adversely affect the primary and secondary mortgage markets, including lenders and investors, as well as borrowers,” Robbins said. “Most importantly, the significant lessening of credit options will markedly diminish the number of borrowers able to finance homes and thereby contribute to downward pressure on real estate prices, adversely affecting the economy as a whole.”