True to form, federal financial regulators lived up to their warnings of impending proposed guidelines for lenders offering nontraditional mortgage products deemed too risky to a growing segment of home buyers and lenders' portfolios as well.

If approved, the guidelines proposed this week could make it tougher for some borrowers to qualify for a mortgage.

"Interagency Guidance on Nontraditional Mortgage Products" is not unlike "Credit Risk Management Guidance For Home Equity Lending" which federal agencies released earlier this year targeting equity loans.

Open for 60 days of public comment, the new proposed edict targets "residential mortgage products that allow borrowers to defer repayment of principal and sometimes interest."

The same group of regulators -- the Office of the Comptroller of the Currency (OCC); Board of Governors of the Federal Reserve System; Federal Deposit Insurance Corporation (FDIC); Office of Thrift Supervision (OTS); and the National Credit Union Administration (NCUA) -- say while the "nontraditional" mortgages can benefit some consumers, allowing them to afford a home they otherwise couldn't buy, too many consumers may not understand higher risks associated with the mortgages and lose their homes.

"These nontraditional mortgage products include 'interest-only' mortgage loans where a borrower pays no principal for the first few years of the loan and 'payment option' adjustable-rate mortgages where a borrower has flexible payment options, including the potential for negative amortization. Institutions are also increasingly combining these mortgages with other practices, such as making simultaneous second-lien (piggy-back) mortgages and allowing reduced documentation (no-doc loans) in evaluating the applicant's creditworthiness," the federal agencies said in a prepared statement.

The guidelines suggest, in part, that lenders:

• Assess borrowers' ability to repay the loan, including any balances added through negative amortization, at the fully indexed rate that would apply, not only initially, but also after the introductory period.

• Recognize that certain nontraditional mortgage loans are untested in a stressed environment and warrant strong risk management standards as well as appropriate capital and loan loss reserves.

• Ensure that borrowers have sufficient information to clearly understand loan terms and associated risks prior to making a product or payment choice.

Whether or not the likely-to-be-approved provisions will have teeth is uncertain.

Lenders all but ignored this year's earlier guidance issued about equity loans and actually increased the level of those loans the feds specifically warned against.

"The (financial regulatory) agencies will carefully scrutinize institutions' lending programs, including policies and procedures, and risk management processes in this area, recognizing that a number of different, but prudent practices may exist. Remedial action will be requested from institutions that do not adequately measure, monitor, and control risk exposures in loan portfolios. Further, the agencies will seek to consistently implement the guidance," the proposed order said.

Published: December 26, 2005

Use of this article without permission is a violation of federal copyright laws.

A journalist for 35-years, Broderick Perkins parlayed an old-school daily newspaper career into a digital news service offering editorial content and consulting services. Perkins' San Jose, CA-based DeadlineNews Group includes the flagship news site, DeadlineNews.Com, offering real estate, personal finance and consumer journalism, and a backshop, the Deadline Newsroom.