New federal guidelines released last Friday take direct aim at mass-marketed "non-traditional" mortgages -- payment-option, negative amortization, interest-only and "stated income" plans -- that have boomed in high cost real estate markets over the past three years.
The joint guidelines, issued by the Treasury Department, Federal Reserve Board, FDIC and the National Credit Union Administration, are designed to tighten up lenders' underwriting standards for payment-option adjustable rate mortgages, interest-only and low-documentation mortgages. The new rules will directly affect all federally-chartered banks, mortgage banking subsidiaries, and credit unions. State financial regulators are expected to duplicate the federal guidelines in forthcoming guidance covering all state-chartered banks, independent mortgage companies and brokers.
The new guidelines almost certainly will reduce the number of payment-option, negative amortization and low-doc mortgages being originated nationwide -- especially for applicants with below-par credit scores, minimal assets and incomes insufficient to handle fully-amortizing payments on the size loan they seek.
That's because the new rules will force lenders to restrict higher-risk loans to applicants who actually have the financial resources to pay for the houses they buy at interest rates and monthly costs considerably higher than what most payment-option and interest-only programs permit. Payment option plans generally allow borrowers to choose from one of three payment plans per month -- a minimum payment that will add to the loan balance (negative amortization, an interest-only payment that will not reduce the principal balance, and a fully-amortized payment of principal and interest.
Despite heavy pressure from banks and mortgage lenders, the financial regulators are requiring that applicants for payment-option and other "higher risk" loans be underwritten at "fully indexed" rates and payments -- not just at the artificially-depressed payment rates most programs offer for the early years of the loan. The rules also require lenders to include in the potential negative amortization amount permitted by the mortgage terms to be included in the maximum principal balance that applicants must be qualified to handle.
The rules also seek to restrain the growing use of low and no-documentation mortgages. The agencies say lenders "should avoid over-reliance on credit scores as a substitute for income verification in the underwriting process. The higher a loan's credit risk, either from loan features or borrower characteristics, the more important it is to verify the borrower's income, assets and outstanding liabilities."
On the subject of income verification, the new financial agency guidance was issued on the eve of the start-up of a new IRS program that will provide lenders nationwide quick income-tax data transcripts -- reported income and federal taxes -- on applicants for up to four tax years in electronic format.
Known as Form 4506-T verifications, the IRS program gives lenders relying on "stated incomes" of borrowers to look behind the curtain and see what incomes applicants reported on their federal tax filings -- and get back transcripts within 24 to 48 hours. The IRS's new "Income Verification Express Service" goes into operation today, October 2, and will be available to all lenders or data vendors who sign up for participation. Cost will be $4.50 per tax year requested.
The IRS program, which is geared to allow lenders to integrate verified income data into their underwriting program -- before granting loans -- instead of receiving the data too late, as under previous, highly-manual, non-electronic fax programs that often took weeks.
The financial regulators presumably will welcome the IRS express verification program because their own guidance tells lenders that "as the level of credit risk increases, the (regulatory agencies) expect institutions to more diligently verify and document a borrower's income and debt-reduction capacity."
Electronic income verifications with express 4506-T's should fit that requirement to a "t."
