Some of the most popular mortgages funding the U.S. housing boom are under new scrutiny by federal financial regulators, and could be reined in by as early as this Fall. During an interview, Barbara Grunkemeyer, deputy Comptroller of the Currency, told Realty Times that her office is spearheading a multi-agency federal examination of lender underwriting, marketing and risk management of booming interest-only and "option payment" adjustable home mortgages.
The product of the examination, she said, is likely to be new guidance for banks and other regulated lenders on underwriting and credit standards for these loans. Grunkemeyer would not say that a tightening of standards would necessarily restrict availability of interest-only and option-ARMs, but that is expected to be one side effect of the frothing regulatory guidance.
Grunkemeyer confirmed that her project was on an unusually fast time track because of widespread concerns in the federal government and the financial industry that some of the new wave of "affordable" adjustables are being underwritten too loosely and could be putting consumers into homes they really cannot afford.
"The growth of interest-only and payment option mortgages" has been at such a rapid pace, said Grunkemeyer, "that we need to issue guidance to shore up risk management standards."
Interest-only adjustables allow consumers to make no principal-reduction payments for a pre-set initial period of time -- anywhere from two years to 10 years typically -- after which time the loan converts to a fully-amortizing loan. After the conversion period, monthly payments often jump by as much as 40 to 50 percent even without major increases in interest rates in the marketplace.
Option ARMs allow borrowers to make minimal monthly payments at below-market rates, adding the unpaid amounts onto the principal balance of the mortgage. In effect, such loans amortize negatively -- the principal balance due to the lender grows rather than declines. If housing price appreciation rates flatten out or decline, borrowers can be left owing lenders more than the price they originally paid to purchase the property.
Given the higher inherent risks in such loans, federal regulators want to make sure banks and other lenders are not compounding their risk exposure through lax underwriting, inattention to appraisal accuracy, and overly generous credit rules. Federal Reserve Chairman Alan Greenspan has worried aloud that by lowering monthly payments dramatically, some new loans may be contributing directly to price inflation, and could eventually trigger local "bubble" deflations.
Grunkemeyer and other regulators are also worried about "conversion risk" for regulated banks. If large numbers of borrowers are unable to afford the sharply higher payments required on their loans after the initial interest-only period is over, many lending institutions could face dangerously high levels of defaults and foreclosures. That, in turn, would affect the banks' "safety and soundness" levels.
Grunkemeyer said that the agencies involved -- including the Fed, the Comptroller, the FDIC and the Office of Thrift Supervision -- are already looking at a select number of financial institutions' case files to determine how they are underwriting, marketing and managing their interest-only and payment-option ARMs.
"They should be doing a thorough job of analyzing (applicants') abilities to repay [the mortgages]," she said. If they are not, they are likely to be required to do so by the forthcoming guidelines from the federal agencies.
That, in turn, could cut down on the overall availability of interest-only and payment option ARMs to home buyers and real estate professionals within the next four to five months.
