Lenders fear regulations on adjustable-rate mortgages

Banks and other mortgage lenders are worried that a regulatory proposal on adjustable-rate mortgages (ARMs) that has the backing of some key lawmakers will lock many borrowers with shaky credit out of the housing market.

Five bank regulators, including the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Controller of the Currency, issued tentative guidance in March to address consumer-protection concerns and underwriting standards in the sub-prime mortgage market.

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In comments submitted to the regulators, several financial-services trade groups were broadly supportive of the guidance but took exception to a proposal to require hybrid ARMs to be underwritten to the “fully-indexed rate,” the higher variable rate owed by the borrower after an initial fixed-rate period.

Such a requirement would, in effect, remove ARMs as an option for many sub-prime borrowers, Chris Stinebert, the president of the American Financial Services Association, wrote in a letter to the regulators.

“A strict implementation” of the proposed guidance “could adversely impact hundreds of thousands of credit-worthy sub-prime borrowers, preventing them from buying a home or refinancing before reset,” he wrote.

The president of the Mortgage Bankers Association (MBA), John M. Robbins, urged the regulators to avoid a “rigid, one-size-fits-all” underwriting standard.

“We look at hybrid ARMs as an affordability product. They make homeownership accessible for many individuals who wouldn’t normally be able to afford it,” MBA’s vice president for government affairs, Erick Gustafson, said.

The regulators proposed the guidance in early March, after a wave of defaults had begun to sweep through the sub-prime mortgage market and many experts blamed the spread of risky mortgages.

In a letter, a coalition of consumer and other special-interest groups, including the AARP and the National Association for the Advancement of Colored People, urged the regulators not to water down language on the underwriting standards in the final guidance.

Rep. Barney Frank (D-Mass.), the chairman of the House Financial Services Committee, said he supports the regulators’ proposed guidance, in part because he believes underwriting standards have grown too lax. “There are some people who shouldn’t be getting the loans they’re getting,” he said.

Frank added that statutory changes would help to ensure that sub-prime borrowers are not shut out of the market. “I think we can deal with that. We’re going to try to give sub-prime borrowers access to FHA, for example,” he said, referring to the Federal Housing Administration, which provides insurance for qualified mortgages.

Last week, legislation to expand the role of the FHA, which currently serves a small minority of homeowners, passed out of the Financial Services Committee. Frank said he planned to introduce other legislation to address the sub-prime mortgage market.

Some groups of lenders back the adoption of a strict ability-to-pay standard for many sub-prime borrowers, according to the comments filed on the proposed guidance. The Consumer Bankers Association (CBA) and America’s Community Bankers wrote that it was appropriate that hybrid ARMs with short fixed-rate periods, such as those loans that reset after two or three months, be underwritten to the fully-indexed rate.

But they argued that the standard should not apply for loans that do not reset for long stretches of time. “The amount of time that would elapse between the closing and the reset is long enough that predicting the index on which the rate will be determined is not meaningful. Nor can the lender reasonably forecast the consumer’s income or circumstances so many years hence,” wrote Steven Zeisel, senior counsel to the CBA.

Some financial-services industry lobbyists believe bank regulators may feel pressure from lawmakers to respond aggressively to the wave of foreclosures in the sub-prime market. “There’s a fair amount of congressional cajoling here,” one financial-services lobbyist said.

In a hearing on the sub-prime mortgage crisis this year, Sen. Chris Dodd (D-Conn.), the chairman of the Senate Banking Committee, blamed regulators for being “spectators” while risky mortgage products spread through the market. The senator urged them to require hybrid ARMs to be underwritten to the fully indexed rate.

Meanwhile, legislation introduced last week by Sens. Charles Schumer (D-N.Y.), Bob Casey Jr. (D-Pa.) and Sherrod Brown (D-Ohio) would, among other things, make the ability-to-pay standard law.