Feds Eye Tough IO, Option ARM Rules

Federal regulators are seeking industry comment before issuing tough underwriting guidance on interest-only and payment-option adjustable-rate mortgages that could have a chilling impact on the mortgage and housing markets.Banking and thrift regulators are proposing that lenders assess a borrower's ability to repay these "nontraditional" mortgages at the fully indexed rate, including any balances added by negative amortization. When it comes to option ARMs, the regulators ask whether the lender should assume that the borrower will make only minimum payments. "The agencies recognize this requirement differs from underwriting standards at some institutions and are specifically requesting comment on this aspect of the guidance," the regulators said. The proposed guidance is being issued for a 60-day comment period. "I think it is very positive that they have issued the guidance for comment because there are a number of institutions who have a successful track record of making these types of loans," said Charlotte Bahin, a partner at the Washington law firm of Lord, Bissell & Brook. The proposed guidance stresses that lenders should recognize the potential for payment shock and that nontraditional loans "often are inappropriate" for borrowers with high loan-to-value ratios, high debt-to-income ratios, and low credit scores. Institutions that originate loans under which the borrower has to rely on the sale or refinancing of the property once amortization begins "may be subject to criticism, corrective action, and higher capital requirements," the proposal says.

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