As the real estate market slows, some mortgage lenders are trying to prop up profits by relaxing lending standards for certain types of loans, endangering borrowers and financial institutions, a top banking regulator said yesterday.
Speaking to the New York Bankers Association, John M. Reich, director of the Office of Thrift Supervision, warned that some lenders are making it too easy for unsophisticated borrowers to take on risky nontraditional mortgages that they may not fully understand. Reich said regulators are "closely monitoring" the growth of loan types in which the payments can suddenly double, creating a payment shock that could force borrowers into foreclosure if housing values were to fall and could also cause financial losses for the lenders who make the loans.
Reich called the increase in such lending troubling. He noted that regulators are crafting a specific warning to the industry, known as a guidance, that will restrict the use of these loans. It could be issued within the next few months.
But a regulatory crackdown on the loans, known as interest-only and option mortgages, could prove problematic for some pricey real estate markets, such as the Washington area, where buyers have become increasingly dependent on such loans.
About two-thirds of all people who bought homes in the Washington area in 2005 used interest-only or option mortgages, many of which have adjustable interest rates, up from 2.2 percent in 2000, according to statistics compiled by LoanPerformance, a real estate information firm. These loans generally have lower monthly payments than traditional fixed-rate loans, at least at the start, but carry the risk that payments could jump steeply.
Local mortgage brokers say borrowers are taking out these loans because it is the only way they can afford to buy a home today. These loans allow borrowers to pay just the interest on the debt, not to pay down the principal, which reduces the monthly expense at the beginning of the loan term.
"These types of products have been enablers when it comes to allowing home prices to rise," said Christopher Cruise, a Silver Spring-based mortgage trainer who runs classes for lenders and regulators around the country. "Without these products, homes couldn't be purchased. If they are taken off the market, it could precipitate a disaster of epic proportions."
These new loans are risky for some borrowers, said Thomas Shaner, executive director of the Maryland Association of Mortgage Brokers, but their use has fueled the local real estate market.
‘Repercussions for market values’
"If people suddenly can't get an interest-only loan because the feds are clamping down on how many are out there, it'll drive the market down," Shaner said. "It'll have repercussions for market values," because fewer people will be able to buy or people will buy less-expensive homes than they might otherwise.
Kevin Petrasic, a spokesman for the Office of Thrift Supervision, said the regulatory guidance, when issued, should have minimal effects on the market because only problematic loans would probably be restricted while similar loans made cautiously would still be permitted.
"Making sure institutions are making loans based on creditworthiness is good for the institutions and good for borrowers," he said. "The last thing we went is borrowers taking out loans they can't pay for three years from now or when the monthly term adjusts."
Banking trade groups, including the Mortgage Bankers Association, have written to regulators opposing some of the changes, saying they are too restrictive and make lenders responsible for problem loans initiated by mortgage brokers.
At yesterday's meeting, Reich also warned that some lending institutions are making too many commercial real estate loans, a policy he noted has in the past "contributed to significant bank failures and instability in the banking system."
John Dugan, comptroller of the currency, who also spoke at the meeting, echoed Reich's concerns about the volume of commercial real estate lending. He also likened it to the lending pattern that preceded the savings and loan bailout of the early 1990s.
The debate about residential lending is occurring during much change in the nation's home-finance system. Home loans used to be mostly fixed-rate for 30 years, but recently lenders have been offering mortgages that allow borrowers to pay less, at least at first. With adjustable-rate mortgages, for example, borrowers bear the risk that if rates climb, the payments will climb, too.
About five years ago, lenders began widely offering interest-only loans, which had previously been available to only wealthy people, who used them to manage cash flow. These loans require borrowers to pay interest but not to begin paying down the principal on the debt. That can cut payments markedly.
Adjustable-rate mortgages
A variant, called option adjustable-rate mortgages, allows borrowers to decide how much they wish to pay each month and whether they want to pay down the principal. The risk in interest-only and option ARMs, however, is that at a future point, the loan payments are recalibrated to make up for payments not made during the early phases of the loan -- and could double in a single month.
These loans also pose the risk that people could end up in homes with higher mortgage balances than when they were bought.