With foreclosures rising, federal bank regulators called on lenders Tuesday to work with distressed borrowers unable to meet payments on high-risk mortgages to help them keep their homes. The heads of Fannie Mae and Freddie Mac said the mortgage finance giants are developing new types of loans to aid homeowners in avoiding default.
Home-mortgage delinquencies and foreclosures have been surging in recent months, especially for people who took out subprime mortgages — higher-priced loans for people with tarnished credit or low incomes who are considered greater risks. The distress has roiled financial markets and stoked anxiety that it could spill over into the broader economy.
The Federal Reserve and the five other federal agencies that regulate banks, thrifts and credit unions, in a joint statement, encouraged the financial insitutions to extend flexible terms to struggling homeowners.
“Prudent workout arrangements that are consistent with safe and sound lending practices are generally in the long-term best interest of both the financial institution and the borrower,” the statement said. “Institutions will not face regulatory penalties if they pursue reasonable workout arrangements with borrowers.”
The initiatives for subprime loans of government-sponsored Fannie Mae and Freddie Mac, the biggest buyers and guarantors of home mortgages in the country, were disclosed by their chief executives at a hearing by the House Financial Services Committee.
Sheila Bair, chairman of the Federal Deposit Insurance Corp., exhorted mortgage lenders to show flexibility toward borrowers to help staunch a flood of defaults among homeowners with subprime loans.
Many of those borrowers “could avoid foreclosure if they were offered (loans) that allow for affordable mortgage payments,” Bair testified. Restructuring their expensive adjustable-rate mortgages “into more affordable products, especially 30-year fixed-rate mortgages, would bring them back to good standing, allow them to repair their credit histories and dampen the impact that foreclosures may have on the broader housing market.”
Most importantly, Bair added, “people would be able to stay in their homes.”
Adjustable-rate mortgages, known as ARMs, are especially prevalent in the subprime market. They are considered higher-risk loans because they typically draw borrowers in with an initial low “teaser” interest rate, which can spike upward after the first few years.
A homeowner who takes out a $200,000 ARM with a teaser rate of 4 percent, for example, initially pays $954.83 monthly in principal and interest. But when the interest rate jumps to 7 percent, say, in the second year of the mortgage, his payments rise to $1,320.59 a month — a move that regulators call “payment shock.”
The home-mortgage business has exploded in the last two decades with big Wall Street investment firms buying loans in bulk from banks and other lenders, and bundling them into securities to be sold to investors, spreading the risk. That has complicated the mortgage industry picture and the search for solutions to the immediate crisis.
Amid rising pressure to act, Democrats in power positions in Congress have started drafting legislation to curb abusive mortgage lending practices that especially target minorities and the elderly, putting people into home loans that they cannot afford to repay. Several civil rights and consumer groups have called for a six-month suspension of foreclosures on subprime mortgages.
An additional complication is the patchwork of federal and state regulatory agencies that hold jurisdiction over financial companies, putting many subprime mortgage lenders outside government regulation.
Rep. Barney Frank, D-Mass., the Financial Services Committee chairman, said at the hearing that lawmakers may act in that area and if they do, “We’re going to put some legal obligations on participants in the process who are not now regulated.”
The greater distance now usually separating the home borrower and the ultimate holder of the mortgage, Bair acknowledged, “has complicated the ability of interested parties to apply flexibility and creativity to assist borrowers facing difficulty.”
Richard Syron, Freddie Mac’s chairman and chief executive, said the company is “working on a major effort to develop more consumer-friendly subprime products that will provide stable financing alternatives going forward,” which are expected to be available by midsummer.
He said the new products will include 30-year and possibly 40-year fixed-rate mortgages as well as adjustable-rate mortgages with longer fixed-rate periods.
Fannie Mae, in a new program called “HomeStay,” is offering new options so that lenders can help subprime borrowers refinance out of high-interest adjustable-rate mortgages or other difficult loans, said President and CEO Daniel Mudd. He said the company plans to stretch the term on subprime loans to 40 years from the current maximum 30 years — which will reduce monthly payments for borrowers by around 5 percent.
About 1.8 million adjustable-rate mortgages are resetting to higher rates this year and next, making foreclosures sure to continue rising, according to a new report by Congress’ Joint Economic Committee. Areas said to be hardest hit by foreclosures include Atlanta, Indianapolis, Denver, Dallas and Detroit.
Fannie Mae and Freddie Mac were created by Congress to pump money into the home-mortgage market by buying home loans from banks and other lenders and turning them into securities for sale on Wall Street. They have grown dynamically in recent years and now finance or guarantee some $4 trillion of home mortgages, representing about half of the single-family mortgages in the country.