Increasingly popular high-risk mortgages could imperil both borrowers and banks if the hot housing market cools off, the head of the Federal Deposit Insurance Corp. said Tuesday.
With home prices breaking records, FDIC Chairman Donald Powell became the latest regulator to voice concern over people who took out interest-only or option adjustable-rate mortgages to buy homes they otherwise could not afford. Some borrowers and mortgage lenders holding such loans could be at risk if housing prices drop or interest rates rise.
“Credit losses are very low now, but mortgage lenders need to be prepared for higher losses,” Powell said in a speech to a gathering of community bankers in Orlando, Fla. “Homeowners taking on these types of mortgage product need to understand how their obligation may grow when their low introductory interest rates expire.”
The FDIC and other federal agencies that regulate banks are evaluating the risks to lenders and examining banks’ lending policies and will issue guidelines for banks where needed, Powell said.
The regulators do not seek to stanch innovation by banks, but to encourage sound banking principles, he said.
Federal Reserve Chairman Alan Greenspan recently turned up the volume on his warnings about the potential dangers of risky home mortgages — and there are signs that some lenders have been getting the message. A few have begun scaling back some types of those mortgages or making them less appealing by raising costs.
Another bank regulator, U.S. Comptroller of the Currency John Dugan, has said that home lenders’ more lenient credit standards and the popularity of risky mortgages “have raised questions about how these loans will fare in the event of a rise in interest rates or a softening in house prices.”
Though there are signs of cooling, home sales still are on pace for a record fifth straight yearly increase, powered by low interest rates. In the meantime, prices have skyrocketed.
Interest-only mortgages require that the homeowner initially pay only the interest on the loan for a set period. Option ARMs give the homeowner flexibility to decide how much to pay each month. One of the options is a minimum payment that covers only a portion of the monthly interest.
These mortgages are appealing to people who need cash for other expenses. But it also exposes them to far greater risk — if housing prices drop, their loan could be worth more than their property. If interest rates rise, their loan will become expensive to pay off.