Guidance Issued On 'Exotics'

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Concerned over the "adjustable" portion of ARMs, the federal regulators have issued proposed guidance on "exotic" mortgage loans.

"These nontraditional mortgage products include 'interest-only' mortgage loans where a borrower pays no principal for the first few years of the loan and 'payment option' adjustable rate mortgages where a borrower has flexible payment options, including the potential for negative amortization," the regulators said. "While innovations in mortgage lending can benefit some consumers, the agencies are concerned that these practices can present unique risks that institutions must appropriately managed."

NCUA was joined by the Office of the Comptroller of the Currency, the Fed, the FDIC, and the Office of Thrift Supervision in issuing the proposed guidance.

The agencies also expressed concern that these products are being offered to "a wider spectrum of borrowers, including subprime borrowers and other who may not otherwise qualify for more traditional mortgage loans or who may not fully understand the associated risks of nontraditional mortgages."

Included in the guidance were suggestions that management should:

* Assess a borrower's ability to repay the loan, including any balances added through negative amortization, at the fully indexed rate that would apply after the introductory period. The agencies said they recognize that this requirement differs from underwriting standards at some institutions and are specifically requesting comment on this aspect of the guidance.

* Recognize that certain nontraditional mortgage loans are untested in a stressed environment and warrant strong risk management standards as well as appropriate capital and loan loss reserves.

* Ensure that borrowers have sufficient information to clearly understand loan terms and associated risks prior to making a product or payment choice.

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