Office of Thrift Supervision Director Ellen Seidman said Tuesday that lenders should offer a subprime mortgage where the rate falls if the borrower's creditworthiness improves.

By issuing a so-called "track record adjusted mortgage," a bank would agree to lower the interest rate if the borrower remained current on the loan for a specified amount of time, Ms. Seidman told the Fannie Mae National Advisory Council.

This type of mortgage would benefit lenders, she said. "There is a powerful incentive during the qualifying condition period not to default," she said. "Longer-term default risk is also likely to be reduced in view of the (potential) decrease in principal and interest payments."

Borrowers also are less likely to refinance high-interest subprime loans if the lender voluntarily lowers the rate, she said. This would particularly benefit banks that retain the mortgage servicing rights, she said.

Regulators are increasingly concerned about all types of subprime lending. The four banking and thrift agencies issued joint guidelines March 1 telling banks that examiners will review these lenders' capital adequacy and risk-management techniques. Comptroller of the Currency John D. Hawke Jr. is expected to release more detailed guidelines for national banks within two weeks.

Subprime refers to loans made to people who are considered a higher than average risk because they have either lower incomes or a blemished credit history. The subprime market is big and growing. For instance, $85 billion in new subprime mortgages were securitized last year, up 30% from 1997, according to Moody's Investors Service.

Ms. Seidman's proposal grew out of a concern that borrowers were opting to pay higher rates rather than improve their credit rating by completing a counseling program.

The rate drop, she said, could be a pre-established amount and be triggered after the first two years of the loan if no payments are missed. Or, a market-based rate could go into effect if the borrower completed counseling and made a year's worth of on-time payments.

Charles E. Coudriet, vice chairman of Saxon Mortgage Inc., a nonbank subprime lender in Richmond, Va., questioned whether Ms. Seidman "thought this all the way through." To cover the greater risk of these types of loans, the initial interest rate charged would have to be even higher than traditional subprime rates, he said.

But some banks already have programs where subprime borrowers are rewarded with lower rates. "It's just good business," said Daniel J. Tredent, president of Charter One Credit Corp., the subprime unit of Cleveland-based Charter One Financial Inc.

The subprime company refers customers to the bank for refinancing if the borrower's creditworthiness improves.

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