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DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
[Docket No. OCC-2007-0005]
FEDERAL RESERVE SYSTEM
[Docket No. OP-1278]
FEDERAL DEPOSIT INSURANCE CORPORATION
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
NATIONAL CREDIT UNION ADMINISTRATION
Statement on Subprime Mortgage Lending
AGENCIES: Office of the Comptroller of the Currency, Treasury (OCC);
Board of Governors of the Federal Reserve System (Board); Federal
Deposit Insurance Corporation (FDIC); Office of Thrift Supervision,
Treasury (OTS); and National Credit Union Administration (NCUA)
(collectively, the Agencies).
ACTION: Final guidance--Statement on Subprime Mortgage Lending.
SUMMARY: The Agencies are issuing a final interagency Statement on
Subprime Mortgage Lending. This guidance has been developed to clarify
how institutions can offer certain adjustable rate mortgage (ARM)
products in a safe and sound manner, and in a way that clearly
discloses the risks that borrowers may assume.
EFFECTIVE DATE: July 10, 2007.
FOR FURTHER INFORMATION CONTACT:
OCC: Michael Bylsma, Director, Community and Consumer Law Division,
(202) 874-5750 or Stephen Jackson, Director, Retail Credit Risk, (202)
Board: Division of Banking Supervision and Regulation: Brian P.
Valenti, Supervisory Financial Analyst, (202) 452-3575, Virginia M.
Gibbs, Senior Supervisory Financial Analyst, (202) 452-2521, or Sabeth
I. Siddique, Assistant Director, (202) 452-3861; Division of Consumer
and Community Affairs: Kathleen C. Ryan, Counsel, (202) 452-3667, or
Jamie Z. Goodson, Attorney, (202) 452-3667; or Legal Division: Kara L.
Handzlik, Attorney (202) 452-3852. Board of Governors of the Federal
Reserve System, 20th Street and Constitution Avenue, NW., Washington,
DC 20551. Users of Telecommunication Device for Deaf only, call (202)
FDIC: Beverlea S. Gardner, Examination Specialist, (202) 898-3640,
Division of Supervision and Consumer Protection; Richard B. Foley,
Counsel (202) 898-3784; Mira N. Marshall, Acting Chief Community
Reinvestment Act and Fair Lending, (202) 898-3912; April A. Breslaw,
Acting Associate Director, Compliance Policy & Exam Support Branch,
Division of Supervision and Consumer Protection, (202) 898-6609.
OTS: Tammy L. Stacy, Director of Consumer Regulation, Compliance
and Consumer Protection Division, (202) 906-6437; Glenn Gimble, Senior
Project Manager, Compliance and Consumer Protection Division, (202)
906-7158; William J. Magrini, Senior Project Manager, Credit Risk,
(202) 906-5744; or Teresa Luther, Economist, Credit Risk, (202) 906-
NCUA: Cory W. Phariss, Program Officer, Examination and Insurance,
The Agencies developed this Statement on Subprime Mortgage Lending
to address emerging risks associated with certain subprime mortgage
products and lending practices. In particular, the Agencies are
concerned about the growing use of ARM products \1\ that provide low
initial payments based on a fixed introductory rate that expires after
a short period, and then adjusts to a variable rate plus a margin for
the remaining term of the loan. These products could result in payment
shock to the borrower. The Agencies are concerned that these products,
typically offered to subprime borrowers, present heightened risks to
lenders and borrowers. Often, these products have additional
characteristics that increase risk. These include qualifying borrowers
based on limited or no documentation of income or imposing substantial
prepayment penalties or prepayment penalty periods that extend beyond
the initial fixed interest rate period. In addition, borrowers may not
be adequately informed of product features and risks, including their
responsibility to pay taxes and insurance, which might be separate from
their mortgage payments.
\1\ For example, ARMs known as ``2/28'' loans feature a fixed
rate for two years and then adjust to a variable rate for the
remaining 28 years. The spread between the initial fixed interest
rate and the fully indexed interest rate in effect at loan
origination typically ranges from 300 to 600 basis points.
These products originally were extended to customers primarily as a
temporary credit accommodation in anticipation of early sale of the
property or in expectation of future earnings growth. However, these
loans have more recently been offered to subprime borrowers as ``credit
repair'' or ``affordability'' products. The Agencies are concerned that
many subprime borrowers may not have sufficient financial capacity to
service a higher debt load, especially if they were qualified based on
a low introductory payment. The Agencies are also concerned that
subprime borrowers may not fully understand the risks and consequences
of obtaining this type of ARM loan. Borrowers who obtain these loans
may face unaffordable monthly payments after the initial rate
adjustment, difficulty in paying real estate taxes and insurance that
were not escrowed, or expensive refinancing fees, any of which could
cause borrowers to default and potentially lose their homes.
In response to these concerns, the Agencies published for comment
the Proposed Statement on Subprime Mortgage Lending (proposed
statement), 72 FR 10533 (March 8, 2007). The proposed statement
provided guidance on the criteria and factors, including payment shock,
that an institution should assess in determining a borrower's ability
to repay the loan. The proposed statement also provided guidance
intended to protect consumers from unfair, deceptive, and other
predatory practices, and to ensure that consumers are provided with
clear and balanced information about the risks and features of these
loans. Finally, the proposed statement addressed the need for strong
controls to adequately manage the risks associated with these products.
The Agencies requested comment on all aspects of the proposed
statement, and specifically requested comment about whether: (1) These
products always present inappropriate risks to institutions and
consumers, or the extent to which they may be appropriate under some
circumstances; (2) the proposed statement would unduly restrict the
ability of existing subprime borrowers to refinance their loans, and
whether other forms of credit are available that would not present the
risk of payment shock; (3) the principles of the proposed statement
should be applied beyond the subprime ARM market; and (4) limitations
on the use of
prepayment penalties would help meet borrower needs.
The Agencies collectively received 137 unique comments on the
proposed statement. Comments were received from financial institutions,
industry-related trade associations (industry groups), consumer and
community groups, government officials, and members of the public.
II. Overview of Public Comments
The commenters were generally supportive of the Agencies' efforts
to provide guidance in this area. However, many financial institution
commenters expressed concern that certain aspects of the proposed
statement were too prescriptive or could unduly restrict subprime
borrowers' access to credit. Many consumer and community group
commenters stated that the proposed statement did not go far enough in
addressing their concerns about these products.
Financial institutions and industry groups stated that they
supported prudent underwriting, but opposed a strict requirement that
ARM loans subject to the proposed statement be underwritten at a fully
indexed rate with a fully amortizing repayment schedule. They also
stated that these loan products are not always inappropriate,
particularly because they can be a useful credit repair vehicle or a
means to establish a favorable credit history. Many of these commenters
expressed concern that the proposed statement would unduly restrict
credit to subprime borrowers. They also requested that the proposed
statement be modified to allow lenders flexibility in helping existing
subprime borrowers refinance out of ARM loans that will reset to a
monthly payment that they cannot afford.
The majority of financial institutions and industry group
commenters opposed the application of the proposed statement outside
the subprime market. A number of these commenters requested
clarification of the scope of the proposed statement and the definition
Some industry group commenters also expressed concern that consumer
disclosure requirements would put federally-regulated institutions at a
disadvantage and cause consumer information overload. They also
requested that any changes to consumer disclosure requirements be part
of a comprehensive reform of existing disclosure regulations.
Consumer and community group commenters generally supported the
proposed statement. Many of these commenters expressed their concern
that the products covered by the proposed statement present
inappropriate risks for subprime borrowers. Many of these commenters
supported extending the scope of the proposed statement to other
mortgage products. These commenters supported the proposed underwriting
criteria, though a number of them suggested stricter underwriting
criteria. They also supported further limiting or prohibiting the use
of reduced documentation and stated income loans, suggesting that such
a reduction would be in the best interests of consumers.
Both industry group and consumer and community group commenters
expressed concern that the proposed statement will not apply to all
lenders. Industry group commenters indicated this would put federally-
regulated financial institutions at a competitive disadvantage.
Consumer and community group commenters encouraged the Agencies to
continue to work with state regulators to extend the principles of the
proposed statement to non-federally supervised institutions. Since the
time that the Agencies announced the proposed statement, the Conference
of State Bank Supervisors (CSBS) and the American Association of
Residential Mortgage Regulators (AARMR) issued a press release
confirming their intent to ``develop a parallel statement for state
supervisors to use with state-supervised entities.'' \2\
\2\ Media Release, CSBS & AARMR, ``CSBS and AARMR Support
Interagency Statement on Subprime Lending'' (March 2, 2007),
available at http://www.csbs.org/AM/Template.cfm?Section=Search&template=/CM/HTMLDisplay.cfm&ContentID=10295
III. Agencies' Action on Final Joint Guidance
The Agencies are issuing the Statement on Subprime Mortgage Lending
(Statement) with some changes to respond to the comments received and
to provide additional clarity. The Statement applies to all banks and
their subsidiaries, bank holding companies and their nonbank
subsidiaries, savings associations and their subsidiaries, savings and
loan holding companies and their subsidiaries, and credit unions.
Significant comments on specific provisions of the proposed statement,
the Agencies' responses, and changes to the proposed statement are
Scope of Guidance
A number of financial institution and industry group commenters and
two credit reporting companies requested that the definition of
``subprime'' be clarified. A financial institution and an industry
group commenter requested a bright-line test to determine if a borrower
falls into the subprime category.
The Agencies considered commenters' requests that a definition of
``subprime'' be included in the Statement. The Agencies determined,
however, that the reference to the subprime borrower characteristics
from the 2001 Expanded Guidance for Subprime Lending Programs (Expanded
Guidance) provides appropriate information for purposes of this
Statement. The Expanded Guidance provides a range of credit risk
characteristics that are associated with subprime borrowers, noting
that the characteristics are illustrative and are not meant to define
specific parameters for all subprime borrowers.\3\ Because the term
``subprime'' is not consistently defined in the marketplace or among
individual institutions, the Agencies believe that incorporating the
subprime borrower credit risk characteristics from the Expanded
Guidance provides sufficient clarity.
\3\ Federally insured credit unions should refer to LCU 04-CU-
13--Specialized Lending Activities.
A number of commenters also requested clarification as to whether
the proposed statement applies to all products with the features
described. In addition, the Agencies specifically requested comment
regarding whether the proposed statement's principles should be applied
beyond the subprime ARM market. All consumer and community groups and
some of the financial institutions who addressed this question
supported application of the proposed statement beyond the subprime
market. However, most financial institution and industry group
commenters opposed application of the proposed statement beyond the
subprime market. These commenters stated that the issues the proposed
statement was designed to address are confined to the subprime market
and expansion of the proposed statement to other markets would
unnecessarily limit the options available to other borrowers.
As with the proposed statement, the Statement retains a focus on
subprime borrowers, due to concern that these consumers may not fully
understand the risks and consequences of these loans and may not have
the financial capacity to deal with increased obligations. The Agencies
did revise the language to indicate that the proposed statement applies
to certain ARM products that have one or more characteristics that can
cause payment shock, as defined in the proposed statement. While the
Statement has retained its focus on
subprime borrowers, the Agencies note that institutions generally
should look to the principles of this Statement when such ARM products
are offered to non-subprime borrowers.
Risk Management Practices
Predatory Lending Considerations
Some financial institution and industry group commenters raised
concerns that the proposed statement implied that subprime lending is
``per se'' predatory. The Statement clarifies that subprime lending is
not synonymous with predatory lending, and that there is no presumption
that the loans to which the Statement applies are predatory.
The proposed statement provided that subprime ARMs should be
underwritten at the fully indexed rate with a fully amortizing
repayment schedule. Many consumer and community groups supported the
proposed statement's underwriting standards. Other consumer and
community groups thought that the proposed qualifying standards did not
go far enough, and suggested that these loans should be underwritten on
the basis of the maximum possible monthly payment. The majority of
industry group commenters who addressed this issue opposed the proposed
underwriting standard as overly prescriptive. Some commenters also
requested that the Statement define ``fully indexed rate with a fully
amortizing repayment schedule.'' All of the commenters that addressed
the issue favored including a reasonable estimate of property taxes and
insurance in an assessment of borrowers' debt-to-income ratios.
The Agencies continue to believe that institutions should maintain
qualification standards that include a credible analysis of a
borrower's capacity to repay the loan according to its terms. This
analysis should consider both principal and interest obligations at the
fully indexed rate with a fully amortizing repayment schedule, plus a
reasonable estimate for real estate taxes and insurance, whether or not
escrowed. Qualifying consumers based on a low introductory payment does
not provide a realistic assessment of a borrower's ability to repay the
loan according to its terms. Therefore, the proposed general guideline
of qualifying borrowers at the fully indexed rate, assuming a fully
amortizing payment, remains unchanged in the final Statement. The
Agencies did, however, provide additional information regarding the
terms ``fully indexed rate'' and ``fully amortizing payment schedule''
to clarify expectations regarding how institutions should assess
borrowers' repayment capacity.
Reduced Documentation or Stated Income Loans
Several commenters raised concerns about reduced documentation or
stated income loans. The majority of commenters who addressed this
issue supported the proposed statement's position that institutions
should be able to readily document income for many borrowers and that
reduced documentation should be accepted only if mitigating factors are
present. A few financial institution and industry group commenters
urged the Agencies to allow lenders some flexibility in deciding when
these loans are appropriate for borrowers whose income is derived from
sources that are difficult to verify. On the other hand, some consumer
and community group commenters stated that borrowers are not always
given the option to document income and thereby pay a lower interest
rate. They also indicated that stated income loans may be a vehicle for
fraud in that borrower income may be inflated to qualify for a loan.
The Agencies believe that verifying income is critical to
conducting a credible analysis of borrowers' repayment capacity,
particularly in connection with loans to subprime borrowers. Therefore,
the final Statement provides that stated income and reduced
documentation should be accepted only if there are mitigating factors
that clearly minimize the need for verification of repayment capacity.
The Statement provides some examples of mitigating factors, and sets
forth an expectation that reliance on mitigating factors should be
documented. The Agencies note that for many borrowers, institutions
should be able to readily document income using recent W-2 statements,
pay stubs, and/or tax returns.
The Agencies specifically requested comment on whether the proposed
statement would unduly restrict the ability of existing subprime
borrowers to refinance out of certain ARMs to avoid payment shock. The
Agencies also asked about the availability to these borrowers of other
mortgage products that do not present the risk of payment shock. The
majority of financial institution and industry group commenters who
responded to this specific question believed that the proposed
statement would unduly restrict existing subprime borrowers' ability to
refinance. However, most consumer and community groups who addressed
the issue expressed the view that allowing existing borrowers to
refinance into another unaffordable ARM was not an acceptable solution
to the problem and, therefore, that eliminating this option would not
be an undue restriction on credit. Some commenters mentioned that
certain government-sponsored entities and lenders have already
committed to revise their lending program criteria and/or create new
programs that potentially may provide alternative mortgage products for
refinancing existing subprime loans.
To address these issues, the Agencies incorporated a section on
workout arrangements in the final text that references the principles
of the April 2007 interagency Statement on Working with Borrowers. The
Agencies believe 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.
Consumer Protection Principles
The Agencies specifically requested comment regarding whether
prepayment penalties should be limited to the initial fixed-rate
period; how this practice, if adopted, would assist consumers and
affect institutions; and whether an institution's providing a window of
90 days prior to the reset date to refinance without a prepayment
penalty would help meet borrower needs. The overwhelming majority of
commenters who addressed this question agreed that prepayment penalties
should be limited to the initial fixed-rate period, and several
commenters proposed a complete prohibition of prepayment penalties.
Commenters suggested different time frames for expiration of the
prepayment penalty period, ranging from 30 to 90 days prior to the
reset date. Several industry group commenters, however, opposed such a
limitation. They stated that prepayment fees are a legitimate means for
lenders and investors to be compensated for origination costs when
borrowers prepay prior to the interest rate reset. Further, these
commenters noted that most lenders do not offer mortgage products that
have prepayment penalty periods that extend beyond the fixed interest
rate period and that borrowers should be allowed time to exit the loan
prior to the reset date.
In light of the comments received, the Agencies revised the
Statement to state
that the period during which prepayment penalties apply should not
exceed the initial reset period, and that institutions generally should
provide borrowers with a reasonable period of time (typically, at least
60 days prior to the reset date) to refinance their loans without
penalty. There is no supervisory expectation for institutions to waive
contractual terms with regard to prepayment penalties on existing
\4\ Federal credit unions are prohibited from charging
prepayment penalties. 12 CFR 701.21.
Consumer Disclosure Issues
Many financial institution and industry group commenters suggested
that the Agencies' consumer protection goals would be better
accomplished through amendments to generally applicable regulations,
such as Regulation Z (Truth in Lending) \5\ or Regulation X (Real
Estate Settlement Procedures).\6\ Some financial institution and
consumer and community group commenters questioned the value of
additional disclosures and expressed concern that the proposed
statement would contribute to consumer information overload. A few
commenters stated that the proposed statement would add burdensome new
disclosure requirements and would result in the provision of confusing
information to consumers.
\5\ 12 CFR part 226 (2006).
\6\ 24 CFR part 3500 (2005).
Some industry group commenters asked the Agencies to provide
uniform disclosures for these products, or to publish illustrations of
the consumer information contemplated by the proposed statement similar
to those previously proposed by the Agencies in connection with
nontraditional mortgage products.\7\ Several commenters also requested
that any disclosures include the maximum possible monthly payment under
the terms of the loan.
\7\ 71 FR 58673 (October 4, 2006).
The Agencies have determined that, given the growth in the market
for the products covered by the Statement and the heightened legal,
compliance, and reputation risks associated with these products,
guidelines are needed now to ensure that consumers will receive the
information they need about the material features of these loans. In
addition, while the Agencies are sensitive to commenters' concerns
regarding disclosure burden, we do not anticipate that the information
outlined in the Statement will result in additional lengthy
disclosures. Rather, the Agencies contemplate that the information can
be provided in a brief narrative format and through the use of examples
based on hypothetical loan transactions. In response to requests by
commenters, the Agencies are working on and expect to publish for
comment proposed illustrations of the type of consumer information
contemplated in the Statement.
The Agencies disagree with the commenters who expressed concern
that the proposed statement appears to establish a suitability standard
under which lenders would be required to assist borrowers in choosing
products that are appropriate to their needs and circumstances. These
commenters argued that lenders are not in a position to determine which
products are most suitable for borrowers, and that this decision should
be left to borrowers themselves. It is not the Agencies' intent to
impose such a standard, nor is there any language in the Statement that
While some commenters who addressed the control systems portion of
the proposed statement supported the Agencies' proposal, some industry
group commenters expressed concern that these provisions were neither
realistic nor practical. A few industry group commenters requested
clarification of the scope of a financial institution's
responsibilities with regard to third parties. Some consumer and
community group commenters requested uniform regulation of and
increased enforcement against third parties.
The Agencies have carefully considered these comments, but have not
revised this portion of the proposed statement. The Agencies do not
expect institutions to assume an unwarranted level of responsibility
for the actions of third parties. Moreover, the control systems
discussed in the Statement are consistent with the Agencies' current
supervisory authority and policies.
The Agencies received no comments on the supervisory review portion
of the proposed statement. However, minor changes have been made to
clarify the circumstances under which the Agencies will take action
against institutions in connection with the products addressed in the
IV. Text of Final Joint Guidance
The final interagency Statement on Subprime Mortgage Lending
Statement on Subprime Mortgage Lending
The Agencies \8\ developed this Statement on Subprime Mortgage
Lending (Subprime Statement) to address emerging issues and questions
relating to certain subprime \9\ mortgage lending practices. The
Agencies are concerned borrowers may not fully understand the risks and
consequences of obtaining products that can cause payment shock.\10\ In
particular, the Agencies are concerned with certain adjustable-rate
mortgage (ARM) products typically offered to subprime borrowers that
have one or more of the following characteristics:
\8\ The Agencies consist of the Board of Governors of the
Federal Reserve System (the Board), the Federal Deposit Insurance
Corporation (FDIC), the National Credit Union Administration (NCUA),
the Office of the Comptroller of the Currency (OCC), and the Office
of Thrift Supervision (OTS).
\9\ The term ``subprime'' is described in the 2001 Expanded
Guidance for Subprime Lending Programs. Federally insured credit
unions should refer to LCU 04-CU-13--Specialized Lending Activities.
\10\ Payment shock refers to a significant increase in the
amount of the monthly payment that generally occurs as the interest
rate adjusts to a fully indexed basis. Products with a wide spread
between the initial interest rate and the fully indexed rate that do
not have payment caps or periodic interest rate caps, or that
contain very high caps, can produce significant payment shock.
Low initial payments based on a fixed introductory rate
that expires after a short period and then adjusts to a variable index
rate plus a margin for the remaining term of the loan; \11\
\11\ For example, ARMs known as ``2/28'' loans feature a fixed
Very high or no limits on how much the payment amount or
the interest rate may increase (``payment or rate caps'') on reset
Limited or no documentation of borrowers' income;
Product features likely to result in frequent refinancing
to maintain an affordable monthly payment; and/or
Substantial prepayment penalties and/or prepayment
penalties that extend beyond the initial fixed interest rate period.
Products with one or more of these features present substantial
risks to both consumers and lenders. These risks are increased if
borrowers are not adequately informed of the product features and
risks, including their responsibility for paying real estate taxes and
insurance, which may be separate from their monthly mortgage payments.
The consequences to borrowers could include: being unable
to afford the monthly payments after the initial rate adjustment
because of payment shock; experiencing difficulty in paying real estate
taxes and insurance that were not escrowed; incurring expensive
refinancing fees, frequently due to closing costs and prepayment
penalties, especially if the prepayment penalty period extends beyond
the rate adjustment date; and losing their homes. Consequences to
lenders may include unwarranted levels of credit, legal, compliance,
reputation, and liquidity risks due to the elevated risks inherent in
The Agencies note that many of these concerns are addressed in
existing interagency guidance. The most prominent are the 1993
Interagency Guidelines for Real Estate Lending (Real Estate
Guidelines), the 1999 Interagency Guidance on Subprime Lending, and the
2001 Expanded Guidance for Subprime Lending Programs (Expanded Subprime
\12\ Federally insured credit unions should refer to LCU 04-CU-
13--Specialized Lending Activities. National banks also should refer
to 12 CFR 34.3(b) and (c), as well as 12 CFR part 30, Appendix C.
While the 2006 Interagency Guidance on Nontraditional Mortgage
Product Risks (NTM Guidance) may not explicitly pertain to products
with the characteristics addressed in this Statement, it outlines
prudent underwriting and consumer protection principles that
institutions also should consider with regard to subprime mortgage
lending. This Statement reiterates many of the principles addressed in
existing guidance relating to prudent risk management practices and
consumer protection laws.\13\
\13\ As with the Interagency Guidance on Nontraditional Mortgage
Product Risks, 71 FR 58609 (October 4, 2006), this Statement applies
to all banks and their subsidiaries, bank holding companies and
their nonbank subsidiaries, savings associations and their
subsidiaries, savings and loan holding companies and their
subsidiaries, and credit unions.
Subprime lending is not synonymous with predatory lending, and
loans with the features described above are not necessarily predatory
in nature. However, institutions should ensure that they do not engage
in the types of predatory lending practices discussed in the Expanded
Subprime Guidance.\14\ Typically, predatory lending involves at least
one of the following elements:
\14\ Federal credit unions should refer to 12 CFR 740.2 and 12
CFR 706 for information on prohibited practices.
Making loans based predominantly on the foreclosure or
liquidation value of a borrower's collateral rather than on the
borrower's ability to repay the mortgage according to its terms;
Inducing a borrower to repeatedly refinance a loan in
order to charge high points and fees each time the loan is refinanced
(``loan flipping''); or
Engaging in fraud or deception to conceal the true nature
of the mortgage loan obligation, or ancillary products, from an
unsuspecting or unsophisticated borrower.
Institutions offering mortgage loans such as these face an elevated
risk that their conduct will violate Section 5 of the Federal Trade
Commission Act (FTC Act), which prohibits unfair or deceptive acts or
\15\ The OCC, the Board, the OTS, and the FDIC enforce this
provision under section 8 of the Federal Deposit Insurance Act. The
OCC, Board, and FDIC also have issued supervisory guidance to the
institutions under their respective jurisdictions concerning unfair
or deceptive acts or practices. See OCC Advisory Letter 2002-3--
Guidance on Unfair or Deceptive Acts or Practices, March 22, 2002,
and 12 CFR part 30, Appendix C; Joint Board and FDIC Guidance on
Unfair or Deceptive Acts or Practices by State-Chartered Banks,
March 11, 2004. The OTS also has issued a regulation that prohibits
savings associations from using advertisements or other
representations that are inaccurate or misrepresent the services or
contracts offered (12 CFR 563.27). The NCUA prohibits federally
insured credit unions from using any advertising or promotional
material that is inaccurate, misleading, or deceptive in any way
concerning its products, services, or financial condition (12 CFR
Institutions should refer to the Real Estate Guidelines, which
provide underwriting standards for all real estate loans.\16\ The Real
Estate Guidelines state that prudently underwritten real estate loans
should reflect all relevant credit factors, including the capacity of
the borrower to adequately service the debt.\17\ The 2006 NTM Guidance
details similar criteria for qualifying borrowers for products that may
result in payment shock.
\16\ Refer to 12 CFR part 34, subpart D (OCC); 12 CFR part 208,
subpart C (Board); 12 CFR part 365 (FDIC); 12 CFR 560.100 and 12 CFR
560.101 (OTS); and 12 CFR 701.21 (NCUA).
\17\ OTS Examination Handbook Section 212, 1-4 Family
Residential Mortgage Lending, also discusses borrower qualification
standards. Federally insured credit unions should refer to LCU 04-
CU-13--Specialized Lending Activities.
Prudent qualifying standards recognize the potential effect of
payment shock in evaluating a borrower's ability to service debt. An
institution's analysis of a borrower's repayment capacity should
include an evaluation of the borrower's ability to repay the debt by
its final maturity at the fully indexed rate,\18\ assuming a fully
amortizing repayment schedule.\19\
\18\ The fully indexed rate equals the index rate prevailing at
origination plus the margin to be added to it after the expiration
of an introductory interest rate. For example, assume that a loan
with an initial fixed rate of 7% will reset to the six-month London
Interbank Offered Rate (LIBOR) plus a margin of 6%. If the six-month
LIBOR rate equals 5.5%, lenders should qualify the borrower at 11.5%
(5.5% + 6%), regardless of any interest rate caps that limit how
quickly the fully indexed rate may be reached.
\19\ The fully amortizing payment schedule should be based on
the term of the loan. For example, the amortizing payment for a ``2/
28'' loan would be calculated based on a 30-year amortization
schedule. For balloon mortgages that contain a borrower option for
an extended amortization period, the fully amortizing payment
schedule can be based on the full term the borrower may choose.
One widely accepted approach in the mortgage industry is to
quantify a borrower's repayment capacity by a debt-to-income (DTI)
ratio. An institution's DTI analysis should include, among other
things, an assessment of a borrower's total monthly housing-related
payments (e.g., principal, interest, taxes, and insurance, or what is
commonly known as PITI) as a percentage of gross monthly income.
This assessment is particularly important if the institution relies
upon reduced documentation or allows other forms of risk layering.
Risk-layering features in a subprime mortgage loan may significantly
increase the risks to both the institution and the borrower. Therefore,
an institution should have clear policies governing the use of risk-
layering features, such as reduced documentation loans or simultaneous
second lien mortgages. When risk-layering features are combined with a
mortgage loan, an institution should demonstrate the existence of
effective mitigating factors that support the underwriting decision and
the borrower's repayment capacity.
Recognizing that loans to subprime borrowers present elevated
credit risk, institutions should verify and document the borrower's
income (both source and amount), assets and liabilities. Stated income
and reduced documentation loans to subprime borrowers should be
accepted only if there are mitigating factors that clearly minimize the
need for direct verification of repayment capacity. Reliance on such
factors also should be documented. Typically, mitigating factors arise
when a borrower with favorable payment performance seeks to refinance
an existing mortgage with a new loan of a similar size and with similar
terms, and the borrower's financial condition has not deteriorated.
Other mitigating factors might include situations where a borrower has
substantial liquid reserves or assets that
demonstrate repayment capacity and can be verified and documented by
the lender. However, a higher interest rate is not considered an
acceptable mitigating factor.
As discussed in the April 2007 interagency Statement on Working
with Borrowers, the Agencies encourage financial institutions to work
constructively with residential borrowers who are in default or whose
default is reasonably foreseeable. 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
Financial institutions should follow prudent underwriting practices
in determining whether to consider a loan modification or a workout
arrangement.\20\ Such arrangements can vary widely based on the
borrower's financial capacity. For example, an institution might
consider modifying loan terms, including converting loans with variable
rates into fixed-rate products to provide financially stressed
borrowers with predictable payment requirements.
\20\ Institutions may need to account for workout arrangements
as troubled debt restructurings and should follow generally accepted
accounting principles in accounting for these transactions.
The Agencies will not criticize financial institutions that pursue
reasonable workout arrangements with borrowers. Further, existing
supervisory guidance and applicable accounting standards do not require
institutions to immediately foreclose on the collateral underlying a
loan when the borrower exhibits repayment difficulties. Institutions
should identify and report credit risk, maintain an adequate allowance
for loan losses, and recognize credit losses in a timely manner.
Fundamental consumer protection principles relevant to the
underwriting and marketing of mortgage loans include:
Approving loans based on the borrower's ability to repay
the loan according to its terms; and
Providing information that enables consumers to understand
material terms, costs, and risks of loan products at a time that will
help the consumer select a product.
Communications with consumers, including advertisements, oral
statements, and promotional materials, should provide clear and
balanced information about the relative benefits and risks of the
products. This information should be provided in a timely manner to
assist consumers in the product selection process, not just upon
submission of an application or at consummation of the loan.
Institutions should not use such communications to steer consumers to
these products to the exclusion of other products offered by the
institution for which the consumer may qualify.
Information provided to consumers should clearly explain the risk
of payment shock and the ramifications of prepayment penalties, balloon
payments, and the lack of escrow for taxes and insurance, as necessary.
The applicability of prepayment penalties should not exceed the initial
reset period. In general, borrowers should be provided a reasonable
period of time (typically at least 60 days prior to the reset date) to
refinance without penalty.\21\
\21\ Federal credit unions are prohibited from charging
Similarly, if borrowers do not understand that their monthly
mortgage payments do not include taxes and insurance, and they have not
budgeted for these essential homeownership expenses, they may be faced
with the need for significant additional funds on short notice.\22\
Therefore, mortgage product descriptions and advertisements should
provide clear, detailed information about the costs, terms, features,
and risks of the loan to the borrower. Consumers should be informed of:
\22\ Institutions generally can address these concerns most
directly by requiring borrowers to escrow funds for real estate
taxes and insurance.
Payment Shock. Potential payment increases, including how
the new payment will be calculated when the introductory fixed rate
\23\ To illustrate: a borrower earning $42,000 per year obtains
a $200,000 ``2/28'' mortgage loan. The loan's two-year introductory
fixed interest rate of 7% requires a principal and interest payment
of $1,331. Escrowing $200 per month for taxes and insurance results
in a total monthly payment of $1,531 ($1,331 + $200), representing a
44% DTI ratio. A fully indexed interest rate of 11.5% (based on a
six-month LIBOR index rate of 5.5% plus a 6% margin) would cause the
borrower's principal and interest payment to increase to $1,956. The
adjusted total monthly payment of $2,156 ($1,956 + $200 for taxes
and insurance) represents a 41% increase in the payment amount and
results in a 62% DTI ratio.
Prepayment Penalties. The existence of any prepayment
penalty, how it will be calculated, and when it may be imposed.\24\
\24\ See footnote 21.
Balloon Payments. The existence of any balloon payment.
Cost of Reduced Documentation Loans. Whether there is a
pricing premium attached to a reduced documentation or stated income
Responsibility for Taxes and Insurance. The requirement to
make payments for real estate taxes and insurance in addition to their
loan payments, if not escrowed, and the fact that taxes and insurance
costs can be substantial.
Institutions should develop strong control systems to monitor
whether actual practices are consistent with their policies and
procedures. Systems should address compliance and consumer information
concerns, as well as safety and soundness, and encompass both
institution personnel and applicable third parties, such as mortgage
brokers or correspondents.
Important controls include establishing appropriate criteria for
hiring and training loan personnel, entering into and maintaining
relationships with third parties, and conducting initial and ongoing
due diligence on third parties. Institutions also should design
compensation programs that avoid providing incentives for originations
inconsistent with sound underwriting and consumer protection
principles, and that do not result in the steering of consumers to
these products to the exclusion of other products for which the
consumer may qualify.
Institutions should have procedures and systems in place to monitor
compliance with applicable laws and regulations, third-party agreements
and internal policies. An institution's controls also should include
appropriate corrective actions in the event of failure to comply with
applicable laws, regulations, third-party agreements or internal
policies. In addition, institutions should initiate procedures to
review consumer complaints to identify potential compliance problems or
other negative trends.
The Agencies will continue to carefully review risk management and
consumer compliance processes, policies, and procedures. The Agencies
will take action against institutions that exhibit predatory lending
practices, violate consumer protection laws or fair lending laws,
engage in unfair or deceptive acts or practices, or otherwise engage in
unsafe or unsound lending practices.
Dated: June 28, 2007.
John C. Dugan,
Comptroller of the Currency.
By order of the Board of Governors of the Federal Reserve
System, June 28, 2007.
Jennifer J. Johnson,
Secretary of the Board.
Dated at Washington, DC, the 27th day of June, 2007.
By order of the Federal Deposit Insurance Corporation.
Robert E. Feldman,
Dated: June 28, 2007.
By the Office of Thrift Supervision.
Dated: June 28, 2007.
By the National Credit Union Administration.
JoAnn M. Johnson,
[FR Doc. 07-3316 Filed 7-9-07; 8:45 am]
BILLING CODE 4810-33-P