Yesterday more than 80 diverse groups representing over 60 million Americans called on federal financial regulators to clarify that high-risk subprime adjustable-rate mortgages (ARMs) should be subject to the same lending standards as other risky products identified by regulators. Last fall, the regulators issued tougher guidelines for lenders that offer certain "non-traditional" mortgages.
The regulatory edict—formally known as "guidance"—failed to clearly include harmful ARMs that are marketed to credit-strapped families of modest means in the high-cost subprime market. The loan types not explicitly included in the regulators' cautionary guidance are known as 2/28s or 3/27s, or "exploding" ARMs. These hybrids begin with a low fixed-interest teaser rate, but switch to an adjustable interest rate with costs that can quickly escalate mortgage payments by hundreds of dollars a month.
"It's like Washington has set out to repair a dangerous street, but they left a gaping hole," said Martin Eakes, CEO of the Center for Responsible Lending. "If regulators act now to provide explicit protections for these dangerous ARMs, we can slow down the flood of foreclosures on subprime loans and help ensure that homeowners get home loans they can sustain."
In a letter to the regulators (attached), dozens of groups (including AARP, the Leadership Conference on Civil Rights, the AFL-CIO, ACORN, Rainbow/Push, NAACP, Consumers Union, Consumer Federation of America, and Center for Responsible Lending) said: "We … call upon you to help protect American families by issuing supplementary guidance to clarify that subprime hybrid ARMs are subject to the same underwriting standards as non-traditional mortgages, particularly the requirement of underwriting at the fully-indexed rate." This would require lenders to consider whether a borrower could afford a loan even after scheduled payment increases occur two or three years into the loan.
The letter notes that the guidance previously issued by the regulators was designed to discourage lenders from making loans that rapidly become more expensive, resulting in "payment shock," yet 2/28s and similar products in the subprime market commonly produce dramatic payment shock.
The letter also indicates that families in communities of color will be affected disproportionately if regulators fail to take action. Over 50 percent of home loans made to African Americans, and 40 percent to Latinos, are subprime loans, and the majority of these are "exploding" ARMs. As it stands now, the guidance issued by regulators only offers explicit protections to loan types that more typically go to white borrowers.
The situation is particularly troubling in light of the decline in housing appreciation, since homeowners who can't afford their mortgages will have a harder time bailing out financially by selling the home. In a recent study on subprime home loans, the Center for Responsible Lending showed that one out of five subprime loans made during the past two years is headed for foreclosure. (See "Losing Ground: Foreclosures in the Subprime Market and Their Cost to Homeowners".) This study is consistent with, or even more conservative than other projections. For example, a recent analysis issued by Lehman Brothers projects that subprime loans made in 2006 will have a 30 percent default rate.
The regulators with jurisdiction over this matter are the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, the Federal Reserve Board, the Office of the Comptroller of the Currency, the National Credit Union Administration and the Conference of State Bank Supervisors. These groups are expected to decide soon whether to explicitly extend their previously issued guidance to subprime hybrid 2/28 and 3/27 adjustable rate mortgages.
For more information: Sharon Reuss, (919) 313-8527 or sharon.reuss@responsiblelending.org.