Nontraditional Mortgage Products Flashcards
What mortgage products are considered nontraditional? (2)
- Interest only mortgages
- Payment option ARMs
What is an interest only mortgage?
Borrower pays no loan principal “only interest” for first few years of the loan after which the rate may fluctuate or become fixed.
What is a payment option ARM?
ARM with flexible payment options and potential for negative amortization. ex: borrower chooses payment based on initial interest rate, interest only option, or fully amortizing P&I payment.
Minimum payments are often less than interest accruing resulting in negative amortization. After a certain number of years the loan reaches a negative amort cap and the loan is recast to increase monthly payments to an amount that will fully amortized the remaining balance on the loan.
Why are nontraditional mortgages important to compliance risk?
Being offered by more lenders and to borrowers who may not qualify for traditional product and who may not fully understand the associated risks.
What specific risks are associated with nontraditional products? (5)
- Underwriting with less stringent income requirements (reduced documentation)
- often combined with second-lien loans, that may have less equity to ensure payment of loan.
- risk layering
- introductory interest rates set below fully indexed rates
- lending to subprime borrowers.
What controls can mitigate risks associated with NT mortgages? (6)
- Loan terms and Underwriting standards are prudent and consider the borrowers repayment capacity.
- strong risk management practices
- Policies and procedures that specify acceptable product attributes, portfolio limits, sales and securitization practices, and risk management
- Strong third party risk managment
- Enhanced reporting to management.
- Disclosures that allow borrowers to clearly understand loan terms and associated risks prior to making a product choice.
What should loan and underwriting standards include for NT mortgages? (4)
- address the effect of a substantial payment increase on the borrowers capacity to repay when loan amortization begins.
- comply with real estate lending standards and appraisal regulations/ guidelines.
- recognize potential impact of payment shock (especially for high DTI, low credit, high LTV borrowers)
- Analyze ability to repay at the fully indexed rate, with full amortization/neg amort.
What is payment shock?
Significant increase in payments once NT loans begin to amortize.
Particularly concerning for payment option ARM loans that may result in excessive negative amortization.
What types of loans are at higher risk under NT mortgages? (2)
Collateral dependent loans
Non-Owner Occupied Investor loans
When should creditors notify borrowers about the associated risks of NT mortgages?
Should notify them about the likelihood of increased payments before product selection and disclosures are provided under TILA.
What should advertisements and communications with customers include regarding NT mortgages? (2)
Clear balanced info about relative benefits and risks including:
- risk of payment shock
- risk of negative amortization
What laws govern NT mortgages? (4)
- TILA
- RESPA
- Fair Lending Laws
- UDAP (Federal Trade Commission Act)
What are the recommended practices for banks with NT mortgage practices? (5)
- Strong communication with customers (with disclosures and marketing)
- product descriptions and promotional materials that include information about costs, terms, features, risks
- Apprise customers of Payment Shock (ex: product description with example of maximum monthly payment)
- Disclose risk of negative amortization, prepayment penalties, reduced documentation.
- Monthly statements on loans that enables customer to make informed payment choices. (ex: statement details amount allocated to principal and interest, amount principal balance increased_
What are potential risks associated with negative amortization for a borrower? (3)
- increasing principal balances
- decreasing home equity.
- difficult to refinance home or obtain cash from equity
What practices should banks avoid with NT products? (5)
- Practices that obscure significant risks
- predicting direction of future interest rates
- discuss cash savings or expanded buying power from NT products vs. typical products
- suggesting minimal payments on payment option ARM will cover interest charges
- misleading claims that interest rates or payment obligations are “fixed”
