# SR 06-15: Interagency Guidance on Nontraditional Mortgage Product Risks

> Federal · Agency guidance · In force

URL: https://www.frixlaw.com/law-library/statutes/FRB_SR0615

## Section

- **Citation:** SR 06-15
- **Heading:** Interagency Guidance on Nontraditional Mortgage Product Risks
- **Jurisdiction:** Federal
- **Kind:** Agency guidance
- **Status:** In force
- **Text as of:** August 14, 2026
- **Source:** Compiled text
- **Location:** Federal Reserve SR/CA Letters / Interagency Guidance on Nontraditional Mortgage Product Risks

## Text

58609
Federal Register / Vol. 71, No. 192 / Wednesday, October 4, 2006 / Notices
7. To determine whether Terry Keith
Hammond willfully and/or repeatedly
violated § 73.1015 of the Commission’s
rules by failing to provide full and
complete responses and documents as
directed by letters of inquiry issued by
the staff of the Enforcement Bureau on
June 14, 2004, and August 10, 2004; and
8. To determine, in light of the
evidence adduced pursuant to the
foregoing designated issues, whether the
captioned application for renewal of the
license for Station KBKH(FM) should be
granted, or denied.
Copies of the Order to Show Cause,
Notice of Opportunity for Hearing, and
Hearing Designation Order are being
sent by certified mail, return receipt
requested, to Terry Keith Hammond. To
avail himself of the opportunity to be
heard, Terry Keith Hammond, pursuant
to § 1.91(c) and § 1.221 of the
Commission’s rules, 47 CFR 1.91(c) and
47 CFR 1.221, in person or by his
attorney, must within 30 days of the
release of this Order, file in triplicate a
written notice of appearance stating an
intention to appear on the date fixed for
the hearing and present evidence on the
issues specified in this Order. Terry
Keith Hammond pursuant to § 73.3594
of the Commission’s rules, 47 CFR
73.3594, shall give notice of the hearing
within the time and in the manner
prescribed in 47 CFR 73.3594, and shall
advise the Commission of the
publication of such notice as required
by 47 CFR 73.3594(g).
Federal Communications Commission.
Marlene H. Dortch,
Secretary.
[FR Doc. E6–16217 Filed 10–3–06; 8:45 am]
BILLING CODE 6712–01–P
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
[Docket No. 06–11]
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
[Docket No. OP–1246]
FEDERAL DEPOSIT INSURANCE
CORPORATION
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
[No
ederal Communications Commission.
Marlene H. Dortch,
Secretary.
[FR Doc. E6–16217 Filed 10–3–06; 8:45 am]
BILLING CODE 6712–01–P
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
[Docket No. 06–11]
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
[Docket No. OP–1246]
FEDERAL DEPOSIT INSURANCE
CORPORATION
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
[No. 2006–35]
NATIONAL CREDIT UNION
ADMINISTRATION
Interagency Guidance on
Nontraditional Mortgage Product Risks
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).
ACTION: Final guidance.
SUMMARY: The OCC, Board, FDIC, OTS,
and NCUA (the Agencies), are issuing
final Interagency Guidance on
Nontraditional Mortgage Product Risks
(guidance). This guidance has been
developed to clarify how institutions
can offer nontraditional mortgage
products in a safe and sound manner,
and in a way that clearly discloses the
risks that borrowers may assume.
FOR FURTHER INFORMATION CONTACT:
OCC: Gregory Nagel, Credit Risk
Specialist, Credit and Market Risk, (202)
874–5170; or Michael S. Bylsma,
Director, or Stephen Van Meter,
Assistant Director, Community and
Consumer Law Division, (202) 874–
5750.
Board: Brian Valenti, Supervisory
Financial Analyst, (202) 452–3575; or
Virginia Gibbs, Senior Supervisory
Financial Analyst, (202) 452–2521; or
Sabeth I. Siddique, Assistant Director,
gory Nagel, Credit Risk
Specialist, Credit and Market Risk, (202)
874–5170; or Michael S. Bylsma,
Director, or Stephen Van Meter,
Assistant Director, Community and
Consumer Law Division, (202) 874–
5750.
Board: Brian Valenti, Supervisory
Financial Analyst, (202) 452–3575; or
Virginia Gibbs, Senior Supervisory
Financial Analyst, (202) 452–2521; or
Sabeth I. Siddique, Assistant Director,
(202) 452–3861, Division of Banking
Supervision and Regulation; Kathleen C.
Ryan, Counsel, Division of Consumer
and Community Affairs, (202) 452–
3667; or Andrew Miller, Counsel, Legal
Division, (202) 452–3428. For users of
Telecommunications Device for the Deaf
(‘‘TDD’’) only, contact (202) 263–4869.
FDIC: Suzy S. Gardner, Examination
Specialist, (202) 898–3640, or April
Breslaw, Chief, Compliance Section,
(202) 898–6609, Division of Supervision
and Consumer Protection; or Ruth R.
Amberg, Senior Counsel, (202) 898–
3736, or Richard Foley, Counsel, (202)
898–3784, Legal Division.
OTS: William Magrini, Senior Project
Manager, Examinations and Supervision
Policy, (202) 906–5744; or Fred Phillips-
Patrick, Director, Credit Policy, (202)
906–7295; or Glenn Gimble, Senior
Project Manager, Compliance and
Consumer Protection, (202) 906–7158.
NCUA: Cory Phariss, Program Officer,
Examination and Insurance, (703) 518–
6618.
SUPPLEMENTARY INFORMATION:
I. Background
The Agencies developed this
guidance to address risks associated
with the growing use of mortgage
products that allow borrowers to defer
payment of principal and, sometimes,
interest. These products, referred to
variously as ‘‘nontraditional’’,
‘‘alternative’’, or ‘‘exotic’’ mortgage
loans (hereinafter referred to as
nontraditional mortgage loans), include
‘‘interest-only’’ mortgages and ‘‘payment
option’’ adjustable-rate mortgages.
These products allow borrowers to
exchange lower payments during an
initial period for higher payments
during a later amortization period
These products, referred to
variously as ‘‘nontraditional’’,
‘‘alternative’’, or ‘‘exotic’’ mortgage
loans (hereinafter referred to as
nontraditional mortgage loans), include
‘‘interest-only’’ mortgages and ‘‘payment
option’’ adjustable-rate mortgages.
These products allow borrowers to
exchange lower payments during an
initial period for higher payments
during a later amortization period.
While similar products have been
available for many years, the number of
institutions offering them has expanded
rapidly. At the same time, these
products are offered to a wider spectrum
of borrowers who may not otherwise
qualify for more traditional mortgages.
The Agencies are concerned that some
borrowers may not fully understand the
risks of these products. While many of
these risks exist in other adjustable-rate
mortgage products, the Agencies
concern is elevated with nontraditional
products because of the lack of principal
amortization and potential for negative
amortization. In addition, institutions
are increasingly combining these loans
with other features that may compound
risk. These features include
simultaneous second-lien mortgages and
the use of reduced documentation in
evaluating an applicant’s
creditworthiness.
In response to these concerns, the
Agencies published for comment
proposed Interagency Guidance on
Nontraditional Mortgage Products, 70
FR 77249 (Dec. 29, 2005). The Agencies
proposed guidance in three primary
areas: ‘‘Loan Terms and Underwriting
Standards’’, ‘‘Portfolio and Risk
Management Practices’’, and ‘‘Consumer
Protection Issues’’. In the first section,
the Agencies sought to ensure that loan
terms and underwriting standards for
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hree primary
areas: ‘‘Loan Terms and Underwriting
Standards’’, ‘‘Portfolio and Risk
Management Practices’’, and ‘‘Consumer
Protection Issues’’. In the first section,
the Agencies sought to ensure that loan
terms and underwriting standards for
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58610
Federal Register / Vol. 71, No. 192 / Wednesday, October 4, 2006 / Notices
1 Nine of these letters requested a thirty-day
extension of the comment period, which the
Agencies granted.
2 Letter to J. Johnson, Board Secretary, et al. from
N. Milner, President & CEO, Conference of State
Bank Supervisors (Feb. 14, 2006); Letter to J.
Johnson, Board Secretary, et al., from B. Kent,
Chair, State Financial Regulators Roundtable.
3 Media Release, CSBS & American Association of
Residential Mortgage Regulators, ‘‘CSBS and
AARMR Consider Guidance on Nontraditional
Mortgage Products for State-Licensed Entities’’
(June 7, 2006), available at http://www.csbs.org/
Content/NavigationMenu/PublicRelations/
PressReleases/News_Releases.htm. The press
release stated:
The guidance being developed by CSBS and
AARMR is based upon proposed guidance issued in
December 2005 by the Office of the Comptroller of
the Currency, the Board of Governors of the Federal
Reserve System, the Federal Deposit Insurance
Corporation, the Office of Thrift Supervision, and
the National Credit Union Administration.
The Federal guidance, when finalized, will only
apply to insured financial institutions and their
affiliates. CSBS and AARMR intend to develop a
modified version of the guidance which will
primarily focus on residential mortgage
underwriting and consumer protection. The
guidance will be offered to State regulators to apply
to their licensed residential mortgage brokers and
lenders
ration.
The Federal guidance, when finalized, will only
apply to insured financial institutions and their
affiliates. CSBS and AARMR intend to develop a
modified version of the guidance which will
primarily focus on residential mortgage
underwriting and consumer protection. The
guidance will be offered to State regulators to apply
to their licensed residential mortgage brokers and
lenders.
nontraditional mortgage loans are
consistent with prudent lending
practices, including credible
consideration of a borrower’s repayment
capacity. The portfolio and risk
management practices section outlined
the need for strong risk management
standards, capital levels commensurate
with the risk, and an allowance for loan
and lease losses (ALLL) that reflects the
collectibility of the portfolio. Finally,
the consumer protection issues section
recommended practices to ensure
consumers have clear and balanced
information prior to making a product
choice. Additionally, this section
described control systems to ensure that
actual practices are consistent with
policies and procedures.
The Agencies together received
approximately 100 letters in response to
the proposal.1 Comments were received
from financial institutions, trade
associations, consumer and community
organizations, state financial regulatory
organizations, and other members of the
public.
II. Overview of Public Comments
The Agencies received a full range of
comments. Some commenters
applauded the Agencies’ initiative in
proposing the guidance, while others
questioned whether guidance is needed.
A majority of the depository
institutions and industry groups that
commented stated that the guidance is
too prescriptive. They suggested
institutions should have more flexibility
in determining appropriate risk
management practices. A number
observed that nontraditional mortgage
products have been offered successfully
for many years
, while others
questioned whether guidance is needed.
A majority of the depository
institutions and industry groups that
commented stated that the guidance is
too prescriptive. They suggested
institutions should have more flexibility
in determining appropriate risk
management practices. A number
observed that nontraditional mortgage
products have been offered successfully
for many years. Others opined that the
guidance would stifle innovation and
result in qualified borrowers not being
approved for these loans. Further, many
questioned whether the guidance is an
appropriate mechanism for addressing
the Agencies’ consumer protection
concerns.
A smaller subset of commenters
argued that the guidance does not go far
enough in regulating or restricting
nontraditional mortgage products. These
commenters included consumer
organizations, individuals, and several
community bankers. Several stated
these products contribute to speculation
and unsustainable appreciation in the
housing market. They expressed
concern that severe problems will occur
if and when there is a downturn in the
economy. Some also argued that these
products are harmful to borrowers and
that borrowers may not understand the
associated risks.
Many commenters voiced concern
that the guidance will not apply to all
lenders, and thus federally regulated
financial institutions will be at a
competitive disadvantage. The Agencies
note that both State financial regulatory
organizations that commented on the
proposed guidance—the Conference of
State Bank Supervisors (CSBS) and the
State Financial Regulators Roundtable
(SFRR)—committed to working with
State regulatory agencies to distribute
guidance that is similar in nature and
scope to the financial service providers
under their jurisdictions.2 These
commenters noted their interest in
addressing the potential for inconsistent
regulatory treatment of lenders based on
whether or not they are supervised
solely by state agencies
ial Regulators Roundtable
(SFRR)—committed to working with
State regulatory agencies to distribute
guidance that is similar in nature and
scope to the financial service providers
under their jurisdictions.2 These
commenters noted their interest in
addressing the potential for inconsistent
regulatory treatment of lenders based on
whether or not they are supervised
solely by state agencies. Subsequently,
the CSBS, along with a national
organization representing state
residential mortgage regulators, issued a
press release confirming their intent to
offer guidance to State regulators to
apply to their licensed residential
mortgage brokers and lenders.3
III. Final Joint Guidance
The Agencies made a number of
changes to the proposal to respond to
commenters’ concerns and to provide
additional clarity. Significant comments
on the specific provisions of the
proposed guidance, the Agencies’’
responses, and changes to the proposed
guidance are discussed as follows.
Scope of the Guidance
Many financial institution and trade
group commenters raised concerns that
the proposed guidance did not
adequately define ‘‘nontraditional
mortgage products’’. They requested
clarification of which products would
be subject to enhanced scrutiny. Some
suggested that the guidance focus on
products that allow negative
amortization, rather than interest-only
loans. Others suggested excluding
certain products with nontraditional
features, such as reverse mortgages and
home equity lines of credit (HELOCs).
Those commenting on interest-only
loans noted that they do not present the
same risks as products that allow for
negative amortization. Those that
argued that HELOCs should be excluded
noted that they are already covered by
interagency guidance issued in 2005.
They also noted that the principal
amount of these loans is generally lower
than that for first mortgages
nes of credit (HELOCs).
Those commenting on interest-only
loans noted that they do not present the
same risks as products that allow for
negative amortization. Those that
argued that HELOCs should be excluded
noted that they are already covered by
interagency guidance issued in 2005.
They also noted that the principal
amount of these loans is generally lower
than that for first mortgages. As for
reverse mortgages, the commenters
pointed out that they were developed
for a specific market segment and do not
present the same concerns as products
mentioned in the guidance.
To address these concerns, the
Agencies are clarifying the types of
products covered by the guidance. In
general, the guidance applies to all
residential mortgage loan products that
allow borrowers to defer repayment of
principal or interest. This includes all
interest-only products and negative
amortization mortgages, with the
exception of HELOCs. The Agencies
decided not to include HELOCs in this
guidance, other than as discussed in the
Simultaneous Second-Lien Loans
section, since they are already covered
by the May 2005 Interagency Credit Risk
Management Guidance for Home Equity
Lending. The Agencies are amending
the May 2005 guidance, however, to
address the consumer disclosure
recommendations included in the
nontraditional mortgage guidance.
The Agencies decided against
focusing solely on negative amortization
products. Many of the interest-only
products pose risks similar to products
that allow negative amortization,
especially when combined with high
leverage and reduced documentation.
Accordingly, they present similar
concerns from a risk management and
consumer protection standpoint. The
Agencies did, however, agree that
reverse mortgages do not present the
types of concerns that are addressed in
the guidance and should be excluded
s pose risks similar to products
that allow negative amortization,
especially when combined with high
leverage and reduced documentation.
Accordingly, they present similar
concerns from a risk management and
consumer protection standpoint. The
Agencies did, however, agree that
reverse mortgages do not present the
types of concerns that are addressed in
the guidance and should be excluded.
Loan Terms and Underwriting
Standards
Qualifying Borrowers
The Agencies proposed that for all
nontraditional mortgage products, the
analysis of borrowers’ repayment
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58611
Federal Register / Vol. 71, No. 192 / Wednesday, October 4, 2006 / Notices
4 This is similar to the standard in the Agencies’
May 2005 Credit Risk Management Guidance for
Home Equity Lending recommending that, for
interest-only and variable rate HELOCs, borrowers
should demonstrate the ability to amortize the fully
drawn line over the loan term.
capacity should include an evaluation
of their ability to repay the debt by final
maturity at the fully indexed rate,
assuming a fully amortizing repayment
schedule. In addition, the proposed
guidance stated that for products that
permit negative amortization, the
repayment analysis should include the
initial loan amount plus any balance
increase that may accrue from negative
amortization. The amount of the balance
increase is tied to the initial terms of the
loan and estimated assuming the
borrower makes only the minimum
payment.
Generally, banks and industry groups
believed that the proposed underwriting
standards were too prescriptive and
asked for more flexibility. Consumer
groups generally supported the
proposed underwriting standards,
warning that deteriorating underwriting
standards are bad for individual
borrowers and poor public policy
n and estimated assuming the
borrower makes only the minimum
payment.
Generally, banks and industry groups
believed that the proposed underwriting
standards were too prescriptive and
asked for more flexibility. Consumer
groups generally supported the
proposed underwriting standards,
warning that deteriorating underwriting
standards are bad for individual
borrowers and poor public policy.
A number of commenters suggested
that industry practice is to underwrite
payment option adjustable-rate
mortgages at the fully indexed rate,
assuming a fully amortizing payment.
Yet several commenters argued that this
standard should not be required when
risks are adequately mitigated.
Moreover, many commenters opposed
assuming a fully amortizing payment for
interest-only loans with extended
interest-only periods. They argued that
the average life span of most mortgage
loans makes it unlikely that many
borrowers will experience the higher
payments associated with amortization.
Additionally, many commenters
opposed the assumption of minimum
payments during the deferral period for
products that permit negative
amortization on the ground that this
assumption suggests that lenders
assume a worst-case scenario.
The Agencies believe that institutions
should maintain qualification standards
that include a credible analysis of a
borrower’s capacity to repay the full
amount of credit that may be extended.
That analysis should consider both
principal and interest at the fully
indexed rate. Using discounted
payments in the qualification process
limits the ability of borrowers to
demonstrate sufficient capacity to repay
under the terms of the loan. Therefore,
the proposed general guideline of
qualifying borrowers at the fully
indexed rate, assuming a fully
amortizing payment, including potential
negative amortization amounts, remains
in the final guidance
ully
indexed rate. Using discounted
payments in the qualification process
limits the ability of borrowers to
demonstrate sufficient capacity to repay
under the terms of the loan. Therefore,
the proposed general guideline of
qualifying borrowers at the fully
indexed rate, assuming a fully
amortizing payment, including potential
negative amortization amounts, remains
in the final guidance.
Regarding interest-only loans with
extended interest-only periods, the
Agencies note that since the average life
of a mortgage is a function of the
housing market and interest rates, the
average may fluctuate over time.
Additionally, the Agencies were
concerned that excluding these loans
from the underwriting standards could
cause some creditors to change their
market offerings to avoid application of
the guidance. Accordingly, the final
guidance does not exclude interest-only
loans with extended interest-only
periods.
Finally, regarding the assumption for
the amount that the balance may
increase due to negative amortization,
the Agencies have revised the language
to respond to commenters’ requests for
clarity. The basic standard, however,
remains unchanged. The Agencies
expect a borrower to demonstrate the
capacity to repay the full loan amount
that may be advanced.4 This includes
the initial loan amount plus any balance
increase that may accrue from the
negative amortization provision. The
final document contains guidance on
determining the amount of any balance
increase that may accrue from the
negative amortization provision, which
does not necessarily equate to the full
negative amortization cap for a
particular loan.
The Agencies requested comment on
whether the guidance should address
consideration of future income or other
future events in the qualification
standards. The commenters generally
agreed that there is no reliable method
for considering future income or other
future events in the underwriting
process
oes not necessarily equate to the full
negative amortization cap for a
particular loan.
The Agencies requested comment on
whether the guidance should address
consideration of future income or other
future events in the qualification
standards. The commenters generally
agreed that there is no reliable method
for considering future income or other
future events in the underwriting
process. Accordingly, the Agencies have
not modified the guidance to address
these issues.
Collateral-Dependent Loans
Commenters that specifically
addressed this aspect of the guidance
concurred that it is unsafe and unsound
to rely solely on an individual
borrower’s ability to sell or refinance
once amortization commences.
However, many expressed concern
about the possibility that the term
‘‘collateral-dependent’’, as it is used in
the guidance, would be interpreted to
apply to stated income and other
reduced documentation loans.
To address this concern, the Agencies
provided clarifying language in a
footnote to this section. The final
guidance provides that a loan will not
be determined to be collateral-
dependent solely because it was
underwritten using reduced
documentation.
Risk Layering
Financial institution and industry
group commenters were generally
critical of the risk layering provisions of
the proposed guidance on the grounds
that they were too prescriptive. These
commenters argued that institutions
should have flexibility in determining
factors that mitigate additional risks
presented by features such as reduced
documentation and simultaneous
second-lien loans. A number of
commenters, however, including
community and consumer
organizations, financial institutions, and
industry associations, suggested that
reduced documentation loans should
not be offered to subprime borrowers
ions
should have flexibility in determining
factors that mitigate additional risks
presented by features such as reduced
documentation and simultaneous
second-lien loans. A number of
commenters, however, including
community and consumer
organizations, financial institutions, and
industry associations, suggested that
reduced documentation loans should
not be offered to subprime borrowers.
Others questioned whether stated
income loans are appropriate under any
circumstances, when used with
nontraditional mortgage products, or
when used for wage earners who can
readily provide standard documentation
of their wages. Several commenters
argued that simultaneous second-lien
loans should be paired with
nontraditional mortgage loans only
when borrowers will continue to have
substantial equity in the property.
The Agencies believe that the
guidance provides adequate flexibility
in the methods and approaches to
mitigating risk, with respect to risk
layering. While the Agencies have not
prohibited any of the practices
discussed, the guidance uniformly
suggests strong quality control and risk
mitigation factors with respect to these
practices.
The Agencies declined to provide
guidance recommending reduced
documentation loans be limited to any
particular set of circumstances. The
final guidance recognizes that mitigating
factors may determine whether such
loans are appropriate but reminds
institutions that a credible analysis of
both a borrower’s willingness and
ability to repay is consistent with sound
and prudent lending practices. The final
guidance also cautions that institutions
generally should be able to readily
document income for wage earners
through means such as W–2 statements,
pay stubs, or tax returns.
Portfolio and Risk Management
Practices
Many financial institution and
industry group commenters opposed
provisions of the proposed guidance for
the setting of concentration limits
dent lending practices. The final
guidance also cautions that institutions
generally should be able to readily
document income for wage earners
through means such as W–2 statements,
pay stubs, or tax returns.
Portfolio and Risk Management
Practices
Many financial institution and
industry group commenters opposed
provisions of the proposed guidance for
the setting of concentration limits. Some
commenters advocated active
monitoring of concentrations of
diversification strategies as more
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5 12 CFR part 226 (2006).
6 24 CFR part 3500 (2005).
7 See 12 CFR part 226.24(c) (2006).
8 See elsewhere in today’s issue of the Federal
Register. (Proposed Illustrations of Consumer
Information for Nontraditional Mortgage Products).
appropriate approaches. The intent of
the guidance was not to set hard
concentration limits for nontraditional
mortgage products. Instead, institutions
with concentrations in these products
should have well-developed monitoring
systems and risk management practices.
The guidance was clarified to reiterate
this point.
Additionally, a number of financial
institution and industry association
commenters opposed the provisions
regarding third-party originations. They
argued that the proposal would force
lenders to have an awareness and
control over third-party practices that is
neither realistic nor practical. In
particular, many of these commenters
argued that lenders should not be
responsible for overseeing the marketing
and borrower disclosure practices of
third parties.
Regarding controls over third-party
practices, the Agencies clarified their
expectations that institutions should
have strong systems and controls for
establishing and maintaining
relationships with third parties
ractical. In
particular, many of these commenters
argued that lenders should not be
responsible for overseeing the marketing
and borrower disclosure practices of
third parties.
Regarding controls over third-party
practices, the Agencies clarified their
expectations that institutions should
have strong systems and controls for
establishing and maintaining
relationships with third parties.
Reliance on third-party relationships
can significantly increase an
institution’s risk profile. The guidance,
therefore, emphasizes the need for
institutions to exercise appropriate due
diligence prior to entering into a third-
party relationship and to provide
ongoing, effective oversight and
controls. In practice, an institution’s risk
management system should reflect the
complexity of its third-party activities
and the overall level of risk involved.
A number of commenters urged the
Agencies to remove language in the
proposed guidance relating to implicit
recourse for loans sold in the secondary
market. They expressed concern that the
proposal added new capital
requirements. The Agencies clarified the
language in the guidance addressing this
issue. The Agencies do not intend to
establish new capital requirements.
Instead, the Agencies’ intent is to
reiterate existing guidelines regarding
implicit recourse under the Agencies’
risk-based capital rules.
Consumer Protection Issues
Communications With Consumers
Many financial institution and trade
group commenters suggested that the
Agencies’ consumer protection goals
would be better accomplished through
generally applicable regulations, such as
Regulation Z (Truth in Lending) 5 or
Regulation X (Real Estate Settlement
Procedures).6 Some commenters stated
that the proposed guidance would add
burdensome new disclosure
requirements and cause a confusing
overlap with current Regulation Z
requirements. They also expressed
concern that the guidance would
contribute to an overload of information
currently provided to consumers
such as
Regulation Z (Truth in Lending) 5 or
Regulation X (Real Estate Settlement
Procedures).6 Some commenters stated
that the proposed guidance would add
burdensome new disclosure
requirements and cause a confusing
overlap with current Regulation Z
requirements. They also expressed
concern that the guidance would
contribute to an overload of information
currently provided to consumers.
Additionally, some argued that
implementing the disclosure provisions
might trigger Regulation Z requirements
concerning advertising.7 Some
commenters also urged the Agencies to
adopt model disclosure forms or other
descriptive materials to assist in
compliance with the guidance.
Some commenters voiced concern
that the Agencies are attempting to
establish a suitability standard similar
to that used in the securities context.
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.
Finally, several community and
consumer organization commenters
questioned whether additional
disclosures are sufficient to protect
borrowers and suggested various
additional measures, such as consumer
education and counseling.
The Agencies carefully considered the
commenters’ argument that consumer
protection issues—particularly,
disclosures—would be better addressed
through generally applicable
regulations. The Agencies determined,
however, that given the growth in this
market, guidelines are needed now to
ensure that consumers will receive the
information they need about the
material features of nontraditional
mortgages as soon as possible.
The Agencies also gave careful
consideration to the commenters’
concerns that the guidelines will
overlap with Regulation Z, add to the
disclosure burden on lenders, and
contribute to information overload.
While the Agencies are sensitive to
these concerns, we do not believe they
warrant significant changes to the
guidance
terial features of nontraditional
mortgages as soon as possible.
The Agencies also gave careful
consideration to the commenters’
concerns that the guidelines will
overlap with Regulation Z, add to the
disclosure burden on lenders, and
contribute to information overload.
While the Agencies are sensitive to
these concerns, we do not believe they
warrant significant changes to the
guidance. The guidance focuses on
providing information to consumers
during the pre-application shopping
phase and post-closing with any
monthly statements lenders choose to
provide to consumers. Moreover, the
Agencies do not anticipate that the
information outlined in the guidance
will result in additional lengthy
disclosures. Rather, the Agencies
contemplate that the information can be
provided in brief narrative format and
through the use of examples based on
hypothetical loan transactions.8 We
have, however, revised the guidance to
make clear that transaction-specific
disclosures are not required. Institutions
will still need to ensure that their
marketing materials promoting their
products comply with Regulation Z, as
applicable.
As previously discussed, some
commenters, including industry trade
associations, asked the Agencies to
include model or sample disclosures or
other descriptive materials as part of the
guidance to assist lenders, including
smaller institutions, in following the
recommended practices for
communications with consumers. The
Agencies have determined not to
include required model or sample
disclosures in the guidance. Instead, the
guidance provides a set of
recommended practices to assist
institutions in addressing particular
risks raised by nontraditional mortgage
products
uidance to assist lenders, including
smaller institutions, in following the
recommended practices for
communications with consumers. The
Agencies have determined not to
include required model or sample
disclosures in the guidance. Instead, the
guidance provides a set of
recommended practices to assist
institutions in addressing particular
risks raised by nontraditional mortgage
products.
The Agencies have determined that it
is desirable to first seek public comment
on potential model disclosures, and in
a Federal Register notice accompanying
this guidance are seeking comment on
proposed illustrations of consumer
information for nontraditional mortgage
products that are consistent with the
recommendations contained in the
guidance. The Agencies appreciate that
some institutions, including community
banks, following the recommendations
set forth in the guidance may prefer not
to incur the costs and other burdens of
developing their own consumer
information documents. The Agencies
are, therefore, requesting comment on
illustrations of the type of information
contemplated by the guidance.
The Agencies disagree with the
commenters who expressed concern
that the guidance appears to establish a
suitability standard, under which
lenders would be required to assist
borrowers in choosing products that are
suitable to their needs and
circumstances. It was not the Agencies’
intent to impose such a standard, nor is
there any language in the guidance that
does so. In any event, the Agencies have
revised certain statements in the
proposed guidance that could have been
interpreted to suggest a requirement to
ensure that borrowers select products
appropriate to their circumstances.
Control Systems
Several commenters requested more
flexibility in designing appropriate
control systems. The Agencies have
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been
interpreted to suggest a requirement to
ensure that borrowers select products
appropriate to their circumstances.
Control Systems
Several commenters requested more
flexibility in designing appropriate
control systems. The Agencies have
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58613
Federal Register / Vol. 71, No. 192 / Wednesday, October 4, 2006 / Notices
1 Interest-only and payment option ARMs are
variations of conventional ARMs, hybrid ARMs,
and fixed rate products. Refer to the Appendix for
additional information on interest-only and
payment option ARM loans. This guidance does not
apply to reverse mortgages; home equity lines of
credit (‘‘HELOCs’’), other than as discussed in the
Simultaneous Second-Lien Loans section; or fully
amortizing residential mortgage loan products.
2 Refer to the Appendix for additional
information on reduced documentation and
simultaneous second-lien loans.
3 Refer to Interagency Guidelines Establishing
Standards for Safety and Soundness. For each
Agency, those respective guidelines are addressed
in: 12 CFR part 30 Appendix A (OCC); 12 CFR part
208 Appendix D–1 (Board); 12 CFR part 364
Appendix A (FDIC); 12 CFR part 570 Appendix A
(OTS); and 12 U.S.C. 1786 (NCUA).
4 Refer to 12 CFR part 34—Real Estate Lending
and Appraisals, OCC Bulletin 2005–3—Standards
for National Banks’ Residential Mortgage Lending,
AL 2003–7—Guidelines for Real Estate Lending
Policies and AL 2003–9—Independent Appraisal
and Evaluation Functions (OCC); 12 CFR 208.51
subpart E and Appendix C and 12 CFR part 225
subpart G (Board); 12 CFR part 365 and Appendix
A, and 12 CFR part 323 (FDIC); 12 CFR 560.101 and
Appendix and 12 CFR part 564 (OTS). Also, refer
to the 1999 Interagency Guidance on the
‘‘Treatment of High LTV Residential Real Estate
Loans’’ and the 1994 ‘‘Interagency Appraisal and
Evaluation Guidelines’’
valuation Functions (OCC); 12 CFR 208.51
subpart E and Appendix C and 12 CFR part 225
subpart G (Board); 12 CFR part 365 and Appendix
A, and 12 CFR part 323 (FDIC); 12 CFR 560.101 and
Appendix and 12 CFR part 564 (OTS). Also, refer
to the 1999 Interagency Guidance on the
‘‘Treatment of High LTV Residential Real Estate
Loans’’ and the 1994 ‘‘Interagency Appraisal and
Evaluation Guidelines’’. Federally Insured Credit
Unions should refer to 12 CFR part 722—Appraisals
and NCUA 03–CU–17—Appraisal and Evaluation
Functions for Real Estate Related Transactions
(NCUA).
revised the ‘‘Control Systems’’ portion
of the guidance to clarify that we are not
requiring any particular means of
monitoring adherence to an institution’s
policies, such as call monitoring or
mystery shopping. Additional changes
have also been made to clarify that the
Agencies do not expect institutions to
assume an unwarranted level of
responsibility for the actions of third
parties. Rather, the control systems that
are expected for loans purchased from
or originated through third parties are
consistent with the Agencies’ current
supervisory policies. As previously
discussed, the Agencies have also made
changes to the portfolio and risk
management practices portion of the
final guidance to clarify their
expectations concerning oversight and
monitoring of third-party originations.
IV. Text of Final Joint Guidance
The text of the final Interagency
Guidance on Nontraditional Mortgage
Product Risks follows:
Interagency Guidance on
Nontraditional Mortgage Product Risks
Residential mortgage lending has
traditionally been a conservatively
managed business with low
delinquencies and losses and reasonably
stable underwriting standards. In the
past few years consumer demand has
been growing, particularly in high
priced real estate markets, for closed-
end residential mortgage loan products
that allow borrowers to defer repayment
of principal and, sometimes, interest
al mortgage lending has
traditionally been a conservatively
managed business with low
delinquencies and losses and reasonably
stable underwriting standards. In the
past few years consumer demand has
been growing, particularly in high
priced real estate markets, for closed-
end residential mortgage loan products
that allow borrowers to defer repayment
of principal and, sometimes, interest.
These mortgage products, herein
referred to as nontraditional mortgage
loans, include such products as
‘‘interest-only’’ mortgages where a
borrower pays no loan principal for the
first few years of the loan and ‘‘payment
option’’ adjustable-rate mortgages
(ARMs) where a borrower has flexible
payment options with the potential for
negative amortization.1
While some institutions have offered
nontraditional mortgages for many years
with appropriate risk management and
sound portfolio performance, the market
for these products and the number of
institutions offering them has expanded
rapidly. Nontraditional mortgage loan
products are now offered by more
lenders to a wider spectrum of
borrowers who may not otherwise
qualify for more traditional mortgage
loans and may not fully understand the
associated risks.
Many of these nontraditional
mortgage loans are underwritten with
less stringent income and asset
verification requirements (‘‘reduced
documentation’’) and are increasingly
combined with simultaneous second-
lien loans.2 Such risk layering,
combined with the broader marketing of
nontraditional mortgage loans, exposes
financial institutions to increased risk
relative to traditional mortgage loans.
Given the potential for heightened
risk levels, management should
carefully consider and appropriately
mitigate exposures created by these
loans
are increasingly
combined with simultaneous second-
lien loans.2 Such risk layering,
combined with the broader marketing of
nontraditional mortgage loans, exposes
financial institutions to increased risk
relative to traditional mortgage loans.
Given the potential for heightened
risk levels, management should
carefully consider and appropriately
mitigate exposures created by these
loans. To manage the risks associated
with nontraditional mortgage loans,
management should:
• Ensure that loan terms and
underwriting standards are consistent
with prudent lending practices,
including consideration of a borrower’s
repayment capacity;
• Recognize that many nontraditional
mortgage loans, particularly when they
have risk-layering features, are untested
in a stressed environment. As evidenced
by experienced institutions, these
products warrant strong risk
management standards, capital levels
commensurate with the risk, and an
allowance for loan and lease losses that
reflects the collectibility of the portfolio;
and
• Ensure that consumers have
sufficient information to clearly
understand loan terms and associated
risks prior to making a product choice.
The Office of the Comptroller of the
Currency (OCC), the Board of Governors
of the Federal Reserve System (Board),
the Federal Deposit Insurance
Corporation (FDIC), the Office of Thrift
Supervision (OTS) and the National
Credit Union Administration (NCUA)
(collectively, the Agencies) expect
institutions to effectively assess and
manage the risks associated with
nontraditional mortgage loan products.3
Institutions should use this guidance
to ensure that risk management
practices adequately address these risks.
The Agencies will carefully scrutinize
risk management processes, policies,
and procedures in this area. Institutions
that do not adequately manage these
risks will be asked to take remedial
action
ess and
manage the risks associated with
nontraditional mortgage loan products.3
Institutions should use this guidance
to ensure that risk management
practices adequately address these risks.
The Agencies will carefully scrutinize
risk management processes, policies,
and procedures in this area. Institutions
that do not adequately manage these
risks will be asked to take remedial
action.
The focus of this guidance is on the
higher risk elements of certain
nontraditional mortgage products, not
the product type itself. Institutions with
sound underwriting, adequate risk
management, and acceptable portfolio
performance will not be subject to
criticism merely for offering such
products.
Loan Terms and Underwriting
Standards
When an institution offers
nontraditional mortgage loan products,
underwriting standards should address
the effect of a substantial payment
increase on the borrower’s capacity to
repay when loan amortization begins.
Underwriting standards should also
comply with the agencies’ real estate
lending standards and appraisal
regulations and associated guidelines.4
Central to prudent lending is the
internal discipline to maintain sound
loan terms and underwriting standards
despite competitive pressures.
Institutions are strongly cautioned
against ceding underwriting standards
to third parties that have different
business objectives, risk tolerances, and
core competencies. Loan terms should
be based on a disciplined analysis of
potential exposures and compensating
factors to ensure risk levels remain
manageable.
Qualifying Borrowers—Payments on
nontraditional loans can increase
significantly when the loans begin to
amortize. Commonly referred to as
payment shock, this increase is of
particular concern for payment option
ARMs where the borrower makes
minimum payments that may result in
negative amortization
of
potential exposures and compensating
factors to ensure risk levels remain
manageable.
Qualifying Borrowers—Payments on
nontraditional loans can increase
significantly when the loans begin to
amortize. Commonly referred to as
payment shock, this increase is of
particular concern for payment option
ARMs where the borrower makes
minimum payments that may result in
negative amortization. Some institutions
manage the potential for excessive
negative amortization and payment
shock by structuring the initial terms to
limit the spread between the
introductory interest rate and the fully
indexed rate. Nevertheless, an
institution’s qualifying standards should
recognize the potential impact of
payment shock, especially for borrowers
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58614
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5 The fully indexed rate equals the index rate
prevailing at origination plus the margin that will
apply after the expiration of an introductory interest
rate. The index rate is a published interest rate to
which the interest rate on an ARM is tied. Some
commonly used indices include the 1-Year
Constant Maturity Treasury Rate (CMT), the 6-
Month London Interbank Offered Rate (LIBOR), the
11th District Cost of Funds (COFI), and the Moving
Treasury Average (MTA), a 12-month moving
average of the monthly average yields of U.S.
Treasury securities adjusted to a constant maturity
of one year. The margin is the number of percentage
points a lender adds to the index value to calculate
the ARM interest rate at each adjustment period. In
different interest rate scenarios, the fully indexed
rate for an ARM loan based on a lagging index (e.g.,
MTA rate) may be significantly different from the
rate on a comparable 30-year fixed-rate product
adjusted to a constant maturity
of one year. The margin is the number of percentage
points a lender adds to the index value to calculate
the ARM interest rate at each adjustment period. In
different interest rate scenarios, the fully indexed
rate for an ARM loan based on a lagging index (e.g.,
MTA rate) may be significantly different from the
rate on a comparable 30-year fixed-rate product. In
these cases, a credible market rate should be used
to qualify the borrower and determine repayment
capacity.
6 The fully amortizing payment schedule should
be based on the term of the loan. For example, the
amortizing payment for a loan with a 5-year interest
only period and a 30-year term 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.
7 The balance that may accrue from the negative
amortization provision does not necessarily equate
to the full negative amortization cap for a particular
loan. The spread between the introductory or
‘‘teaser’’ rate and the accrual rate will determine
whether or not a loan balance has the potential to
reach the negative amortization cap before the end
of the initial payment option period (usually five
years). For example, a loan with a 115 percent
negative amortization cap but a small spread
between the introductory rate and the accrual rate
may only reach a 109 percent maximum loan
balance before the end of the initial payment option
period, even if only minimum payments are made.
The borrower could be qualified based on this
lower maximum loan balance.
8 A loan will not be determined to be ‘‘collateral-
dependent’’ solely through the use of reduced
documentation.
9 Interagency Guidance on Subprime Lending,
March 1, 1999, and Expanded Guidance for
Subprime Lending Programs, January 31, 2001
the initial payment option
period, even if only minimum payments are made.
The borrower could be qualified based on this
lower maximum loan balance.
8 A loan will not be determined to be ‘‘collateral-
dependent’’ solely through the use of reduced
documentation.
9 Interagency Guidance on Subprime Lending,
March 1, 1999, and Expanded Guidance for
Subprime Lending Programs, January 31, 2001.
Federally insured credit unions should refer to 04–
CU–12—Specialized Lending Activities (NCUA).
with high loan-to-value (LTV) ratios,
high debt-to-income (DTI) ratios, and
low credit scores. Recognizing that an
institution’s underwriting criteria are
based on multiple factors, an institution
should consider these factors jointly in
the qualification process and may
develop a range of reasonable tolerances
for each factor. However, the criteria
should be based upon prudent and
appropriate underwriting standards,
considering both the borrower’s
characteristics and the product’s
attributes.
For all nontraditional mortgage loan
products, an institution’s analysis of a
borrower’s repayment capacity should
include an evaluation of their ability to
repay the debt by final maturity at the
fully indexed rate,5 assuming a fully
amortizing repayment schedule.6 In
addition, for products that permit
negative amortization, the repayment
analysis should be based upon the
initial loan amount plus any balance
increase that may accrue from the
negative amortization provision.7
Furthermore, the analysis of
repayment capacity should avoid over-
reliance on credit scores as a substitute
for income verification in the
underwriting process. The higher a
loan’s credit risk, either from loan
features or borrower characteristics, the
more important it is to verify the
borrower’s income, assets, and
outstanding liabilities
ue from the
negative amortization provision.7
Furthermore, the analysis of
repayment capacity should avoid over-
reliance on credit scores as a substitute
for income verification in the
underwriting process. The higher a
loan’s credit risk, either from loan
features or borrower characteristics, the
more important it is to verify the
borrower’s income, assets, and
outstanding liabilities.
Collateral-Dependent Loans—
Institutions should avoid the use of loan
terms and underwriting practices that
may heighten the need for a borrower to
rely on the sale or refinancing of the
property once amortization begins.
Loans to individuals who do not
demonstrate the capacity to repay, as
structured, from sources other than the
collateral pledged are generally
considered unsafe and unsound.8
Institutions that originate collateral-
dependent mortgage loans may be
subject to criticism, corrective action,
and higher capital requirements.
Risk Layering—Institutions that
originate or purchase mortgage loans
that combine nontraditional features,
such as interest only loans with reduced
documentation or a simultaneous
second-lien loan, face increased risk.
When features are layered, an
institution should demonstrate that
mitigating factors support the
underwriting decision and the
borrower’s repayment capacity.
Mitigating factors could include higher
credit scores, lower LTV and DTI ratios,
significant liquid assets, mortgage
insurance or other credit enhancements.
While higher pricing is often used to
address elevated risk levels, it does not
replace the need for sound
underwriting.
Reduced Documentation—Institutions
increasingly rely on reduced
documentation, particularly unverified
income, to qualify borrowers for
nontraditional mortgage loans. Because
these practices essentially substitute
assumptions and unverified information
for analysis of a borrower’s repayment
capacity and general creditworthiness,
they should be used with caution
d for sound
underwriting.
Reduced Documentation—Institutions
increasingly rely on reduced
documentation, particularly unverified
income, to qualify borrowers for
nontraditional mortgage loans. Because
these practices essentially substitute
assumptions and unverified information
for analysis of a borrower’s repayment
capacity and general creditworthiness,
they should be used with caution. As
the level of credit risk increases, the
Agencies expect an institution to more
diligently verify and document a
borrower’s income and debt reduction
capacity. Clear policies should govern
the use of reduced documentation. For
example, stated income should be
accepted only if there are mitigating
factors that clearly minimize the need
for direct verification of repayment
capacity. For many borrowers,
institutions generally should be able to
readily document income using recent
W–2 statements, pay stubs, or tax
returns.
Simultaneous Second-Lien Loans—
Simultaneous second-lien loans reduce
owner equity and increase credit risk.
Historically, as combined loan-to-value
ratios rise, so do defaults. A delinquent
borrower with minimal or no equity in
a property may have little incentive to
work with a lender to bring the loan
current and avoid foreclosure. In
addition, second-lien home equity lines
of credit (HELOCs) typically increase
borrower exposure to increasing interest
rates and monthly payment burdens.
Loans with minimal or no owner equity
generally should not have a payment
structure that allows for delayed or
negative amortization without other
significant risk mitigating factors.
Introductory Interest Rates—Many
institutions offer introductory interest
rates set well below the fully indexed
rate as a marketing tool for payment
option ARM products. When developing
nontraditional mortgage product terms,
an institution should consider the
spread between the introductory rate
and the fully indexed rate
e amortization without other
significant risk mitigating factors.
Introductory Interest Rates—Many
institutions offer introductory interest
rates set well below the fully indexed
rate as a marketing tool for payment
option ARM products. When developing
nontraditional mortgage product terms,
an institution should consider the
spread between the introductory rate
and the fully indexed rate. Since initial
and subsequent monthly payments are
based on these low introductory rates, a
wide initial spread means that
borrowers are more likely to experience
negative amortization, severe payment
shock, and an earlier-than-scheduled
recasting of monthly payments.
Institutions should minimize the
likelihood of disruptive early recastings
and extraordinary payment shock when
setting introductory rates.
Lending to Subprime Borrowers—
Mortgage programs that target subprime
borrowers through tailored marketing,
underwriting standards, and risk
selection should follow the applicable
interagency guidance on subprime
lending.9 Among other things, the
subprime guidance discusses
circumstances under which subprime
lending can become predatory or
abusive. Institutions designing
nontraditional mortgage loans for
subprime borrowers should pay
particular attention to this guidance.
They should also recognize that risk-
layering features in loans to subprime
borrowers may significantly increase
risks for both the institution and the
borrower.
Non-Owner-Occupied Investor
Loans—Borrowers financing non-owner-
occupied investment properties should
qualify for loans based on their ability
to service the debt over the life of the
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ncrease
risks for both the institution and the
borrower.
Non-Owner-Occupied Investor
Loans—Borrowers financing non-owner-
occupied investment properties should
qualify for loans based on their ability
to service the debt over the life of the
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58615
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10 Federally insured credit unions must comply
with 12 CFR part 723 for loans meeting the
definition of member business loans.
11 Refer to OCC Bulletin 2001–47—Third-Party
Relationships and AL 2000–9—Third-Party Risk
(OCC). Federally insured credit unions should refer
to 01–CU–20 (NCUA), Due Diligence over Third
Party Service Providers. Savings associations
should refer to OTS Thrift Bulletin 82a—Third
Party Arrangements.
12 Refer to ‘‘Interagency Questions and Answers
on Capital Treatment of Recourse, Direct Credit
Substitutes, and Residual Interests in Asset
Securitizations’’, May 23, 2002; OCC Bulletin 2002–
22 (OCC); SR letter 02–16 (Board); Financial
Institution Letter (FIL–54–2002) (FDIC); and CEO
Letter 163 (OTS). See OCC’s Comptroller Handbook
for Asset Securitization, November 1997. See OTS
Examination Handbook Section 221, Asset-Backed
Securitization. The Board also addressed risk
management and capital adequacy of exposures
arising from secondary market credit activities in
SR letter 97–21. Federally insured credit unions
should refer to 12 CFR Part 702 (NCUA).
loan. Loan terms should reflect an
appropriate combined LTV ratio that
considers the potential for negative
amortization and maintains sufficient
borrower equity over the life of the loan
lso addressed risk
management and capital adequacy of exposures
arising from secondary market credit activities in
SR letter 97–21. Federally insured credit unions
should refer to 12 CFR Part 702 (NCUA).
loan. Loan terms should reflect an
appropriate combined LTV ratio that
considers the potential for negative
amortization and maintains sufficient
borrower equity over the life of the loan.
Further, underwriting standards should
require evidence that the borrower has
sufficient cash reserves to service the
loan, considering the possibility of
extended periods of property vacancy
and the variability of debt service
requirements associated with
nontraditional mortgage loan
products.10
Portfolio and Risk Management
Practices
Institutions should ensure that risk
management practices keep pace with
the growth and changing risk profile of
their nontraditional mortgage loan
portfolios and changes in the market.
Active portfolio management is
especially important for institutions that
project or have already experienced
significant growth or concentration
levels. Institutions that originate or
invest in nontraditional mortgage loans
should adopt more robust risk
management practices and manage these
exposures in a thoughtful, systematic
manner. To meet these expectations,
institutions should:
• Develop written policies that
specify acceptable product attributes,
production and portfolio limits, sales
and securitization practices, and risk
management expectations;
• Design enhanced performance
measures and management reporting
that provide early warning for
increasing risk;
• Establish appropriate ALLL levels
that consider the credit quality of the
portfolio and conditions that affect
collectibility; and
• Maintain capital at levels that
reflect portfolio characteristics and the
effect of stressed economic conditions
on collectibility. Institutions should
hold capital commensurate with the risk
characteristics of their nontraditional
mortgage loan portfolios
Establish appropriate ALLL levels
that consider the credit quality of the
portfolio and conditions that affect
collectibility; and
• Maintain capital at levels that
reflect portfolio characteristics and the
effect of stressed economic conditions
on collectibility. Institutions should
hold capital commensurate with the risk
characteristics of their nontraditional
mortgage loan portfolios.
Policies—An institution’s policies for
nontraditional mortgage lending activity
should set acceptable levels of risk
through its operating practices,
accounting procedures, and policy
exception tolerances. Policies should
reflect appropriate limits on risk
layering and should include risk
management tools for risk mitigation
purposes. Further, an institution should
set growth and volume limits by loan
type, with special attention for products
and product combinations in need of
heightened attention due to easing terms
or rapid growth.
Concentrations—Institutions with
concentrations in nontraditional
mortgage products should have well-
developed monitoring systems and risk
management practices. Monitoring
should keep track of concentrations in
key portfolio segments such as loan
types, third-party originations,
geographic area, and property
occupancy status. Concentrations also
should be monitored by key portfolio
characteristics such as loans with high
combined LTV ratios, loans with high
DTI ratios, loans with the potential for
negative amortization, loans to
borrowers with credit scores below
established thresholds, loans with risk-
layered features, and non-owner-
occupied investor loans. Further,
institutions should consider the effect of
employee incentive programs that could
produce higher concentrations of
nontraditional mortgage loans.
Concentrations that are not effectively
managed will be subject to elevated
supervisory attention and potential
examiner criticism to ensure timely
remedial action
s with risk-
layered features, and non-owner-
occupied investor loans. Further,
institutions should consider the effect of
employee incentive programs that could
produce higher concentrations of
nontraditional mortgage loans.
Concentrations that are not effectively
managed will be subject to elevated
supervisory attention and potential
examiner criticism to ensure timely
remedial action.
Controls—An institution’s quality
control, compliance, and audit
procedures should focus on mortgage
lending activities posing high risk.
Controls to monitor compliance with
underwriting standards and exceptions
to those standards are especially
important for nontraditional loan
products. The quality control function
should regularly review a sample of
nontraditional mortgage loans from all
origination channels and a
representative sample of underwriters to
confirm that policies are being followed.
When control systems or operating
practices are found deficient, business-
line managers should be held
accountable for correcting deficiencies
in a timely manner. Since many
nontraditional mortgage loans permit a
borrower to defer principal and, in some
cases, interest payments for extended
periods, institutions should have strong
controls over accruals, customer service
and collections. Policy exceptions made
by servicing and collections personnel
should be carefully monitored to
confirm that practices such as re-aging,
payment deferrals, and loan
modifications are not inadvertently
increasing risk. Customer service and
collections personnel should receive
product-specific training on the features
and potential customer issues with
these products.
Third-Party Originations—Institutions
often use third parties, such as mortgage
brokers or correspondents, to originate
nontraditional mortgage loans.
Institutions should have strong systems
and controls in place for establishing
and maintaining relationships with
third parties, including procedures for
performing due diligence
features
and potential customer issues with
these products.
Third-Party Originations—Institutions
often use third parties, such as mortgage
brokers or correspondents, to originate
nontraditional mortgage loans.
Institutions should have strong systems
and controls in place for establishing
and maintaining relationships with
third parties, including procedures for
performing due diligence. Oversight of
third parties should involve monitoring
the quality of originations so that they
reflect the institution’s lending
standards and compliance with
applicable laws and regulations.
Monitoring procedures should track
the quality of loans by both origination
source and key borrower characteristics.
This will help institutions identify
problems such as early payment
defaults, incomplete documentation,
and fraud. If appraisal, loan
documentation, credit problems or
consumer complaints are discovered,
the institution should take immediate
action. Remedial action could include
more thorough application reviews,
more frequent re-underwriting, or even
termination of the third-party
relationship.11
Secondary Market Activity—The
sophistication of an institution’s
secondary market risk management
practices should be commensurate with
the nature and volume of activity.
Institutions with significant secondary
market activities should have
comprehensive, formal strategies for
managing risks.12 Contingency planning
should include how the institution will
respond to reduced demand in the
secondary market.
While third-party loan sales can
transfer a portion of the credit risk, an
institution remains exposed to
reputation risk when credit losses on
sold mortgage loans or securitization
transactions exceed expectations. As a
result, an institution may determine that
it is necessary to repurchase defaulted
mortgages to protect its reputation and
maintain access to the markets
econdary market.
While third-party loan sales can
transfer a portion of the credit risk, an
institution remains exposed to
reputation risk when credit losses on
sold mortgage loans or securitization
transactions exceed expectations. As a
result, an institution may determine that
it is necessary to repurchase defaulted
mortgages to protect its reputation and
maintain access to the markets. In the
agencies’ view, the repurchase of
mortgage loans beyond the selling
institution’s contractual obligation is
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13 Refer to 12 CFR part 3 Appendix A, Section 4
(OCC); 12 CFR parts 208 and 225, Appendix A,
III.B.3 (FRB); 12 CFR part 325, Appendix A, II.B
(FDIC); 12 CFR 567 (OTS); and 12 CFR part 702
(NCUA) for each Agency’s capital treatment of
recourse.
14 Refer to the ‘‘Interagency Advisory on Mortgage
Banking’’, February 25, 2003, issued by the bank
and thrift regulatory agencies. Federally Insured
Credit Unions with assets of $10 million or more
are reminded they must report and value
nontraditional mortgages and related mortgage
servicing rights, if any, consistent with generally
accepted accounting principles in the Call Reports
they file with the NCUA Board.
implicit recourse. Under the agencies’
risk-based capital rules, a repurchasing
institution would be required to
maintain risk-based capital against the
entire pool or securitization.13
Institutions should familiarize
themselves with these guidelines before
deciding to support mortgage loan pools
or buying back loans in default.
Management Information and
Reporting—Reporting systems should
allow management to detect changes in
the risk profile of its nontraditional
mortgage loan portfolio
uired to
maintain risk-based capital against the
entire pool or securitization.13
Institutions should familiarize
themselves with these guidelines before
deciding to support mortgage loan pools
or buying back loans in default.
Management Information and
Reporting—Reporting systems should
allow management to detect changes in
the risk profile of its nontraditional
mortgage loan portfolio. The structure
and content should allow the isolation
of key loan products, risk-layering loan
features, and borrower characteristics.
Reporting should also allow
management to recognize deteriorating
performance in any of these areas before
it has progressed too far. At a minimum,
information should be available by loan
type (e.g., interest-only mortgage loans
and payment option ARMs); by risk-
layering features (e.g., payment option
ARM with stated income and interest-
only mortgage loans with simultaneous
second-lien mortgages); by underwriting
characteristics (e.g., LTV, DTI, and
credit score); and by borrower
performance (e.g., payment patterns,
delinquencies, interest accruals, and
negative amortization).
Portfolio volume and performance
should be tracked against expectations,
internal lending standards and policy
limits. Volume and performance
expectations should be established at
the subportfolio and aggregate portfolio
levels. Variance analyses should be
performed regularly to identify
exceptions to policies and prescribed
thresholds. Qualitative analysis should
occur when actual performance deviates
from established policies and
thresholds. Variance analysis is critical
to the monitoring of a portfolio’s risk
characteristics and should be an integral
part of establishing and adjusting risk
tolerance levels.
Stress Testing—Based on the size and
complexity of their lending operations,
institutions should perform sensitivity
analysis on key portfolio segments to
identify and quantify events that may
increase risks in a segment or the entire
portfolio
ical
to the monitoring of a portfolio’s risk
characteristics and should be an integral
part of establishing and adjusting risk
tolerance levels.
Stress Testing—Based on the size and
complexity of their lending operations,
institutions should perform sensitivity
analysis on key portfolio segments to
identify and quantify events that may
increase risks in a segment or the entire
portfolio. The scope of the analysis
should generally include stress tests on
key performance drivers such as interest
rates, employment levels, economic
growth, housing value fluctuations, and
other factors beyond the institution’s
immediate control. Stress tests typically
assume rapid deterioration in one or
more factors and attempt to estimate the
potential influence on default rates and
loss severity. Stress testing should aid
an institution in identifying, monitoring
and managing risk, as well as
developing appropriate and cost-
effective loss mitigation strategies. The
stress testing results should provide
direct feedback in determining
underwriting standards, product terms,
portfolio concentration limits, and
capital levels.
Capital and Allowance for Loan and
Lease Losses—Institutions should
establish an appropriate allowance for
loan and lease losses (ALLL) for the
estimated credit losses inherent in their
nontraditional mortgage loan portfolios.
They should also consider the higher
risk of loss posed by layered risks when
establishing their ALLL.
Moreover, institutions should
recognize that their limited performance
history with these products, particularly
in a stressed environment, increases
performance uncertainty. Capital levels
should be commensurate with the risk
characteristics of the nontraditional
mortgage loan portfolios. Lax
underwriting standards or poor portfolio
performance may warrant higher capital
levels
r ALLL.
Moreover, institutions should
recognize that their limited performance
history with these products, particularly
in a stressed environment, increases
performance uncertainty. Capital levels
should be commensurate with the risk
characteristics of the nontraditional
mortgage loan portfolios. Lax
underwriting standards or poor portfolio
performance may warrant higher capital
levels.
When establishing an appropriate
ALLL and considering the adequacy of
capital, institutions should segment
their nontraditional mortgage loan
portfolios into pools with similar credit
risk characteristics. The basic segments
typically include collateral and loan
characteristics, geographic
concentrations, and borrower qualifying
attributes. Segments could also
differentiate loans by payment and
portfolio characteristics, such as loans
on which borrowers usually make only
minimum payments, mortgages with
existing balances above original
balances, and mortgages subject to
sizable payment shock. The objective is
to identify credit quality indicators that
affect collectibility for ALLL
measurement purposes. In addition,
understanding characteristics that
influence expected performance also
provides meaningful information about
future loss exposure that would aid in
determining adequate capital levels.
Institutions with material mortgage
banking activities and mortgage
servicing assets should apply sound
practices in valuing the mortgage
servicing rights for nontraditional
mortgages. In accordance with
interagency guidance, the valuation
process should follow generally
accepted accounting principles and use
reasonable and supportable
assumptions.14
Consumer Protection Issues
While nontraditional mortgage loans
provide flexibility for consumers, the
Agencies are concerned that consumers
may enter into these transactions
without fully understanding the product
terms
In accordance with
interagency guidance, the valuation
process should follow generally
accepted accounting principles and use
reasonable and supportable
assumptions.14
Consumer Protection Issues
While nontraditional mortgage loans
provide flexibility for consumers, the
Agencies are concerned that consumers
may enter into these transactions
without fully understanding the product
terms. Nontraditional mortgage products
have been advertised and promoted
based on their affordability in the near
term; that is, their lower initial monthly
payments compared with traditional
types of mortgages. In addition to
apprising consumers of the benefits of
nontraditional mortgage products,
institutions should take appropriate
steps to alert consumers to the risks of
these products, including the likelihood
of increased future payment obligations.
This information should be provided in
a timely manner—before disclosures
may be required under the Truth in
Lending Act or other laws—to assist the
consumer in the product selection
process.
Concerns and Objectives—More than
traditional ARMs, mortgage products
such as payment option ARMs and
interest-only mortgages can carry a
significant risk of payment shock and
negative amortization that may not be
fully understood by consumers. For
example, consumer payment obligations
may increase substantially at the end of
an interest-only period or upon the
‘‘recast’’ of a payment option ARM. The
magnitude of these payment increases
may be affected by factors such as the
expiration of promotional interest rates,
increases in the interest rate index, and
negative amortization. Negative
amortization also results in lower levels
of home equity as compared to a
traditional amortizing mortgage product.
When borrowers go to sell or refinance
the property, they may find that
negative amortization has substantially
reduced or eliminated their equity in it
even when the property has
appreciated
t rates,
increases in the interest rate index, and
negative amortization. Negative
amortization also results in lower levels
of home equity as compared to a
traditional amortizing mortgage product.
When borrowers go to sell or refinance
the property, they may find that
negative amortization has substantially
reduced or eliminated their equity in it
even when the property has
appreciated. The concern that
consumers may not fully understand
these products would be exacerbated by
marketing and promotional practices
that emphasize potential benefits
without also providing clear and
balanced information about material
risks.
In light of these considerations,
communications with consumers,
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15 These program disclosures apply to ARM
products and must be provided at the time an
application is provided or before the consumer pays
a nonrefundable fee, whichever is earlier.
16 The OCC, the Board, and the FDIC enforce this
provision under the FTC Act and section 8 of the
FDI Act. Each of these agencies has also 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; Joint Board and
FDIC Guidance on Unfair or Deceptive Acts or
Practices by State-Chartered Banks, March 11, 2004.
Federally insured credit unions are prohibited 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 740.2
nfair or Deceptive
Acts or Practices, March 22, 2002; Joint Board and
FDIC Guidance on Unfair or Deceptive Acts or
Practices by State-Chartered Banks, March 11, 2004.
Federally insured credit unions are prohibited 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 740.2. The OTS also has 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. This regulation
supplements its authority under the FTC Act.
17 Institutions also should review the
recommendations relating to mortgage lending
practices set forth in other supervisory guidance
from their respective primary regulators, as
applicable, including guidance on abusive lending
practices.
18 Institutions also should strive to: (1) Focus on
information important to consumer decision
making; (2) highlight key information so that it will
be noticed; (3) employ a user-friendly and readily
navigable format for presenting the information;
and (4) use plain language, with concrete and
realistic examples. Comparative tables and
information describing key features of available
loan products, including reduced documentation
programs, also may be useful for consumers
considering the nontraditional mortgage products
and other loan features described in this guidance.
19 Institutions may not be able to incorporate all
of the practices recommended in this guidance
when advertising nontraditional mortgages through
certain forms of media, such as radio, television, or
billboards. Nevertheless, institutions should
provide clear and balanced information about the
risks of these products in all forms of advertising.
20 Consumers also should be apprised of other
material changes in payment obligations, such as
balloon payments
recommended in this guidance
when advertising nontraditional mortgages through
certain forms of media, such as radio, television, or
billboards. Nevertheless, institutions should
provide clear and balanced information about the
risks of these products in all forms of advertising.
20 Consumers also should be apprised of other
material changes in payment obligations, such as
balloon payments.
21 Federal credit unions are prohibited from
imposing prepayment penalties. 12 CFR
701.21(c)(6).
including advertisements, oral
statements, promotional materials, and
monthly statements, should provide
clear and balanced information about
the relative benefits and risks of these
products, including the risk of payment
shock and the risk of negative
amortization. Clear, balanced, and
timely communication to consumers of
the risks of these products will provide
consumers with useful information at
crucial decision-making points, such as
when they are shopping for loans or
deciding which monthly payment
amount to make. Such communication
should help minimize potential
consumer confusion and complaints,
foster good customer relations, and
reduce legal and other risks to the
institution.
Legal Risks—Institutions that offer
nontraditional mortgage products must
ensure that they do so in a manner that
complies with all applicable laws and
regulations. With respect to the
disclosures and other information
provided to consumers, applicable laws
and regulations include the following:
• Truth in Lending Act (TILA) and its
implementing regulation, Regulation Z.
• Section 5 of the Federal Trade
Commission Act (FTC Act). TILA and
Regulation Z contain rules governing
disclosures that institutions must
provide for closed-end mortgages in
advertisements, with an application,15
before loan consummation, and when
interest rates change
s
and regulations include the following:
• Truth in Lending Act (TILA) and its
implementing regulation, Regulation Z.
• Section 5 of the Federal Trade
Commission Act (FTC Act). TILA and
Regulation Z contain rules governing
disclosures that institutions must
provide for closed-end mortgages in
advertisements, with an application,15
before loan consummation, and when
interest rates change. Section 5 of the
FTC Act prohibits unfair or deceptive
acts or practices.16
Other Federal laws, including the fair
lending laws and the Real Estate
Settlement Procedures Act (RESPA),
also apply to these transactions.
Moreover, the Agencies note that the
sale or securitization of a loan may not
affect an institution’s potential liability
for violations of TILA, RESPA, the FTC
Act, or other laws in connection with its
origination of the loan. State laws,
including laws regarding unfair or
deceptive acts or practices, also may
apply.
Recommended Practices
Recommended practices for
addressing the risks raised by
nontraditional mortgage products
include the following:17
Communications with Consumers—
When promoting or describing
nontraditional mortgage products,
institutions should provide consumers
with information that is designed to
help them make informed decisions
when selecting and using these
products. Meeting this objective
requires appropriate attention to the
timing, content, and clarity of
information presented to consumers.
Thus, institutions should provide
consumers with information at a time
that will help consumers select products
and choose among payment options
ers
with information that is designed to
help them make informed decisions
when selecting and using these
products. Meeting this objective
requires appropriate attention to the
timing, content, and clarity of
information presented to consumers.
Thus, institutions should provide
consumers with information at a time
that will help consumers select products
and choose among payment options. For
example, institutions should offer clear
and balanced product descriptions
when a consumer is shopping for a
mortgage—such as when the consumer
makes an inquiry to the institution
about a mortgage product and receives
information about nontraditional
mortgage products, or when marketing
relating to nontraditional mortgage
products is provided by the institution
to the consumer—not just upon the
submission of an application or at
consummation.18 The provision of such
information would serve as an
important supplement to the disclosures
currently required under TILA and
Regulation Z or other laws.19
Promotional Materials and Product
Descriptions. Promotional materials and
other product descriptions should
provide information about the costs,
terms, features, and risks of
nontraditional mortgages that can assist
consumers in their product selection
decisions, including information about
the matters discussed below.
• Payment Shock. Institutions should
apprise consumers of potential increases
in payment obligations for these
products, including circumstances in
which interest rates or negative
amortization reach a contractual limit
, features, and risks of
nontraditional mortgages that can assist
consumers in their product selection
decisions, including information about
the matters discussed below.
• Payment Shock. Institutions should
apprise consumers of potential increases
in payment obligations for these
products, including circumstances in
which interest rates or negative
amortization reach a contractual limit.
For example, product descriptions
could state the maximum monthly
payment a consumer would be required
to pay under a hypothetical loan
example once amortizing payments are
required and the interest rate and
negative amortization caps have been
reached.20 Such information also could
describe when structural payment
changes will occur (e.g., when
introductory rates expire, or when
amortizing payments are required), and
what the new payment amount would
be or how it would be calculated. As
applicable, these descriptions could
indicate that a higher payment may be
required at other points in time due to
factors such as negative amortization or
increases in the interest rate index.
• Negative Amortization. When
negative amortization is possible under
the terms of a nontraditional mortgage
product, consumers should be apprised
of the potential for increasing principal
balances and decreasing home equity, as
well as other potential adverse
consequences of negative amortization.
For example, product descriptions
should disclose the effect of negative
amortization on loan balances and home
equity, and could describe the potential
consequences to the consumer of
making minimum payments that cause
the loan to negatively amortize. (One
possible consequence is that it could be
more difficult to refinance the loan or to
obtain cash upon a sale of the home).
• Prepayment Penalties
product descriptions
should disclose the effect of negative
amortization on loan balances and home
equity, and could describe the potential
consequences to the consumer of
making minimum payments that cause
the loan to negatively amortize. (One
possible consequence is that it could be
more difficult to refinance the loan or to
obtain cash upon a sale of the home).
• Prepayment Penalties. If the
institution may impose a penalty in the
event that the consumer prepays the
mortgage, consumers should be alerted
to this fact and to the need to ask the
lender about the amount of any such
penalty.21
• Cost of Reduced Documentation
Loans. If an institution offers both
reduced and full documentation loan
programs and there is a pricing
premium attached to the reduced
documentation program, consumers
should be alerted to this fact.
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22 For example, marketing materials for payment
option ARMs may promote low predictable
payments until the recast date. Such marketing
should be avoided in circumstances in which the
minimum payments are so low that negative
amortization caps would be reached and higher
payment obligations would be triggered before the
scheduled recast, even if interest rates remain
constant.
Monthly Statements on Payment
Option ARMs. Monthly statements that
are provided to consumers on payment
option ARMs should provide
information that enables consumers to
make informed payment choices,
including an explanation of each
payment option available and the
impact of that choice on loan balances.
For example, the monthly payment
statement should contain an
explanation, as applicable, next to the
minimum payment amount that making
this payment would result in an
increase to the consumer’s outstanding
loan balance
mation that enables consumers to
make informed payment choices,
including an explanation of each
payment option available and the
impact of that choice on loan balances.
For example, the monthly payment
statement should contain an
explanation, as applicable, next to the
minimum payment amount that making
this payment would result in an
increase to the consumer’s outstanding
loan balance. Payment statements also
could provide the consumer’s current
loan balance, what portion of the
consumer’s previous payment was
allocated to principal and to interest,
and, if applicable, the amount by which
the principal balance increased.
Institutions should avoid leading
payment option ARM borrowers to
select a non-amortizing or negatively-
amortizing payment (for example,
through the format or content of
monthly statements).
Practices to Avoid. Institutions also
should avoid practices that obscure
significant risks to the consumer. For
example, if an institution advertises or
promotes a nontraditional mortgage by
emphasizing the comparatively lower
initial payments permitted for these
loans, the institution also should
provide clear and comparably
prominent information alerting the
consumer to the risks. Such information
should explain, as relevant, that these
payment amounts will increase, that a
balloon payment may be due, and that
the loan balance will not decrease and
may even increase due to the deferral of
interest and/or principal payments.
Similarly, institutions should avoid
promoting payment patterns that are
structurally unlikely to occur.22 Such
practices could raise legal and other
risks for institutions, as described more
fully above
ent amounts will increase, that a
balloon payment may be due, and that
the loan balance will not decrease and
may even increase due to the deferral of
interest and/or principal payments.
Similarly, institutions should avoid
promoting payment patterns that are
structurally unlikely to occur.22 Such
practices could raise legal and other
risks for institutions, as described more
fully above.
Institutions also should avoid such
practices as: Giving consumers
unwarranted assurances or predictions
about the future direction of interest
rates (and, consequently, the borrower’s
future obligations); making one-sided
representations about the cash savings
or expanded buying power to be
realized from nontraditional mortgage
products in comparison with amortizing
mortgages; suggesting that initial
minimum payments in a payment
option ARM will cover accrued interest
(or principal and interest) charges; and
making misleading claims that interest
rates or payment obligations for these
products are ‘‘fixed’’.
Control Systems—Institutions should
develop and use strong control systems
to monitor whether actual practices are
consistent with their policies and
procedures relating to nontraditional
mortgage products. Institutions should
design control systems to address
compliance and consumer information
concerns as well as the safety and
soundness considerations discussed in
this guidance. Lending personnel
should be trained so that they are able
to convey information to consumers
about product terms and risks in a
timely, accurate, and balanced manner.
As products evolve and new products
are introduced, lending personnel
should receive additional training, as
necessary, to continue to be able to
convey information to consumers in this
manner. Lending personnel should be
monitored to determine whether they
are following these policies and
procedures. Institutions should review
consumer complaints to identify
potential compliance, reputation, and
other risks
new products
are introduced, lending personnel
should receive additional training, as
necessary, to continue to be able to
convey information to consumers in this
manner. Lending personnel should be
monitored to determine whether they
are following these policies and
procedures. Institutions should review
consumer complaints to identify
potential compliance, reputation, and
other risks. Attention should be paid to
appropriate legal review and to using
compensation programs that do not
improperly encourage lending
personnel to direct consumers to
particular products.
With respect to nontraditional
mortgage loans that an institution
makes, purchases, or services using a
third party, such as a mortgage broker,
correspondent, or other intermediary,
the institution should take appropriate
steps to mitigate risks relating to
compliance and consumer information
concerns discussed in this guidance.
These steps would ordinarily include,
among other things, (1) Conducting due
diligence and establishing other criteria
for entering into and maintaining
relationships with such third parties, (2)
establishing criteria for third-party
compensation designed to avoid
providing incentives for originations
inconsistent with this guidance, (3)
setting requirements for agreements
with such third parties, (4) establishing
procedures and systems to monitor
compliance with applicable agreements,
bank policies, and laws, and (5)
implementing appropriate corrective
actions in the event that the third party
fails to comply with applicable
agreements, bank policies, or laws.
Appendix: Terms Used in This
Document
Interest-only Mortgage Loan—A
nontraditional mortgage on which, for a
specified number of years (e.g., three or five
years), the borrower is required to pay only
the interest due on the loan during which
time the rate may fluctuate or may be fixed
ns in the event that the third party
fails to comply with applicable
agreements, bank policies, or laws.
Appendix: Terms Used in This
Document
Interest-only Mortgage Loan—A
nontraditional mortgage on which, for a
specified number of years (e.g., three or five
years), the borrower is required to pay only
the interest due on the loan during which
time the rate may fluctuate or may be fixed.
After the interest-only period, the rate may be
fixed or fluctuate based on the prescribed
index and payments include both principal
and interest.
Payment Option ARM—A nontraditional
mortgage that allows the borrower to choose
from a number of different payment options.
For example, each month, the borrower may
choose a minimum payment option based on
a ‘‘start’’ or introductory interest rate, an
interest-only payment option based on the
fully indexed interest rate, or a fully
amortizing principal and interest payment
option based on a 15-year or 30-year loan
term, plus any required escrow payments.
The minimum payment option can be less
than the interest accruing on the loan,
resulting in negative amortization. The
interest-only option avoids negative
amortization but does not provide for
principal amortization. After a specified
number of years, or if the loan reaches a
certain negative amortization cap, the
required monthly payment amount is recast
to require payments that will fully amortize
the outstanding balance over the remaining
loan term.
Reduced Documentation—A loan feature
that is commonly referred to as ‘‘low doc/no
doc’’, ‘‘no income/no asset’’, ‘‘stated income’’
or ‘‘stated assets’’. For mortgage loans with
this feature, an institution sets reduced or
minimal documentation standards to
substantiate the borrower’s income and
assets
payments that will fully amortize
the outstanding balance over the remaining
loan term.
Reduced Documentation—A loan feature
that is commonly referred to as ‘‘low doc/no
doc’’, ‘‘no income/no asset’’, ‘‘stated income’’
or ‘‘stated assets’’. For mortgage loans with
this feature, an institution sets reduced or
minimal documentation standards to
substantiate the borrower’s income and
assets.
Simultaneous Second-Lien Loan—A
lending arrangement where either a closed-
end second-lien or a home equity line of
credit (HELOC) is originated simultaneously
with the first lien mortgage loan, typically in
lieu of a higher down payment.
Dated: September 25, 2006.
John C. Dugan,
Comptroller of the Currency.
By order of the Board of Governors of the
Federal Reserve System, September 27, 2006.
Jennifer J. Johnson,
Secretary of the Board.
Dated at Washington, DC, this 27th day of
September, 2006.
Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
Dated: September 28, 2006.
By the Office of Thrift Supervision.
John M. Reich,
Director.
By the National Credit Union
Administration on September 28, 2006.
JoAnn M. Johnson,
Chairman.
[FR Doc. 06–8480 Filed 10–3–06; 8:45 am]
BILLING CODE 4810–33–P, 6210–01–P, 6714–01–P,
6720–01–P, 7535–01–P
VerDate Aug<31>2005
14:45 Oct 03, 2006
Jkt 211001
PO 00000
Frm 00043
Fmt 4703
Sfmt 4703
E:\FR\FM\04OCN1.SGM
04OCN1
rwilkins on PROD1PC63 with NOTICES

## Nearby sections

- [SR 00-3 (SUP) Information Technology Examination Frequency](https://www.frixlaw.com/law-library/statutes/FRB_SR0003.md)
- [SR 00-8 (SUP) Revised Uniform Retail Credit Classification and Account Management Policy](https://www.frixlaw.com/law-library/statutes/FRB_SR0008.md)
- [SR 00-9 (SPE) Supervisory Guidance on Equity Investment and Merchant Banking Activities](https://www.frixlaw.com/law-library/statutes/FRB_SR0009.md)
- [SR 00-13 (SUP) Framework for Financial Holding Company Supervision](https://www.frixlaw.com/law-library/statutes/FRB_SR0013.md)
- [SR 00-14 (SUP) Enhancements to the Interagency Program for Supervising the U.S. Operations of Foreign Banking Organizations](https://www.frixlaw.com/law-library/statutes/FRB_SR0014.md)
- [SR 01-4 (GEN) Subprime Lending](https://www.frixlaw.com/law-library/statutes/FRB_SR0104.md)
- [SR 01-5 (SUP) Examination of Fiduciary Activities](https://www.frixlaw.com/law-library/statutes/FRB_SR0105.md)
- [SR 01-11 (SUP) Identity Theft and Pretext Calling](https://www.frixlaw.com/law-library/statutes/FRB_SR0111.md)
- [SR 01-12 (SUP) Interagency Guidance on Loans Held for Sale](https://www.frixlaw.com/law-library/statutes/FRB_SR0112.md)
- [SR 01-14 (SUP) Joint Agency Advisory on Rate-Sensitive Deposits](https://www.frixlaw.com/law-library/statutes/FRB_SR0114.md)
- [SR 01-15 (SUP) Standards for Safeguarding Customer Information](https://www.frixlaw.com/law-library/statutes/FRB_SR0115.md)
- [SR 01-17 (SUP) Final Interagency Policy Statement on Allowance for Loan and Lease Losses (ALLL) Methodologies and Documentation for Banks and Savings Institutions](https://www.frixlaw.com/law-library/statutes/FRB_SR0117.md)
- [SR 01-21 (GEN) Communications with Foreign Bank Regulatory and Supervisory Authorities](https://www.frixlaw.com/law-library/statutes/FRB_SR0121.md)
- [SR 01-25 (GEN) Guidelines for Using External Experts on Examinations, Inspections, and Other Bank Supervision Matters](https://www.frixlaw.com/law-library/statutes/FRB_SR0125.md)

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Source: Frix Law Library, https://www.frixlaw.com/law-library/statutes/FRB_SR0615. Check the current official text before relying on it. Not legal advice.