Alternative Mortgage Products: Impact on Defaults Remains
Unclear, but Disclosure of Risks to Borrowers Could Be Improved
(20-SEP-06, GAO-06-1112T).
Alternative mortgage products (AMPs) can make homes more
affordable by allowing borrowers to defer repayment of principal
or part of the interest for the first few years of the mortgage.
Recent growth in AMP lending has heightened the importance of
borrowers' understanding and lenders' management of AMP risks.
GAO's report discusses the (1) recent trends in the AMP market,
(2) potential AMP risks for borrowers and lenders, (3) extent to
which mortgage disclosures discuss AMP risks, and (4) federal and
selected state regulatory response to AMP risks. GAO used
regulatory and industry data to analyze changes in AMP monthly
payments under various scenarios; reviewed available studies; and
interviewed relevant federal and state regulators and mortgage
industry groups, and consumer groups.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-06-1112T
ACCNO: A61191
TITLE: Alternative Mortgage Products: Impact on Defaults Remains
Unclear, but Disclosure of Risks to Borrowers Could Be Improved
DATE: 09/20/2006
SUBJECT: Consumer protection
Debt
Federal regulations
Homeowners loans
Housing
Information disclosure
Lending institutions
Loan defaults
Loan repayments
Mortgage interest rates
Mortgage loans
Risk assessment
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GAO-06-1112T
* Background
* AMP Lending Rapidly Grew and Borrower Characteristics Change
* Borrowers Could Face Payment Shock; Lenders Face Credit Risk
* Borrowers May Not Be Well-informed of AMP Risks and Mortgage
* Mortgage Advertising May Not Clearly or Effectively Explain
* Federal Disclosures May Not Clearly and Completely Explain A
* Federal Banking Regulators Issued Guidance, Sought Industry
* Most States in Our Sample Responded to AMP-Lending Risks wit
* GAO Contact and Staff Acknowledgments
* Order by Mail or Phone
Testimony
Before the Subcommittees on Housing and Transportation and Economic
Policy, Committee on Banking, Housing, and Urban Affairs, U.S. Senate
United States Government Accountability Office
GAO
For Release on Delivery Expected at 10:00 a.m. EDT
Wednesday, September 20, 2006
ALTERNATIVE MORTGAGE PRODUCTS
Impact on Defaults Remains Unclear, but Disclosure of Risks to Borrowers
Could Be Improved
Statement of Orice M. Williams, Director Financial Markets and Community
Investments
GAO-06-1112T
Chairmen and Members of the Subcommittees:
I am pleased to be here today to discuss our work on alternative mortgage
products (AMPs). As you know, an increasing number of borrowers have
turned to AMPs, such as interest-only and payment-option adjustable rate
mortgages (ARMs), to purchase homes they might not be able to afford with
conventional fixed-rate mortgage payments. These products initially keep
borrowers' payments low by allowing consumers in the short term to defer
principal payments or make payments that do not cover principal or all
accrued interest. However, unless the borrower refinances the mortgage or
sells the property, the monthly payments eventually will increase when the
interest-only and deferred payment periods end and higher, fully
amortizing payments begin.
My remarks will summarize the findings from the report being released
today, which was prepared at the request of the Chairman of the
Subcommittee on Housing and Transportation.1 Specifically, I will discuss:
(1) recent trends in the AMP market, (2) the impact of AMPs on borrowers
and on the safety and soundness of financial institutions, (3) the extent
to which mortgage disclosures discuss the risks of AMPs, (4) the federal
regulatory response to the risks of AMPs for lenders and borrowers, and
(5) selected state regulatory responses to the risks of AMPs for lenders
and borrowers. We gathered information from federal and state banking
regulators, consumer groups, and the mortgage industry on AMP-lending
trends and risks to borrowers and lenders, including laws and regulations
on mortgage disclosures. We also reviewed a sample of disclosures to
determine the extent to which they addressed AMP risks.
In summary, we found the following:
o AMP lending tripled over a 3-year period, and many borrowers
were using interest-only or payment-option adjustable-rate
products to purchase homes in high-priced markets. AMP lending has
been concentrated in the higher-priced regional markets on the
East and West Coasts in states such as California, Washington,
Virginia, and Maryland.
o Lenders may have increased risks to themselves and their
customers by relaxing underwriting standards and through
"risk-layering", which includes combining AMPs with less stringent
income and asset verification requirements or lending to borrowers
with lower credit scores and higher debt-to-income ratios.
However, it is too early to determine the extent to which high
foreclosure rates will result or whether lenders will be affected.
o A wider spectrum of borrowers that are now using AMPs may not
fully understand their risks because (1) AMP loans often have
complicated terms and features, (2) AMP advertising sometimes
emphasizes the benefits of AMPs over their risks, and (3) mortgage
disclosures can be unclearly written and may be hard to
understand. Moreover, current federal disclosure requirements do
not require lenders to address AMP-specific terms and risks.
o Federal banking regulators collectively responded to
AMP-lending concerns by issuing draft guidance that called for
tightened underwriting, enhanced risk-management policies, and
better information for consumers. Regulators also have
individually responded by monitoring AMP lending, beginning to
update the regulation governing mortgage disclosures, Regulation
Z, and reinforcing the message about managing AMP risks to the
mortgage industry.
o State regulators included in our review generally addressed
concerns about AMP lending through their licensing and examination
processes, although a few states have started to collect more
AMP-specific information as a prelude to other possible actions.
Given the complexity of AMPs and their more widespread use,
mortgage disclosures that can help borrowers make informed
decisions are important. Although federal banking regulators have
taken a range of proactive steps to address AMP lending, current
federal standards for disclosures do not require information on
AMP-specific risks. Therefore, we recommended in our report that
as the Federal Reserve Board reviews Regulation Z, it consider
improving the clarity and comprehensiveness of mortgage
disclosures by requiring language that explains key features and
potential risks specific to AMPs.
Background
Borrowers obtain residential mortgages through either mortgage
lenders or brokers. Mortgage lenders can be federally or
state-chartered banks or mortgage lending subsidiaries of these
banks or of bank holding companies. Independent lenders, which are
neither banks nor affiliates of banks, also may fund home loans to
borrowers. Mortgage brokers act as intermediaries between lenders
and borrowers, and for a fee, help connect borrowers with various
lenders that may provide a wider selection of mortgage products.
Federal banking regulators-Office of the Comptroller of the
Currency (OCC), the Board of Governors of the Federal Reserve
System (Federal Reserve), Federal Deposit Insurance Corporation
(FDIC), National Credit Union Administration (NCUA), and Office of
Thrift Supervision (OTS)-have, among other things, responsibility
for ensuring the safety and soundness of the institutions they
oversee. To pursue this goal, regulators establish capital
requirements for banks; conduct on-site examinations and off-site
monitoring to assess their financial conditions; and monitor their
compliance with applicable banking laws, regulations, and agency
guidance. As part of their examinations, for example, regulators
review mortgage lending practices, including underwriting,
risk-management, and portfolio management practices, and try to
determine the amount of risk lenders have assumed. From a safety
and soundness perspective, risk involves the potential that either
anticipated or unanticipated events may have an adverse impact on
a bank's capital or earnings. In mortgage lending, regulators pay
close attention to credit risk-that is the concerns that borrowers
may become delinquent or default on their mortgages and that
lenders may not be paid in full for the loans they have issued.
Certain federal consumer protection laws, including the Truth in
Lending Act and its implementing regulation, Regulation Z, apply
to all mortgage lenders and brokers that close loans in their own
names. Each lender's primary federal supervisory agency has
responsibility for enforcing Regulation Z and generally uses
examinations and consumer complaint investigations to check for
compliance with both the act and its regulation. In addition, the
Federal Trade Commission (FTC) is responsible for enforcing
certain federal consumer protection laws for brokers and lenders
that are not depository institutions, including state-chartered
independent mortgage lenders and mortgage lending subsidiaries of
financial holding companies. However, FTC is not a supervisory
agency. FTC uses a variety of information sources in the
enforcement process, including FTC investigations, consumer
complaints, and state and federal agencies.
State banking and financial regulators are responsible for
overseeing independent lenders and mortgage brokers and generally
do so through licensing that mandates certain experience,
education, and operations requirements to engage in mortgage
activities. States also may examine independent lenders and
mortgage brokers to ensure compliance with licensing requirements,
review their lending and brokerage functions, and look for unfair
or unethical business practices. In the event such practices or
consumer complaints occur, regulators and attorneys general may
pursue actions that include license suspension or revocation,
monetary fines, and lawsuits.
AMP Lending Rapidly Grew and Borrower Characteristics Changed as
Consumers Sought Mortgage Products That Increased Affordability
From 2003 through 2005, AMP lending grew rapidly, with
originations increasing threefold from less than 10 percent of
residential mortgages to about 30 percent. Most of the
originations during this period consisted of interest-only ARMs
and payment-option ARMs, and most of this lending occurred in
higher-priced regional markets concentrated on the East and West
Coasts. For example, based on data from mortgage securitizations
in 2005, about 47 percent of interest-only ARMs and 58 percent of
payment-option ARMs were originated in California, which contained
7 of the 20 highest-priced metropolitan real estate markets in the
country. On the East Coast, Virginia, Maryland, New Jersey, and
Florida as well as Washington, D.C., exhibited a high
concentration of AMP lending in 2005. Other examples of states
with high concentrations of AMP lending include Washington,
Nevada, and Arizona. These areas also experienced higher rates of
home price appreciation during this period than the rest of the
United States.
In addition to this growth, the characteristics of AMP borrowers
have changed. Historically, AMP borrowers consisted of wealthy and
financially sophisticated borrowers who used these specialized
products as financial management tools. However, today a wider
range of borrowers use AMPs as affordability products to purchase
homes that might otherwise be unaffordable using conventional
fixed-rate mortgages.
Borrowers Could Face Payment Shock; Lenders Face Credit Risk but
Appear to Be Taking Steps to Manage the Risk
Although AMPs have increased affordability for some borrowers,
they could lead to increased payments or "payment shock" for
borrowers and corresponding credit risk for lenders. Unless the
mortgages are refinanced or the properties sold, AMPs eventually
reach points when interest-only and deferred payment periods end
and higher, fully amortizing payments begin. Regulators and
consumer advocates have expressed concern that some borrowers
might not be able to afford these higher monthly payments. To
illustrate this point, we simulated what would happen to a
borrower in 2004 that made minimum monthly payments on a $400,000
payment-option ARM. As figure 1 shows, the borrower could see
payments rise from $1,287 to $2,931, or 128 percent, at the end of
the 5-year payment-option period.2 In addition, with a wider range
of AMP borrowers now than in the past, those with fewer financial
resources or limited equity in their homes might find refinancing
their mortgages or selling their homes difficult, particularly if
their loans have negatively amortized or their homes have not
appreciated in value.
Figure 1: Increase in Minimum Monthly Payments and Outstanding
Loan Balance with an April 2004 $400,000 Payment-Option ARM,
Assuming Rising Interest Rates
In addition, borrowers who cannot afford higher payments and may
become delinquent or default on their mortgages may pose credit
risks to lenders because these borrowers may not repay their loans
in full. Lenders also may have increased risks to themselves and
their customers by relaxing underwriting standards and through
risk-layering. For example, some lenders combined AMPs with less
stringent income and asset verification requirements than
traditionally permitted for these products or lent to borrowers
with lower credit scores and higher debt-to-income ratios.
Although regulatory officials have expressed concerns about AMP
risks and underwriting practices, they said that banks and lenders
generally have taken steps to manage the resulting credit risk.
Federal and state banking regulatory officials and lenders with
whom we spoke said most banks have diversified their assets to
manage the credit risk of AMPs held in their portfolios, or have
reduced their risk through loan sales or securitization. In
addition, federal regulatory officials told us that while
underwriting trends may have loosened over time, lenders have
generally attempted to mitigate their risk from AMP lending. For
example, OCC and Federal Reserve officials told us that most
lenders qualify payment-option ARM borrowers at fully indexed
rates, not at introductory interest rates, to help ensure that
borrowers have financial resources to manage future mortgage
increases, or to pay more on their mortgages than the minimum
monthly payment. OCC officials also said that some lenders may
mitigate risk by having some stricter criteria for AMPs than for
traditional mortgages for some elements of their underwriting
standards. Although we are encouraged by these existing risk
mitigation and management strategies, most AMPs issued between
2003 and 2005, however, have not reset to require fully amortizing
payments, and it is too soon to tell how many borrowers will
eventually experience payment shock or financial distress. As
such, in our report we agree with federal regulatory officials and
industry participants that it was too soon to tell the extent to
which AMP risks may result in delinquencies and foreclosures for
borrowers and losses for banks that hold AMPs in their portfolios.
However, we noted that past experience with these products may not
be a good indicator for future AMP performance because the
characteristics of AMP borrowers have changed.
Borrowers May Not Be Well-informed of AMP Risks and Mortgage
Disclosures May Not Effectively Describe These Risks to Consumers
Regulatory officials and consumer advocates expressed concern that
some AMP borrowers may not be well-informed about the terms and
risks of their complex AMP loans. Obstacles to understanding these
products include advertising that may not clearly or effectively
convey AMP risks, and federal mortgage disclosure requirements
that do not require lenders to tailor disclosures to the specific
risks of AMPs to borrowers.
Mortgage Advertising May Not Clearly or Effectively Explain AMP Risks
Marketing materials that we reviewed indicated that advertising by
lenders and brokers may not clearly provide information to inform
consumers about the potential risks of AMPs. For example, one
advertisement we reviewed promoted a low initial interest rate and
low monthly mortgage payments without clarifying that the low
interest rate would not last the full term of the loan.
In other cases, promotional materials emphasized the benefits of
AMPs without effectively explaining the associated risks. Some
advertising, for example, emphasized loans with low monthly
payment options without effectively disclosing the possibility of
interest rate changes or mortgage payment increases. One print
advertisement we reviewed for a payment-option ARM emphasized the
benefit of a low initial interest rate but noted in small print on
its second page that the low initial rate applied only to the
first month of the loan and could increase or decrease thereafter.
Federal Disclosures May Not Clearly and Completely Explain AMP
Specific Risks
Regulatory officials noted that current Regulation Z requirements
address traditional fixed-rate and adjustable-rate products, but
not more complex products such as AMPs that feature risks such as
negative amortization and payment shock. To better understand the
quality of AMP disclosures, we reviewed eight interest-only and
payment-option ARM disclosures provided to borrowers from
federally regulated lenders. These disclosures were provided to
borrowers between 2004 and 2006 by six federally regulated lenders
that collectively made over 25 percent of the interest-only and
payment option ARMs produced in 2005.We found that these
disclosures addressed current Regulation Z requirements, but some
did not provide full and clear explanations of AMP risks such as
negative
amortization or payment shock. For example, as shown in figure 2,
the disclosure simply states that monthly payments could increase
or decrease on the basis of interest rate changes, which may be
sufficient for a traditional ARM product, but does not inform
borrowers about the potential magnitude of payment change, which
may be more relevant for certain AMPs. In addition, most of the
disclosures we reviewed did not explain that negative
amortization, particularly in a rising interest rate environment,
could cause AMP loans to reset more quickly than borrowers
anticipated and require higher monthly mortgage payments sooner
than expected.
Figure 2: Example of 2005 Interest-only ARM Disclosure Explaining
How Monthly Payments Can Change
In addition, the AMP disclosures generally did not conform to
leading practices in the federal government, such as key "plain
English" principles for readability or design. For example, the
Securities and Exchange Commission's "A Plain English Handbook:
How to Create Clear SEC Disclosure Documents (1998)" offered
guidance for developing clearly written investment product
disclosures and presenting information in visually effective and
readable ways. The sample disclosures we reviewed, however, were
generally written with language too complex for many adults to
fully understand. Most of the disclosures also used small,
hard-to-read typeface, which when combined with an ineffective use
of white space and headings, made them even more difficult to read
and buried key information.
Federal Banking Regulators Issued Guidance, Sought Industry
Comments, and Took Other Actions to Respond to Concerns about AMP
Lending
Federal banking regulators have taken a range of actions-including
issuing draft interagency guidance, seeking industry comments,
reinforcing messages about AMP risks and guidance principles in
many forums, and taking other individual regulatory actions-to
respond to concerns about the growth and risks of AMP lending.
Federal banking regulators issued draft interagency guidance in
December 2005 that recommended prudent underwriting, portfolio and
risk management, and information disclosure practices related to
AMP lending. The draft guidance calls for lenders to consider the
potential impact of payment shock on borrowers' capacity to repay
their mortgages and to qualify borrowers on their ability to make
fully amortizing payments on the basis of fully indexed interest
rates. It also recommends that lenders develop written policies
and procedures that describe portfolio limits, mortgage sales and
securitization practices, and risk-management expectations. In
addition, to improve consumer understanding of AMPs, the draft
guidance suggests that lender communications with borrowers,
including advertisements and promotional materials, be consistent
with actual product terms, and that institutions avoid practices
that might obscure the risks of AMPs to borrowers. When finalized,
the guidance will apply to all federally regulated financial
institutions.3
During the public comment period for the guidance, lenders and
others suggested in their letters that the stricter underwriting
recommendations were overly prescriptive and might put federally
and state-regulated banks at a competitive disadvantage because
the guidance would not apply to independent mortgage lenders or
brokers. Lenders said that this could result in fewer mortgage
choices for consumers. Consumer advocates questioned whether the
guidance would actually help protect consumers. They noted that
guidance might be difficult to enforce because it does not carry
the same force as law or regulation. Federal banking regulatory
officials are using these comments as they finalize the guidance.
Even before drafting the guidance, federal regulatory officials
had publicly reinforced their concerns about AMPs in speeches, at
conferences, and through the media. According to a Federal Reserve
official, these actions have raised awareness of AMP issues and
reinforced the message that financial institutions and the general
public need to manage risks and understand these products.
Some regulatory officials have also taken agency-specific steps to
address AMP lending, including reviewing high-risk lending, which
would include AMPs, and improving consumer education about AMP
risks. For example, FDIC officials told us that they have
developed a review program to identify high-risk lending areas and
evaluate risk management and underwriting approaches. NCUA
officials said that they have informally contacted their largest
credit unions to assess the extent of AMP lending at these
institutions. OTS officials said that they have performed a review
of OTS's 68 most active AMP lenders to assess and respond to
potential AMP lending risks and OCC have begun to conduct reviews
of their lenders' AMP promotional and marketing materials to
assess how well they inform consumers. In response to concerns
about disclosures, the Federal Reserve officials told us that they
initiated a review of Regulation Z that includes reviewing the
disclosures required for all mortgage loans, including AMPs, and
have begun taking steps to consider disclosure revisions. During
the summer of 2006, the Federal Reserve held hearings across the
country on home-equity lending, AMP issues, and the adequacy of
consumer disclosures for mortgage products. According to Federal
Reserve officials, the Federal Reserve is currently reviewing the
hearing transcripts and public comment letters to help develop
plans and recommendations for revising Regulation Z. In addition,
they said that they are currently revising their consumer handbook
on ARM loans, known as the CHARM booklet, to include information
about AMPs. Finally, in May 2006, FTC officials said that they
sponsored a public workshop that explored consumer protection
issues as a result of AMP growth in the mortgage marketplace and
worked with federal banking regulators and other federal
departments to create a brochure to assist consumers with mortgage
information.
Most States in Our Sample Responded to AMP-Lending Risks within
Existing Regulatory Frameworks, While Others Have Taken Additional
Actions
State banking and financial regulatory officials from the eight
states in our sample expressed concerns about AMP lending in their
states; however, most relied on their existing regulatory system
of licensing and examining mortgage lenders and brokers to stay
abreast of and react to AMP issues. Most of the officials in our
sample expressed concern about AMP lending and the negative
effects it could have on consumers, including how well consumers
understood complex AMP loans and the potential impact of payment
shock, financial difficulties, or default and foreclosure. Other
officials expressed concern about whether consumers received
complete information about AMPs, saying that federal disclosures
were complicated, difficult to comprehend, and often were not very
useful to consumers.
In addition to these general consumer protection concerns, some
state officials spoke about state-specific issues. For example,
Ohio officials expressed AMP concerns in the context of larger
economic concerns, noting that AMP mortgages were part of wider
economic challenges facing the state. Ohio already has high rates
of mortgage foreclosures and unemployment that have hurt both
Ohio's consumers and its overall economy. In Nevada, officials
worried that lenders and brokers have engaged in practices that
sometimes take advantage of senior citizens by offering them AMP
loans that they either did not need or could not afford.
Most of the state regulatory officials said that they have relied
upon state law to license mortgage lenders and brokers and ensure
they meet minimum experience and operations standards. Most said
they also periodically examine these entities for compliance with
state licensing, mortgage lending, and consumer protection laws,
including applicable fair advertising requirements. As such, most
of the regulatory officials relied on systems already in place to
investigate AMP issues or complaints and, when needed, used
applicable licensing and consumer protection laws to respond to
problems such as unfair and deceptive trade practices.
Some state regulatory officials with whom we spoke said they have
taken other actions to better understand the issues associated
with AMP lending and expand consumer protections. For example,
some states such as New Jersey and Nevada have gathered data on
AMPs to better understand AMP lending and risks. Others, such as
New York, plan to use guidance developed by regulatory
associations to help oversee AMP lending by independent mortgage
lenders and brokers.
In summary, it is too soon to tell the extent to which payment
shock will produce financial distress for some borrowers and
induce defaults that would affect banks that hold AMPs in their
portfolios. However, the popularity, complexity, and widespread
marketing of AMPs highlight the importance of mortgage disclosures
to help borrowers make informed mortgage decisions. As a result,
while we commend the Federal Reserve's efforts to review and
revise Regulation Z, we recommended in our report that the Board
of Governors of the Federal Reserve System consider amending
federal mortgage disclosure requirements to improve the clarity
and comprehensiveness of AMP disclosures. In response to our
recommendation, the Federal Reserve said that it will conduct
consumer testing to determine appropriate content and formats and
use design consultants to develop model disclosure forms intended
to better communicate information.
Chairmen of the subcommittees, this completes my prepared
statement. I would be pleased to respond to any questions you or
other Members may have at this time.
GAO Contact and Staff Acknowledgments
For additional information about this testimony, please contact
Orice M. Williams on (202) 512-5837 or at [email protected] .
Contact points for our Offices of Congressional Relations and
Public Affairs may be found on the last page of this statement.
Individuals making key contributions to this testimony include
Karen Tremba, Assistant Director; Tania Calhoun; Bethany Claus
Widick; Stefanie Jonkman; Marc Molino; Robert Pollard; Barbara
Roesmann; and Steve Ruszczyk.
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1GAO, Alternative Mortgage Products: Impact on Defaults Remains Unclear,
but Disclosure of Risks to Borrowers Could Be Improved, GAO-06-1021
(Washington, D.C.: Sept. 19, 2006).
2This example assumes a $400,000 payment-option ARM with a 1 percent
initial interest rate, a 7.5 percent annual payment increase cap, and a 10
percent negative amortization cap. The example reflects actual interest
rates for 2004 to 2006 and rates are assumed to remain unchanged
thereafter. With an initial interest rate of 1 percent the borrower's
minimum payment would be $1,287. However, the lender likely would have
qualified the borrower based on a fully indexed rate of 4.41 percent,
which corresponds to a first-year's fully amortizing monthly payment of
$2,039. Federal Reserve and OCC officials told us that lenders generally
qualify payment-option ARM borrowers at the fully indexed interest rate.
Although the borrower is faced with a payment shock of 128 percent in year
six as a result of making minimum payments, the increase is 44 percent
more than the monthly payment that was originally used to qualify the
borrower.
3Federally regulated financial institutions include all banks and their
subsidiaries, bank holding companies and their non bank subsidiaries,
savings associations and their subsidiaries, savings and loan holding
companies and their subsidiaries, and credit unions.
250316
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www.gao.gov/cgi-bin/getrpt? GAO-06-1112T .
To view the full product, including the scope
and methodology, click on the link above.
For more information, contact Orice M. Williams at (202) 512-8678 or
[email protected].
Highlights of GAO-06-1112T , a testimony to the Subcommittees on Housing
and Transportation and Economic Policy, Committee on Banking, Housing, and
Urban Affairs, U. S. Senate
September 20, 2006
ALTERNATIVE MORTGAGE PRODUCTS
Impact on Defaults Remains Unclear, but Disclosure of Risks to Borrowers
Could Be Improved
Alternative mortgage products (AMPs) can make homes more affordable by
allowing borrowers to defer repayment of principal or part of the interest
for the first few years of the mortgage. Recent growth in AMP lending has
heightened the importance of borrowers' understanding and lenders'
management of AMP risks. GAO's report discusses the (1) recent trends in
the AMP market, (2) potential AMP risks for borrowers and lenders, (3)
extent to which mortgage disclosures discuss AMP risks, and (4) federal
and selected state regulatory response to AMP risks. GAO used regulatory
and industry data to analyze changes in AMP monthly payments under various
scenarios; reviewed available studies; and interviewed relevant federal
and state regulators and mortgage industry groups, and consumer groups.
What GAO Recommends
GAO's report includes a recommendation that as part of the Federal Reserve
Board's review of existing mortgage disclosure requirements, it should
consider revising those requirements to improve the clarity and
comprehensiveness of AMP disclosures. The Federal Reserve responded that
it will conduct consumer testing to determine appropriate content and
formats and use design consultants to develop model disclosure forms
intended to better communicate information.
From 2003 through 2005, AMP originations, comprising mostly interest-only
and payment-option adjustable-rate mortgages, grew from less than 10
percent of residential mortgage originations to about 30 percent. They
were highly concentrated on the East and West Coasts, especially in
California. Federally and state-regulated banks and independent mortgage
lenders and brokers market AMPs, which have been used for years as a
financial management tool by wealthy and financially sophisticated
borrowers. In recent years, however, AMPs have been marketed as an
"affordability" product to allow borrowers to purchase homes they
otherwise might not be able to afford with a conventional fixed-rate
mortgage.
Because AMP borrowers can defer repayment of principal, and sometimes part
of the interest, for several years, some may eventually face payment
increases large enough to be described as "payment shock." Mortgage
statistics show that lenders offered AMPs to less creditworthy and less
wealthy borrowers than in the past. Some of these recent borrowers may
have more difficulty refinancing or selling their homes to avoid higher
monthly payments, particularly in an interest-rate environment where
interest rates have risen or if the equity in their homes fell because
they were making only minimum monthly payments or home values did not
increase. As a result, delinquencies and defaults could rise. Federal
banking regulators stated that most banks appeared to be managing their
credit risk well by diversifying their portfolios or through loan sales or
securitizations. However, because the monthly payments for most AMPs
originated between 2003 and 2005 have not reset to cover both interest and
principal, it is too soon to tell to what extent payment shocks would
result in increased delinquencies or foreclosures for borrowers and in
losses for banks.
Regulators and others are concerned that borrowers may not be
well-informed about the risks of AMPs, due to their complexity and because
promotional materials by some lenders and brokers do not provide balanced
information on AMPs benefits and risks. Although lenders and certain
brokers are required to provide borrowers with written disclosures at loan
application and closing, federal standards on these disclosures do not
currently require specific information on AMPs that could better help
borrowers understand key terms and risks.
In December 2005, federal banking regulators issued draft interagency
guidance on AMP lending that discussed prudent underwriting, portfolio and
risk management, and consumer disclosure practices. Some lenders commented
that the recommendations were too prescriptive and could limit consumer
choices of mortgages. Consumer advocates expressed concerns about the
enforceability of these recommendations because they are presented in
guidance and not in regulation. State regulators GAO contacted generally
relied on existing regulatory structure of licensing and examining
independent mortgage lenders and brokers to oversee AMP lending.
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