NCUA proposes guidance on 'interest-only' mortgages

ALEXANDRIA, Va. (12/21/05)--The National Credit Union Administration (NCUA) and its sister federal agencies want credit unions and banks to review proposed guidance covering residential mortgage products that allow borrowers to defer repayment of principal and sometimes interest.

According to NCUA, these nontraditional mortgage products include "interest-only" mortgage loans where a borrower pays no principal for the first few years of the loan and "payment option" adjustable-rate mortgages where a borrower has flexible payment options, including the potential for negative amortization.

The agencies also said financial institutions are increasingly combining these mortgages with other practices, such as making simultaneous second-lien mortgages and allowing reduced documentation in evaluating the applicant's creditworthiness.

According to a statement, the agencies said these practices can present "unique risks that institutions must appropriately manage." They also expressed concern that these products and practices are being offered to a wider spectrum of borrowers--including subprime borrowers and others who may not otherwise qualify for more traditional mortgage loans or who may not fully understand the associated risks of nontraditional mortgages.

The proposed guidance addresses the importance of carefully managing the potential heightened risk levels created by these loans, and recommends financial institutions:

  • Assess a borrower's ability to repay the loan, including any balances added through negative amortization, at the fully indexed rate that would apply after the introductory period. The agencies recognize that this requirement differs from underwriting standards at some institutions and are specifically requesting comment on this aspect of the guidance.

  • Recognize that certain nontraditional mortgage loans are untested in a stressed environment and warrant strong risk management standards as well as appropriate capital and loan loss reserves.

  • Ensure that borrowers have sufficient information to clearly understand loan terms and associated risks prior to making a product or payment choice.

Comment is requested on all aspects of the guidance, particularly on the section regarding comprehensive debt service qualification standards. Comments are due sixty days after publication in the Federal Register. Use the resource link below to review the proposed guidelines.

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Resource Links
Proposed Guidance on Nontraditional Mortgage Products (pdf file)


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