WASHINGTON — Federal bank regulators, worried about a surge in defaults on high-risk home mortgages, on Friday called on lenders to exercise caution in making subprime loans and closely evaluate borrowers’ ability to repay them.
The proposed guidance issued by the Federal Reserve and the other four federal agencies that regulate banks, thrifts and credit unions, comes in increasingly troubled market for subprime mortgage loans. Home-mortgage delinquencies and foreclosures are spiking, especially for people who took out subprime mortgages — higher-interest loans for those with blemished credit records or low incomes who are considered higher risk — during the sizzling housing boom that waned in the second half of 2005.
Fed Chairman Ben Bernanke has said the central bank is concerned about the rise in delinquencies. Several financial companies that specialize in subprime mortgages have seen their shares plummet in recent weeks, roiling the industry sector. The weakness in the subprime market was seen to be a factor contributing to this week’s tumultuous decline on Wall Street.
The market for subprime mortgages has exploded in recent years during the housing boom, from fewer than 5 percent of all new mortgage loans in 1994 to an estimated 20 percent currently.
In their notice putting out the guidance for public comment, the banking regulators noted concerns that borrowers “may not fully understand the risks and consequences” of taking out subprime mortgages, and that the mortgages “may pose an elevated credit risk to financial institutions.”
Adjustable-rate mortgages are especially prevalent in the subprime market. They are considered higher-risk loans because they typically draw borrowers in with an initial low, or “teaser” interest rate, which can rise markedly over time. The proposed guidelines direct banks to base their lending decisions on borrowers’ ability to repay home loans at the full final rate, as opposed to the teaser rate.
In addition, the guidelines say that banks should provide consumers “clear and balanced information about the relative benefits and risks” of subprime mortgages.
On Tuesday, mortgage finance giant Freddie Mac said it will stop buying those subprime mortgages that it deems to be the most vulnerable to default or foreclosure.
Write-offs of home mortgage loans by banks and thrifts reached a three-year high in the fourth quarter last year, according to the Federal Deposit Insurance Corp.
Low-documentation, interest-only and other nontraditional mortgages, which are riskier than conventional home loans, have vaulted in popularity in recent years and raised concern about defaults if borrowers cannot meet rising mortgage payments. In addition to the Fed, the agencies issuing the proposed guidance are the FDIC, the National Credit Union Administration, and the Treasury Department’s Office of the Comptroller of the Currency and Office of Thrift Supervision. The guidelines could be formally adopted sometime after the 60-day public comment period.