The nation's top bank regulator issued an alarm Thursday about mortgages with artificially low starting payments, telling participants at a Los Angeles conference that borrowers needed better warnings that their bills inevitably would jump.
After the steep rise in home prices over the last few years, such loans have helped people stretch their finances to buy properties. But eventually, the payments ramp up.
"After the limited initial period ends, the monthly payment for the holder of a nontraditional mortgage must increase — even if interest rates stay flat — and the size of that increase can be very substantial," Comptroller of the Currency John C. Dugan said.
Under some circumstances, he added, payments can double after five years. Borrowers who can't make the higher payments risk losing their homes, and lenders could suffer big losses if they are forced to foreclose.
Dugan's remarks, in a speech to an economic conference sponsored by the Greenlining Institute a fair-lending advocacy group, was the latest salvo by regulators who have proposed tighter restrictions on the use of exotic mortgages that are advertised as making homes more affordable.
Dugan said regulators were not urging a wholesale clamp-down on interest-only, payment-option and other nontraditional loans. Instead, he said, they are looking to strengthen disclosure rules and approval requirements to ensure that borrowers can meet their obligations.
Regulators were studying comments from lenders, advocacy groups and others and may modify the guidelines before finalizing them, Dugan said.
Major lenders, many of them based in California, have issued nontraditional mortgages in record numbers. One such loan at first requires payment of just the interest that accrues each month. Such loans accounted for 26.4% of U.S. mortgages last year, up from 10.3% in 2003, according to San Francisco data firm Loan Performance.
Another type, the payment-option adjustable rate mortgage, allows borrowers to pay less than accrued interest, with the difference added to the loan principal. Such option ARM loans accounted for 10.4% of mortgages last year, up from 0.4% in 2003, Loan Performance reported.
Last quarter, Calabasas-based Countrywide Home Loans issued $24.5 billion in option ARM loans, making it No. 1 in that category, Mortgage Servicing News, an industry newsletter, said recently. That was almost twice as much as a year earlier. Wells Fargo Home Mortgage led interest-only lenders with $31.7 billion in originations, more than triple its year-earlier level.
An earnings report Thursday from option-ARM specialist Golden West Financial Corp. provided evidence that option ARM borrowers are increasingly choosing the low-payment option on their loans.
Nearly all of Golden West's loans allow borrowers to pay less than full interest during the early years of the loan. Analysts watch the interest that borrowers put off as a risk factor. On March 31, Golden West had $665.7 million of so-called deferred interest on its books, up from $90.1 million a year earlier.
As a proportion of total loans, the amount remained small, constituting 0.54% of what borrowers owe on all Golden West loans, but that was up nearly sevenfold from .08% in the first quarter of 2005.
Herbert Sandler, Golden West's chairman, described the increase as part of a typical cycle that occurs when interest rates rise. He said his company and other thrifts with lengthy experience in option ARMs were careful to explain the risks to borrowers. They also underwrite the loans carefully by making sure borrowers can afford the fully adjusted payments and appraising the homes carefully to ensure there is adequate equity protecting the mortgage, he said.
Sandler said problems had been created by new option ARM lenders that set starting payments unrealistically low and sell their loans to Wall Street. "We hear lots and lots of stories of institutions inappropriately underwriting the loans and then selling them off so the risk shifts to someone else," he said.
Golden West, the biggest California-based thrift, earned $390.9 million, or $1.25 a share, compared with $348.3 million, or $1.12 a share, a year earlier. Revenue rose from $787.2 million to $919.6 million.
The earnings missed Wall Street estimates by a penny, and Golden West shares fell $1.65 to $70.24.
Two other California banks, UnionBanCal Corp. and Cathay General Corp., released financial results Thursday.
San Francisco-based UnionBanCal said first-quarter earnings slipped to $173 million, or 1.18 a share, from $182 million, or $1.21. The year-earlier period included a 7-cent-a-share tax gain.
Los Angeles-based Cathay General, a Chinese American bank, reported profit of $27.3 million, or 54 cents a share, up from $25 million, or 49 cents a share.
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