**\[OCC-20%-4810-33-P\]**

**\[Board-20%-6210-01-P\]**

**\[FDIC-20%-6714-01-P\]**

**\[OTS-20%-6720-01-P\]**

**\[NCUA-20%-7535-01-P\]**

**DEPARTMENT OF THE TREASURY**

**Office of the Comptroller of the Currency**

**\[Docket No. OCC-2007-0005\]**

**FEDERAL RESERVE SYSTEM**

**\[Docket No. OP-1278\]**

**FEDERAL DEPOSIT INSURANCE CORPORATION**

**DEPARTMENT OF THE TREASURY**

**Office of Thrift Supervision**

**\[No. 2007-31\]**

**NATIONAL CREDIT UNION ADMINISTRATION**

**Statement on Subprime Mortgage Lending**

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)
(collectively, the Agencies).

ACTION: Final guidance -- Statement on Subprime Mortgage Lending.

SUMMARY: The Agencies are issuing a final interagency Statement on
Subprime Mortgage Lending. This guidance has been developed to clarify
how institutions can offer certain adjustable rate mortgage (ARM)
products in a safe and sound manner, and in a way that clearly discloses
the risks that borrowers may assume.

EFFECTIVE DATE: \[INSERT date of publication in FEDERAL REGISTER\].

FOR FURTHER INFORMATION CONTACT:

OCC: Michael Bylsma, Director, Community and Consumer Law Division,
(202) 874-5750 or Stephen Jackson, Director, Retail Credit Risk, (202)
874-5170.

Board: Division of Banking Supervision and Regulation: Brian P. Valenti,
Supervisory Financial Analyst, (202) 452-3575, Virginia M. Gibbs, Senior
Supervisory Financial Analyst, (202) 452-2521, or Sabeth I. Siddique,
Assistant Director, (202) 452-3861; Division of Consumer and Community
Affairs: Kathleen C. Ryan, Counsel, (202) 452-3667, or Jamie Z. Goodson,
Attorney, (202) 452-3667; or Legal Division: Kara L. Handzlik, Attorney
(202) 452-3852. Board of Governors of the Federal Reserve System, 20^th^
Street and Constitution Avenue, NW., Washington, DC 20551. Users of
Telecommunication Device for Deaf only, call (202) 263-4869.

[FDIC:]{.underline} Beverlea S. Gardner, Examination Specialist, (202)
898-3640, Division of Supervision and Consumer Protection; Richard B.
Foley, Counsel (202) 898-3784; Mira N. Marshall, Acting Chief Community
Reinvestment Act and Fair Lending, (202) 898-3912; April A. Breslaw,
Acting Associate Director, Compliance Policy & Exam Support Branch,
Division of Supervision and Consumer Protection, (202) 898-6609.

[OTS]{.underline}: Tammy L. Stacy, Director of Consumer Regulation,
Compliance and Consumer Protection Division, (202) 906-6437; Glenn
Gimble, Senior Project Manager, Compliance and Consumer Protection
Division, (202) 906-7158; William J. Magrini, Senior Project Manager,
Credit Risk, (202) 906-5744; or Teresa Luther, Economist, Credit Risk,
(202) 906-6798.

[NCUA]{.underline}: Cory W. Phariss, Program Officer, Examination and
Insurance, (703) 518-6618.

**SUPPLEMENTARY INFORMATION:**

**I. Background**

The Agencies developed this Statement on Subprime Mortgage Lending to
address emerging risks associated with certain subprime mortgage
products and lending practices. In particular, the Agencies are
concerned about the growing use of ARM products[^1] that provide low
initial payments based on a fixed introductory rate that expires after a
short period, and then adjusts to a variable rate plus a margin for the
remaining term of the loan. These products could result in payment shock
to the borrower. The Agencies are concerned that these products,
typically offered to subprime borrowers, present heightened risks to
lenders and borrowers. Often, these products have additional
characteristics that increase risk. These include qualifying borrowers
based on limited or no documentation of income or imposing substantial
prepayment penalties or prepayment penalty periods that extend beyond
the initial fixed interest rate period. In addition, borrowers may not
be adequately informed of product features and risks, including their
responsibility to pay taxes and insurance, which might be separate from
their mortgage payments.

These products originally were extended to customers primarily as a
temporary credit accommodation in anticipation of early sale of the
property or in expectation of future earnings growth. However, these
loans have more recently been offered to subprime borrowers as "credit
repair" or "affordability" products. The Agencies are concerned that
many subprime borrowers may not have sufficient financial capacity to
service a higher debt load, especially if they were qualified based on a
low introductory payment. The Agencies are also concerned that subprime
borrowers may not fully understand the risks and consequences of
obtaining this type of ARM loan. Borrowers who obtain these loans may
face unaffordable monthly payments after the initial rate adjustment,
difficulty in paying real estate taxes and insurance that were not
escrowed, or expensive refinancing fees, any of which could cause
borrowers to default and potentially lose their homes.

In response to these concerns, the Agencies published for comment the
*Proposed Statement on Subprime Mortgage Lending* (proposed statement),
72 FR 10533 (March 8, 2007). The proposed statement provided guidance on
the criteria and factors, including payment shock, that an institution
should assess in determining a borrower's ability to repay the loan. The
proposed statement also provided guidance intended to protect consumers
from unfair, deceptive, and other predatory practices, and to ensure
that consumers are provided with clear and balanced information about
the risks and features of these loans. Finally, the proposed statement
addressed the need for strong controls to adequately manage the risks
associated with these products.

The Agencies requested comment on all aspects of the proposed statement,
and specifically requested comment about whether: 1) these products
always present inappropriate risks to institutions and consumers, or the
extent to which they may be appropriate under some circumstances; 2) the
proposed statement would unduly restrict the ability of existing
subprime borrowers to refinance their loans, and whether other forms of
credit are available that would not present the risk of payment shock;
3) the principles of the proposed statement should be applied beyond the
subprime ARM market; and 4) limitations on the use of prepayment
penalties would help meet borrower needs.

The Agencies collectively received 137 unique comments on the proposed
statement. Comments were received from financial institutions,
industry-related trade associations (industry groups), consumer and
community groups, government officials, and members of the public.

**II. Overview of Public Comments**

The commenters were generally supportive of the Agencies' efforts to
provide guidance in this area. However, many financial institution
commenters expressed concern that certain aspects of the proposed
statement were too prescriptive or could unduly restrict subprime
borrowers' access to credit. Many consumer and community group
commenters stated that the proposed statement did not go far enough in
addressing their concerns about these products.

Financial institutions and industry groups stated that they supported
prudent underwriting, but opposed a strict requirement that ARM loans
subject to the proposed statement be underwritten at a fully indexed
rate with a fully amortizing repayment schedule. They also stated that
these loan products are not always inappropriate, particularly because
they can be a useful credit repair vehicle or a means to establish a
favorable credit history. Many of these commenters expressed concern
that the proposed statement would unduly restrict credit to subprime
borrowers. They also requested that the proposed statement be modified
to allow lenders flexibility in helping existing subprime borrowers
refinance out of ARM loans that will reset to a monthly payment that
they cannot afford.

The majority of financial institutions and industry group commenters
opposed the application of the proposed statement outside the subprime
market. A number of these commenters requested clarification of the
scope of the proposed statement and the definition of "subprime."

Some industry group commenters also expressed concern that consumer
disclosure requirements would put federally-regulated institutions at a
disadvantage and cause consumer information overload. They also
requested that any changes to consumer disclosure requirements be part
of a comprehensive reform of existing disclosure regulations.

Consumer and community group commenters generally supported the proposed
statement. Many of these commenters expressed their concern that the
products covered by the proposed statement present inappropriate risks
for subprime borrowers. Many of these commenters supported extending the
scope of the proposed statement to other mortgage products. These
commenters supported the proposed underwriting criteria, though a number
of them suggested stricter underwriting criteria. They also supported
further limiting or prohibiting the use of reduced documentation and
stated income loans, suggesting that such a reduction would be in the
best interests of consumers.

Both industry group and consumer and community group commenters
expressed concern that the proposed statement will not apply to all
lenders. Industry group commenters indicated this would put
federally-regulated financial institutions at a competitive
disadvantage. Consumer and community group commenters encouraged the
Agencies to continue to work with state regulators to extend the
principles of the proposed statement to non-federally supervised
institutions. Since the time that the Agencies announced the proposed
statement, the Conference of State Bank Supervisors (CSBS) and the
American Association of Residential Mortgage Regulators (AARMR) issued a
press release confirming their intent to "develop a parallel statement
for state supervisors to use with state-supervised entities."[^2]

**III. Agencies' Action on Final Joint Guidance**

The Agencies are issuing the *Statement on Subprime Mortgage Lending*
(Statement) with some changes to respond to the comments received and to
provide additional clarity. The Statement applies to all banks and their
subsidiaries, bank holding companies and their nonbank subsidiaries,
savings associations and their subsidiaries, savings and loan holding
companies and their subsidiaries, and credit unions. Significant
comments on specific provisions of the proposed statement, the Agencies'
responses, and changes to the proposed statement are discussed below.

***[Scope of Guidance]{.underline}***

A number of financial institution and industry group commenters and two
credit reporting companies requested that the definition of "subprime"
be clarified. A financial institution and an industry group commenter
requested a bright-line test to determine if a borrower falls into the
subprime category.

The Agencies considered commenters' requests that a definition of
"subprime" be included in the Statement. The Agencies determined,
however, that the reference to the subprime borrower characteristics
from the *2001 Expanded Guidance for Subprime Lending Programs*
(Expanded Guidance) provides appropriate information for purposes of
this Statement. The Expanded Guidance provides a range of credit risk
characteristics that are associated with subprime borrowers, noting that
the characteristics are illustrative and are not meant to define
specific parameters for all subprime borrowers.[^3] Because the term
"subprime" is not consistently defined in the marketplace or among
individual institutions, the Agencies believe that incorporating the
subprime borrower credit risk characteristics from the Expanded Guidance
provides sufficient clarity.

A number of commenters also requested clarification as to whether the
proposed statement applies to all products with the features described.
In addition, the Agencies specifically requested comment regarding
whether the proposed statement's principles should be applied beyond the
subprime ARM market. All consumer and community groups and some of the
financial institutions who addressed this question supported application
of the proposed statement beyond the subprime market. However, most
financial institution and industry group commenters opposed application
of the proposed statement beyond the subprime market. These commenters
stated that the issues the proposed statement was designed to address
are confined to the subprime market and expansion of the proposed
statement to other markets would unnecessarily limit the options
available to other borrowers.

As with the proposed statement, the Statement retains a focus on
subprime borrowers, due to concern that these consumers may not fully
understand the risks and consequences of these loans and may not have
the financial capacity to deal with increased obligations. The Agencies
did revise the language to indicate that the proposed statement applies
to certain ARM products that have one or more characteristics that can
cause payment shock, as defined in the proposed statement. While the
Statement has retained its focus on subprime borrowers, the Agencies
note that institutions generally should look to the principles of this
Statement when such ARM products are offered to non-subprime borrowers.

***[Risk Management Practices]{.underline}***

**Predatory Lending Considerations**

Some financial institution and industry group commenters raised concerns
that the proposed statement implied that subprime lending is "per se"
predatory. The Statement clarifies that subprime lending is not
synonymous with predatory lending, and that there is no presumption that
the loans to which the Statement applies are predatory.

**Qualifying Standards**

The proposed statement provided that subprime ARMs should be
underwritten at the fully indexed rate with a fully amortizing repayment
schedule. Many consumer and community groups supported the proposed
statement's underwriting standards. Other consumer and community groups
thought that the proposed qualifying standards did not go far enough,
and suggested that these loans should be underwritten on the basis of
the maximum possible monthly payment. The majority of industry group
commenters who addressed this issue opposed the proposed underwriting
standard as overly prescriptive. Some commenters also requested that the
Statement define "fully indexed rate with a fully amortizing repayment
schedule." All of the commenters that addressed the issue favored
including a reasonable estimate of property taxes and insurance in an
assessment of borrowers' debt-to-income ratios.

The Agencies continue to believe that institutions should maintain
qualification standards that include a credible analysis of a borrower's
capacity to repay the loan according to its terms. This analysis should
consider both principal and interest obligations at the fully indexed
rate with a fully amortizing repayment schedule, plus a reasonable
estimate for real estate taxes and insurance, whether or not escrowed.
Qualifying consumers based on a low introductory payment does not
provide a realistic assessment of a borrower's ability to repay the loan
according to its terms. Therefore, the proposed general guideline of
qualifying borrowers at the fully indexed rate, assuming a fully
amortizing payment, remains unchanged in the final Statement. The
Agencies did, however, provide additional information regarding the
terms "fully indexed rate" and "fully amortizing payment schedule" to
clarify expectations regarding how institutions should assess borrowers'
repayment capacity.

**Reduced Documentation or Stated Income Loans**

Several commenters raised concerns about reduced documentation or stated
income loans. The majority of commenters who addressed this issue
supported the proposed statement's position that institutions should be
able to readily document income for many borrowers and that reduced
documentation should be accepted only if mitigating factors are present.
A few financial institution and industry group commenters urged the
Agencies to allow lenders some flexibility in deciding when these loans
are appropriate for borrowers whose income is derived from sources that
are difficult to verify. On the other hand, some consumer and community
group commenters stated that borrowers are not always given the option
to document income and thereby pay a lower interest rate. They also
indicated that stated income loans may be a vehicle for fraud in that
borrower income may be inflated to qualify for a loan.

The Agencies believe that verifying income is critical to conducting a
credible analysis of borrowers' repayment capacity, particularly in
connection with loans to subprime borrowers. Therefore, the final
Statement provides that stated income and reduced documentation should
be accepted only if there are mitigating factors that clearly minimize
the need for verification of repayment capacity. The Statement provides
some examples of mitigating factors, and sets forth an expectation that
reliance on mitigating factors should be documented. The Agencies note
that for many borrowers, institutions should be able to readily document
income using recent W-2 statements, pay stubs, and/or tax returns.

***[Workout Arrangements]{.underline}***

The Agencies specifically requested comment on whether the proposed
statement would unduly restrict the ability of existing subprime
borrowers to refinance out of certain ARMs to avoid payment shock. The
Agencies also asked about the availability to these borrowers of other
mortgage products that do not present the risk of payment shock. The
majority of financial institution and industry group commenters who
responded to this specific question believed that the proposed statement
would unduly restrict existing subprime borrowers' ability to refinance.
However, most consumer and community groups who addressed the issue
expressed the view that allowing existing borrowers to refinance into
another unaffordable ARM was not an acceptable solution to the problem
and, therefore, that eliminating this option would not be an undue
restriction on credit. Some commenters mentioned that certain government
sponsored entities and lenders have already committed to revise their
lending program criteria and/or create new programs that potentially may
provide alternative mortgage products for refinancing existing subprime
loans.

To address these issues, the Agencies incorporated a section on workout
arrangements in the final text that references the principles of the
April 2007 interagency *Statement on Working with Borrowers*. The
Agencies believe prudent workout arrangements that are consistent with
safe and sound lending practices are generally in the long-term best
interest of both the financial institution and the borrower.

***[Consumer Protection Principles]{.underline}***

**Prepayment Penalties**

The Agencies specifically requested comment regarding whether prepayment
penalties should be limited to the initial fixed-rate period; how this
practice, if adopted, would assist consumers and affect institutions;
and whether an institution's providing a window of 90 days prior to the
reset date to refinance without a prepayment penalty would help meet
borrower needs. The overwhelming majority of commenters who addressed
this question agreed that prepayment penalties should be limited to the
initial fixed-rate period, and several commenters proposed a complete
prohibition of prepayment penalties. Commenters suggested different time
frames for expiration of the prepayment penalty period, ranging from 30
to 90 days prior to the reset date. Several industry group commenters,
however, opposed such a limitation. They stated that prepayment fees are
a legitimate means for lenders and investors to be compensated for
origination costs when borrowers prepay prior to the interest rate
reset. Further, these commenters noted that most lenders do not offer
mortgage products that have prepayment penalty periods that extend
beyond the fixed interest rate period and that borrowers should be
allowed time to exit the loan prior to the reset date.

In light of the comments received, the Agencies revised the Statement to
state that the period during which prepayment penalties apply should not
exceed the initial reset period, and that institutions generally should
provide borrowers with a reasonable period of time (typically, at least
60 days prior to the reset date) to refinance their loans without
penalty. There is no supervisory expectation for institutions to waive
contractual terms with regard to prepayment penalties on existing
loans.[^4]

**Consumer Disclosure Issues**

Many financial institution and industry group commenters suggested that
the Agencies' consumer protection goals would be better accomplished
through amendments to generally applicable regulations, such as
Regulation Z (Truth in Lending)[^5] or Regulation X (Real Estate
Settlement Procedures).[^6] Some financial institution and consumer and
community group commenters questioned the value of additional
disclosures and expressed concern that the proposed statement would
contribute to consumer information overload. A few commenters stated
that the proposed statement would add burdensome new disclosure
requirements and would result in the provision of confusing information
to consumers.

Some industry group commenters asked the Agencies to provide uniform
disclosures for these products, or to publish illustrations of the
consumer information contemplated by the proposed statement similar to
those previously proposed by the Agencies in connection with
nontraditional mortgage products.[^7] Several commenters also requested
that any disclosures include the maximum possible monthly payment under
the terms of the loan.

The Agencies have determined that, given the growth in the market for
the products covered by the Statement and the heightened legal,
compliance, and reputation risks associated with these products,
guidelines are needed now to ensure that consumers will receive the
information they need about the material features of these loans. In
addition, while the Agencies are sensitive to commenters' concerns
regarding disclosure burden, we do not anticipate that the information
outlined in the Statement will result in additional lengthy disclosures.
Rather, the Agencies contemplate that the information can be provided in
a brief narrative format and through the use of examples based on
hypothetical loan transactions. In response to requests by commenters,
the Agencies are working on and expect to publish for comment proposed
illustrations of the type of consumer information contemplated in the
Statement.

The Agencies disagree with the commenters who expressed concern that the
proposed statement appears to establish a suitability standard under
which lenders would be required to assist borrowers in choosing products
that are appropriate to their needs and circumstances. 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. It is not the Agencies' intent to impose such a
standard, nor is there any language in the Statement that does so.

***[Control Systems]{.underline}***

While some commenters who addressed the control systems portion of the
proposed statement supported the Agencies' proposal, some industry group
commenters expressed concern that these provisions were neither
realistic nor practical. A few industry group commenters requested
clarification of the scope of a financial institution's responsibilities
with regard to third parties. Some consumer and community group
commenters requested uniform regulation of and increased enforcement
against third parties.

The Agencies have carefully considered these comments, but have not
revised this portion of the proposed statement. The Agencies do not
expect institutions to assume an unwarranted level of responsibility for
the actions of third parties. Moreover, the control systems discussed in
the Statement are consistent with the Agencies' current supervisory
authority and policies.

***[Supervisory Review]{.underline}***

The Agencies received no comments on the supervisory review portion of
the proposed statement. However, minor changes have been made to clarify
the circumstances under which the Agencies will take action against
institutions in connection with the products addressed in the Statement.

**IV. Text of Final Joint Guidance**

The final interagency Statement on Subprime Mortgage Lending appears
below.

**Statement on Subprime Mortgage Lending**

The Agencies[^8] developed this Statement on Subprime Mortgage Lending
(Subprime Statement) to address emerging issues and questions relating
to certain subprime[^9] mortgage lending practices. The Agencies are
concerned borrowers may not fully understand the risks and consequences
of obtaining products that can cause payment shock.[^10] In particular,
the Agencies are concerned with certain adjustable-rate mortgage (ARM)
products typically offered to subprime borrowers that have one or more
of the following characteristics:

-   Low initial payments based on a fixed introductory rate that expires
    after a short period and then adjusts to a variable index rate plus
    a margin for the remaining term of the loan;[^11]

-   Very high or no limits on how much the payment amount or the
    interest rate may increase ("payment or rate caps") on reset dates;

-   Limited or no documentation of borrowers' income;

-   Product features likely to result in frequent refinancing to
    maintain an affordable monthly payment; and/or

-   Substantial prepayment penalties and/or prepayment penalties that
    extend beyond the initial fixed interest rate period.

Products with one or more of these features present substantial risks to
both consumers and lenders. These risks are increased if borrowers are
not adequately informed of the product features and risks, including
their responsibility for paying real estate taxes and insurance, which
may be separate from their monthly mortgage payments. The consequences
to borrowers could include: being unable to afford the monthly payments
after the initial rate adjustment because of payment shock; experiencing
difficulty in paying real estate taxes and insurance that were not
escrowed; incurring expensive refinancing fees, frequently due to
closing costs and prepayment penalties, especially if the prepayment
penalty period extends beyond the rate adjustment date; and losing their
homes. Consequences to lenders may include unwarranted levels of credit,
legal, compliance, reputation, and liquidity risks due to the elevated
risks inherent in these products.

The Agencies note that many of these concerns are addressed in existing
interagency guidance. The most prominent are the 1993 *Interagency
Guidelines for Real Estate Lending* (*Real Estate Guidelines*), the 1999
*Interagency Guidance on Subprime Lending*, and the 2001 *Expanded
Guidance for Subprime Lending Programs* (*Expanded Subprime
Guidance*).[^12]

While the 2006 *Interagency Guidance on Nontraditional Mortgage Product
Risks* (*NTM Guidance*) may not explicitly pertain to products with the
characteristics addressed in this Statement, it outlines prudent
underwriting and consumer protection principles that institutions also
should consider with regard to subprime mortgage lending. This Statement
reiterates many of the principles addressed in existing guidance
relating to prudent risk management practices and consumer protection
laws.[^13]

**Risk Management Practices**

***[Predatory Lending Considerations]{.underline}***

Subprime lending is not synonymous with predatory lending, and loans
with the features described above are not necessarily predatory in
nature. However, institutions should ensure that they do not engage in
the types of predatory lending practices discussed in the *Expanded
Subprime Guidance*.[^14] Typically, predatory lending involves at least
one of the following elements:

-   Making loans based predominantly on the foreclosure or liquidation
    value of a borrower's collateral rather than on the borrower's
    ability to repay the mortgage according to its terms;

-   Inducing a borrower to repeatedly refinance a loan in order to
    charge high points and fees each time the loan is refinanced ("loan
    flipping"); or

-   Engaging in fraud or deception to conceal the true nature of the
    mortgage loan obligation, or ancillary products, from an
    unsuspecting or unsophisticated borrower.

Institutions offering mortgage loans such as these face an elevated risk
that their conduct will violate Section 5 of the Federal Trade
Commission Act (FTC Act), which prohibits unfair or deceptive acts or
practices.[^15]

***[Underwriting Standards]{.underline}***

Institutions should refer to the *Real Estate Guidelines*, which provide
underwriting standards for all real estate loans.[^16] The *Real Estate
Guidelines* state that prudently underwritten real estate loans should
reflect all relevant credit factors, including the capacity of the
borrower to adequately service the debt.[^17] The 2006 *NTM Guidance*
details similar criteria for qualifying borrowers for products that may
result in payment shock.

Prudent qualifying standards recognize the potential effect of payment
shock in evaluating a borrower's ability to service debt. An
institution's analysis of a borrower's repayment capacity should include
an evaluation of the borrower's ability to repay the debt by its final
maturity at the fully indexed rate,[^18] assuming a fully amortizing
repayment schedule.[^19]

One widely accepted approach in the mortgage industry is to quantify a
borrower's repayment capacity by a debt-to-income (DTI) ratio. An
institution's DTI analysis should include, among other things, an
assessment of a borrower's total monthly housing-related payments
(*e.g.,* principal, interest, taxes, and insurance, or what is commonly
known as PITI) as a percentage of gross monthly income.

This assessment is particularly important if the institution relies upon
reduced documentation or allows other forms of risk layering.
Risk-layering features in a subprime mortgage loan may significantly
increase the risks to both the institution and the borrower. Therefore,
an institution should have clear policies governing the use of
risk-layering features, such as reduced documentation loans or
simultaneous second lien mortgages. When risk-layering features are
combined with a mortgage loan, an institution should demonstrate the
existence of effective mitigating factors that support the underwriting
decision and the borrower's repayment capacity.

Recognizing that loans to subprime borrowers present elevated credit
risk, institutions should verify and document the borrower's income
(both source and amount), assets and liabilities. Stated income and
reduced documentation loans to subprime borrowers should be accepted
only if there are mitigating factors that clearly minimize the need for
direct verification of repayment capacity. Reliance on such factors also
should be documented. Typically, mitigating factors arise when a
borrower with favorable payment performance seeks to refinance an
existing mortgage with a new loan of a similar size and with similar
terms, and the borrower's financial condition has not deteriorated.
Other mitigating factors might include situations where a borrower has
substantial liquid reserves or assets that demonstrate repayment
capacity and can be verified and documented by the lender. However, a
higher interest rate is not considered an acceptable mitigating factor.

**Workout Arrangements**

As discussed in the April 2007 interagency *Statement on Working with
Borrowers*, the Agencies encourage financial institutions to work
constructively with residential borrowers who are in default or whose
default is reasonably foreseeable. Prudent workout arrangements that are
consistent with safe and sound lending practices are generally in the
long-term best interest of both the financial institution and the
borrower.

Financial institutions should follow prudent underwriting practices in
determining whether to consider a loan modification or a workout
arrangement.[^20] Such arrangements can vary widely based on the
borrower's financial capacity. For example, an institution might
consider modifying loan terms, including converting loans with variable
rates into fixed-rate products to provide financially stressed borrowers
with predictable payment requirements.

The Agencies will not criticize financial institutions that pursue
reasonable workout arrangements with borrowers. Further, existing
supervisory guidance and applicable accounting standards do not require
institutions to immediately foreclose on the collateral underlying a
loan when the borrower exhibits repayment difficulties. Institutions
should identify and report credit risk, maintain an adequate allowance
for loan losses, and recognize credit losses in a timely manner.

**Consumer Protection Principles**

Fundamental consumer protection principles relevant to the underwriting
and marketing of mortgage loans include:

-   Approving loans based on the borrower's ability to repay the loan
    according to its terms; and

-   Providing information that enables consumers to understand material
    terms, costs, and risks of loan products at a time that will help
    the consumer select a product.

Communications with consumers, including advertisements, oral
statements, and promotional materials, should provide clear and balanced
information about the relative benefits and risks of the products. This
information should be provided in a timely manner to assist consumers in
the product selection process, not just upon submission of an
application or at consummation of the loan. Institutions should not use
such communications to steer consumers to these products to the
exclusion of other products offered by the institution for which the
consumer may qualify.

Information provided to consumers should clearly explain the risk of
payment shock and the ramifications of prepayment penalties, balloon
payments, and the lack of escrow for taxes and insurance, as necessary.
The applicability of prepayment penalties should not exceed the initial
reset period. In general, borrowers should be provided a reasonable
period of time (typically at least 60 days prior to the reset date) to
refinance without penalty.[^21]

Similarly, if borrowers do not understand that their monthly mortgage
payments do not include taxes and insurance, and they have not budgeted
for these essential homeownership expenses, they may be faced with the
need for significant additional funds on short notice.[^22] Therefore,
mortgage product descriptions and advertisements should provide clear,
detailed information about the costs, terms, features, and risks of the
loan to the borrower. Consumers should be informed of:

-   *[Payment Shock]{.underline}*. Potential payment increases,
    including how the new payment will be calculated when the
    introductory fixed rate expires.[^23]

-   *[Prepayment Penalties]{.underline}*. The existence of any
    prepayment penalty, how it will be calculated, and when it may be
    imposed.[^24]

-   *[Balloon Payments]{.underline}*. The existence of any balloon
    payment.

-   *[Cost of Reduced Documentation Loans]{.underline}*. Whether there
    is a pricing premium attached to a reduced documentation or stated
    income loan program.

-   *[Responsibility for Taxes and Insurance]{.underline}*. The
    requirement to make payments for real estate taxes and insurance in
    addition to their loan payments, if not escrowed, and the fact that
    taxes and insurance costs can be substantial.

    **Control Systems**

Institutions should develop strong control systems to monitor whether
actual practices are consistent with their policies and procedures.
Systems should address compliance and consumer information concerns, as
well as safety and soundness, and encompass both institution personnel
and applicable third parties, such as mortgage brokers or
correspondents.

Important controls include establishing appropriate criteria for hiring
and training loan personnel, entering into and maintaining relationships
with third parties, and conducting initial and ongoing due diligence on
third parties. Institutions also should design compensation programs
that avoid providing incentives for originations inconsistent with sound
underwriting and consumer protection principles, and that do not result
in the steering of consumers to these products to the exclusion of other
products for which the consumer may qualify.

Institutions should have procedures and systems in place to monitor
compliance with applicable laws and regulations, third-party agreements
and internal policies. An institution's controls also should include
appropriate corrective actions in the event of failure to comply with
applicable laws, regulations, third-party agreements or internal
policies. In addition, institutions should initiate procedures to review
consumer complaints to identify potential compliance problems or other
negative trends.

**Supervisory Review**

The Agencies will continue to carefully review risk management and
consumer compliance processes, policies, and procedures. The Agencies
will take action against institutions that exhibit predatory lending
practices, violate consumer protection laws or fair lending laws, engage
in unfair or deceptive acts or practices, or otherwise engage in unsafe
or unsound lending practices.

\[THIS SIGNATURE PAGE RELATES TO THE FINAL GUIDANCE TITLED "STATEMENT ON
SUBPRIME MORTGAGE LENDING"\]

Dated:

John C. Dugan,

Comptroller of the Currency

\[THIS SIGNATURE PAGE RELATES TO THE FINAL GUIDANCE TITLED "STATEMENT ON
SUBPRIME MORTGAGE LENDING"\]

By order of the Board of Governors of the Federal Reserve System,
\[DATE\]

Jennifer J. Johnson

Secretary of the Board

\[THIS SIGNATURE PAGE RELATES TO THE FINAL GUIDANCE TITLED "STATEMENT ON
SUBPRIME MORTGAGE LENDING"\]

Dated at Washington, D.C., the 27th day of June, 2007

By order of the Federal Deposit Insurance Corporation

Robert E. Feldman,

Executive Secretary

\[THIS SIGNATURE PAGE RELATES TO THE FINAL GUIDANCE TITLED "STATEMENT ON
SUBPRIME MORTGAGE LENDING"\]

Dated: \[\_\_\_\_\_\_\_\_\_\]

By the Office of Thrift Supervision

John Reich,

Director

\[THIS SIGNATURE PAGE RELATES TO THE FINAL GUIDANCE TITLED "STATEMENT ON
SUBPRIME MORTGAGE LENDING"\]

Dated: \[\_\_\_\_\_\_\_\_\_\]

By the National Credit Union Administration

JoAnn M. Johnson,

Chairman

[^1]: For example, ARMs known as "2/28" loans feature a fixed rate for
    two years and then adjust to a variable rate for the remaining 28
    years. The spread between the initial fixed interest rate and the
    fully indexed interest rate in effect at loan origination typically
    ranges from 300 to 600 basis points.

[^2]: Media Release, CSBS & AARMR, "CSBS and AARMR Support Interagency
    Statement on Subprime Lending" (March 2, 2007), available at
    [http://www.csbs.org/AM/Template.cfm?Section=Search&template=/CM/HTMLDisplay.cfm&ContentID=10295]{.underline}.

[^3]: Federally insured credit unions should refer to LCU 04-CU-13 --
    *Specialized Lending Activities*.

[^4]: Federal credit unions are prohibited from charging prepayment
    penalties. 12 CFR 701.21.

[^5]: 12 CFR part 226 (2006).

[^6]: 24 CFR part 3500 (2005).

[^7]: 71 FR 58673 (October 4, 2006).

[^8]: The Agencies consist of the Board of Governors of the Federal
    Reserve System (the Board), the Federal Deposit Insurance
    Corporation (FDIC), the National Credit Union Administration (NCUA),
    the Office of the Comptroller of the Currency (OCC), and the Office
    of Thrift Supervision (OTS).

[^9]: The term "subprime" is described in the 2001 *Expanded Guidance
    for Subprime Lending Programs*. Federally insured credit unions
    should refer to LCU 04-CU-13 -- *Specialized Lending Activities*.

[^10]: Payment shock refers to a significant increase in the amount of
    the monthly payment that generally occurs as the interest rate
    adjusts to a fully indexed basis. Products with a wide spread
    between the initial interest rate and the fully indexed rate that do
    not have payment caps or periodic interest rate caps, or that
    contain very high caps, can produce significant payment shock.

[^11]: For example, ARMs known as "2/28" loans feature a fixed rate for
    two years and then adjust to a variable rate for the remaining 28
    years. The spread between the initial fixed interest rate and the
    fully indexed interest rate in effect at loan origination typically
    ranges from 300 to 600 basis points.

[^12]: Federally insured credit unions should refer to LCU 04-CU-13 --
    *Specialized Lending Activities*. National banks also should refer
    to 12 CFR 34.3(b) and (c), as well as 12 CFR part 30, Appendix C.

[^13]: As with the *Interagency Guidance on Nontraditional Mortgage
    Product Risks*, 71 FR 58609 (October 4, 2006), this Statement
    applies to all banks and their subsidiaries, bank holding companies
    and their nonbank subsidiaries, savings associations and their
    subsidiaries, savings and loan holding companies and their
    subsidiaries, and credit unions.

[^14]: Federal credit unions should refer to 12 CFR 740.2 and 12 CFR 706
    for information on prohibited practices.

[^15]: The OCC, the Board, the OTS, and the FDIC enforce this provision
    under section 8 of the Federal Deposit Insurance Act. The OCC,
    Board, and FDIC also have 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, and 12 CFR part 30, Appendix C; Joint Board and FDIC
    *Guidance on Unfair or Deceptive Acts or Practices by
    State-Chartered Banks*, March 11, 2004. The OTS also has issued 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). The
    NCUA prohibits federally insured credit unions 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).

[^16]: Refer to 12 CFR part 34, subpart D (OCC); 12 CFR part 208,
    subpart C (Board); 12 CFR part 365 (FDIC); 12 CFR 560.100 and 12 CFR
    560.101 (OTS); and 12 CFR 701.21 (NCUA).

[^17]: OTS Examination Handbook Section 212, *1-4 Family Residential
    Mortgage Lending*, also discusses borrower qualification standards.
    Federally insured credit unions should refer to LCU 04-CU-13-
    *Specialized Lending Activities.*

[^18]: The fully indexed rate equals the index rate prevailing at
    origination plus the margin to be added to it after the expiration
    of an introductory interest rate. For example, assume that a loan
    with an initial fixed rate of 7% will reset to the six-month London
    Interbank Offered Rate (LIBOR) plus a margin of 6%. If the six-month
    LIBOR rate equals 5.5%, lenders should qualify the borrower at 11.5%
    (5.5% + 6%), regardless of any interest rate caps that limit how
    quickly the fully indexed rate may be reached.

[^19]: The fully amortizing payment schedule should be based on the term
    of the loan. For example, the amortizing payment for a "2/28" loan
    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.

[^20]: Institutions may need to account for workout arrangements as
    troubled debt restructurings and should follow generally accepted
    accounting principles in accounting for these transactions.

[^21]: Federal credit unions are prohibited from charging prepayment
    penalties. 12 CFR 701.21.

[^22]: Institutions generally can address these concerns most directly
    by requiring borrowers to escrow funds for real estate taxes and
    insurance.

[^23]: To illustrate: a borrower earning \$42,000 per year obtains a
    \$200,000 "2/28" mortgage loan. The loan's two-year introductory
    fixed interest rate of 7% requires a principal and interest payment
    of \$1,331. Escrowing \$200 per month for taxes and insurance
    results in a total monthly payment of \$1,531 (\$1,331 + \$200),
    representing a 44% DTI ratio. A fully indexed interest rate of 11.5%
    (based on a six-month LIBOR index rate of 5.5% plus a 6% margin)
    would cause the borrower's principal and interest payment to
    increase to \$1,956. The adjusted total monthly payment of \$2,156
    (\$1,956 + \$200 for taxes and insurance) represents a 41% increase
    in the payment amount and results in a 62% DTI ratio.

[^24]: See footnote 21.