S. HRG.109–1083 

CALCULATED RISK: ASSESSING NON-TRADITIONAL 

MORTGAGE PRODUCTS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON HOUSING AND 

TRANSPORTATION 

AND THE

SUBCOMMITTEE ON ECONOMIC POLICY 

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED NINTH CONGRESS 

SECOND SESSION 

ON 

THE ISSUES SURROUNDING NON-TRADITIONAL MORTGAGES AND THEIR 

POSSIBLE IMPLICATIONS FOR CONSUMERS, FINANCIAL INSTITUTIONS, 

AND THE ECONOMY 

WEDNESDAY, SEPTEMBER 20, 2006 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html 

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CALCULATED RISK: ASSESSING NON-TRADITIONAL MORTGAGE PRODUCTS 

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50–305 2009

S. HRG.109–1083 

CALCULATED RISK: ASSESSING NON-TRADITIONAL 

MORTGAGE PRODUCTS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON HOUSING AND 

TRANSPORTATION 

AND THE

SUBCOMMITTEE ON ECONOMIC POLICY 

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED NINTH CONGRESS 

SECOND SESSION 

ON 

THE ISSUES SURROUNDING NON-TRADITIONAL MORTGAGES AND THEIR 

POSSIBLE IMPLICATIONS FOR CONSUMERS, FINANCIAL INSTITUTIONS, 

AND THE ECONOMY 

WEDNESDAY, SEPTEMBER 20, 2006 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html 

smartinez on DSKD5P82C1PROD with HEARING

(II) 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

RICHARD C. SHELBY, Alabama, Chairman 

ROBERT F. BENNETT, Utah 

WAYNE ALLARD, Colorado 

MICHAEL B. ENZI, Wyoming 

CHUCK HAGEL, Nebraska 

RICK SANTORUM, Pennsylvania 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

JOHN E. SUNUNU, New Hampshire 

ELIZABETH DOLE, North Carolina 

MEL MARTINEZ, Florida 

PAUL S. SARBANES, Maryland 

CHRISTOPHER J. DODD, Connecticut 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

THOMAS R. CARPER, Delaware 

DEBBIE STABENOW, Michigan 

ROBERT MENENDEZ, New Jersey 

WILLIAM D. DUHNKE, Staff Director and Counsel 

STEVEN B. HARRIS, Democratic Staff Director and Chief Counsel 

PEGGY R. KUHN, Senior Financial Economist 

MARK A. CALABRIA, Senior Professional Staff Member 

JOHNATHAN MILLER, Democratic Professional Staff 

JOSEPH R. KOLINSKI, Chief Clerk and Computer Systems Administrator 

GEORGE E. WHITTLE, Editor 

SUBCOMMITTEE ON HOUSING AND TRANSPORTATION

WAYNE ALLARD, Colorado, Chairman 

JACK REED, Rhode Island, Ranking Member 

RICK SANTORUM, Pennsylvania 

ELIZABETH DOLE, North Carolina 

MICHAEL B. ENZI, Wyoming 

ROBERT F. BENNETT, Utah 

MEL MARTINEZ, Florida 

RICHARD C. SHELBY, Alabama 

DEBBIE STABENOW, Michigan 

ROBERT MENENDEZ, New Jersey 

CHRISTOPHER J. DODD, Connecticut 

THOMAS R. CARPER, Delaware 

CHARLES E. SCHUMER, New York 

TEWANA WILKERSON, Staff Director 

DIDEM NISANCI, Democratic Staff Director 

KARA STEIN, Legislative Assistant 

SUBCOMMITTEE ON ECONOMIC POLICY

JIM BUNNING, Kentucky, Chairman 

CHARLES E. SCHUMER, New York, Ranking Member 

RICHARD C. SHELBY, Alabama 

WILLIAM HENDERSON, Staff Director 

CARMENCITA N. WHONDER, Democratic Staff Director 

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(III) 

C O N T E N T S 

WEDNESDAY, SEPTEMBER 20, 2006 

Page 

Opening statement of Chairman Allard ................................................................ 1 

Opening statement of Chairman Bunning ............................................................ 5 

Opening statements, comments, or prepared statements of: 

Senator Reed ..................................................................................................... 4 

Senator Sarbanes .............................................................................................. 7 

Senator Carper ................................................................................................. 8 

Prepared statement ................................................................................... 46 

Senator Schumer .............................................................................................. 37 

WITNESSES 

Orice Williams, Director, Government Accountability Office .............................. 9 

Prepared Statement ......................................................................................... 47 

Response to written questions of: 

Senator Bunning ....................................................................................... 294 

Kathryn E. Dick, Deputy Comptroller for Credit and Market Risk, Office 

of the Comptroller of the Currency ..................................................................... 10 

Prepared Statement ......................................................................................... 111 

Sandra Braunstein, Director of the Division of Consumer and Community 

Affairs, Federal Reserve ...................................................................................... 12 

Prepared Statement ......................................................................................... 125 

Response to written questions of: 

Senator Bunning ....................................................................................... 296 

Senator Reed .............................................................................................. 300 

Sandra Thompson, Director of the Division of Supervision and Consumer 

Protection, Federal Deposit Insurance Corporation .......................................... 14 

Prepared Statement ......................................................................................... 139 

Response to written questions of: 

Senator Bunning ....................................................................................... 303 

Senator Reed .............................................................................................. 306 

Scott Albinson, Managing Director for Examinations, Supervision, and 

Consumer Protection, Office of Thrift Supervision ........................................... 15 

Prepared Statement ......................................................................................... 156 

Response to written questions of: 

Senator Bunning ....................................................................................... 310 

Senator Reed .............................................................................................. 313 

Felecia A. Rotellini, Superintendent, Arizona Department of Financial 

Institutions ........................................................................................................... 17 

Prepared Statement ......................................................................................... 174 

Response to written questions of: 

Senators Allard and Bunning ................................................................... 315 

Robert Broeksmit, Chairman of the Residential Board of Governors, Mortgage 

Bankers Association ............................................................................................. 26 

Prepared Statement ......................................................................................... 187 

George Hanzimanolis, NAMB President-Elect, Bankers First Mortgage, Inc. ... 28 

Prepared Statement ......................................................................................... 210 

William Simpson, Chairman, Republic Mortgage Insurance Company .............. 30 

Prepared Statement ......................................................................................... 224 

Response to written questions of: 

Senator Bunning ....................................................................................... 321 

Senator Reed .............................................................................................. 322 

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IV 

Michael Calhoun, President, Center for Responsible Lending ............................ 31 

Prepared Statement ......................................................................................... 239 

Response to written questions of: 

Senator Bunning ....................................................................................... 322 

Senator Reed .............................................................................................. 326 

Allen Fishbein, Director of Housing Policy, Consumer Federation of America .. 33 

Prepared Statement ......................................................................................... 262 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Greg Griffin, David Olinger and Jeffrey A. Roberts, Denver Post Staff Writers, The Denver Post, ‘‘FORECLOSING ON THE AMERICAN DREAM 

/ Part of an occasional series / No money down: a high-risk gamble,’’ 

article dated September 17, 2006 ....................................................................... 331 

Statement from the Consumer Mortgage Coalition .............................................. 336 

Statement from the National Association of REALTORS® ................................. 370 

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(1) 

CALCULATED RISK: ASSESSING NONTRADITIONAL MORTGAGE PRODUCTS 

WEDNESDAY, SEPTEMBER 20, 2006 

U.S. SENATE, SUBCOMMITTEE ON HOUSING AND TRANSPORTATION, SUBCOMMITTEE ON ECONOMIC POLICY, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Subcommittees met at 10:03 a.m., in room SD–538, Dirksen 

Senate Office Building, Hon. Wayne Allard, and the Hon. Jim 

Bunning, Chairmen of the Subcommittees, presiding. 

OPENING STATEMENT OF SENATOR WAYNE ALLARD 

Chairman ALLARD. I am going to call the Committee to order. 

This is a joint hearing of the Subcommittee on Housing and 

Transportation and the Subcommittee on Economic Policy. I will be 

joined this morning later on by Chairman Bunning on Economic 

Policy and minority side. I have a reputation of getting started on 

time. So I would like to get started on time, and my colleagues can 

drag in as they do. 

We are going to run a pretty tight hearing today because we 

have lots of witnesses and we have a lot of time constraints. So I 

am going to enforce the 5-minute rule very strictly even on my colleagues. I think you would agree to that, Mr. Chairman, to make 

sure that we can stay within our time line. 

Chairman Bunning, I have been informed that we have a vote, 

perhaps at eleven o’clock. So maybe you and I can switch off and 

keep the meeting going when we get to that point in time. 

I would like to welcome everyone to the joint hearing of the Subcommittee on Housing and Transportation and the Subcommittee 

on Economic Policy. I was pleased to co-chair the hearing with Senator Bunning last week to examine developments in the housing 

markets, and at that time, we heard a great deal of discussion regarding non-traditional mortgage products, and Senator Bunning 

and I felt that the issue was of such importance that we should 

hold a second hearing to examine it in greater depth. 

This is a topic that is not just inside the beltway conversation 

consideration. For example, The Denver Post, my State of Colorado, 

headlines last Sunday on ‘‘No Money Down, High-Risk Gamble’’. It 

is talking about home loans and whatnot. This is a topic which typical American families are following very closely, and the article 

raised many interesting points, and I would ask unanimous consent for the entire article to be entered into the record. 

Without objection, that will be so ordered. 

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2 

While these products may be considered non-traditional, they are 

certainly not new. Variations of interest only loans have existed at 

least since the 1930’s and payment option mortgages have been in 

use since the 1980’s, I understand. There has been a significant 

shift, however, in the consumer base for these mortgage products. 

Over the previous two decades, non-traditional mortgages were 

primarily utilized by wealthy financially sophisticated individuals 

looking to manage cash-flow or maximize financial flexibility. However, following years of dramatic increases in houses prices, average consumers began taking non-traditional mortgages in order to 

make home ownership more affordable or to increase the amount 

of home that they could qualify to purchase. 

Let us look at Chart 1. Non-traditional products have surged in 

popularity. According to the ‘‘First American Real Estate Solution’’, 

interest only and payment option loans comprised only 1.9 percent 

of the mortgage market in the year 2000. That is reflected in the 

chart that you see here on your left. However, their share of the 

mortgage, market expanded to 36.6 percent in 2005. That is reflected on the chart there on your right. 

An interest only loan allows the consumer to make payments 

covering only the interest on the loan balance for a period of time, 

generally three to 10 years. At that time, the consumer must also 

begin making payments which cover the principal. Because the period in which the principal is repaid is compressed, payments can 

jump significantly. 

I would like to go Chart No. 2, the payment shock chart. Payment option mortgages, which is the second type of mortgage we 

want to review today, offer consumers a choice of four different 

mortgage payments. There is a 15-year amortization payment, 

which is a traditional loan; a 30-year amortization payment, where 

you pay on the interest and you pay equity into the house, you pay 

down the house; a payment covering interest only or a minimum 

payment, which is the bottom line. Because consumers choosing the 

minimum payment are not even covering the interest on the loan, 

the loan balance actually increases, making the loan negatively 

amortizing. The loan balance can continue to increase until it 

reaches a preset cap at which point the loan resets and becomes 

fully amortizing. At this point, payments can jump significantly, 

sometimes double or more, which is referred to at times as just 

payment shock. 

As we go to Chart No. 3, why have we seen such an upsurge in 

non-traditional mortgages recently? Well, quite simply, they can 

make homeownership more affordable by lowering payments and 

allowing homeowners to potentially qualify a larger mortgage. As 

part of the Mountain Census Region, my home State of Colorado 

has been part of the highest regional home price increases over the 

past year. It is no coincidence that the uptick in non-traditional 

mortgages parallels the uptick in home prices. 

As this chart demonstrates, an interest only loan can allow a 

consumer to buy a 20 percent more expensive home. Non-traditional mortgages can also provide financial flexibility. For example, 

a buyer who doesn’t intend to remain in a house for very long could 

buy more house because of initially loan low payments. 

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These mortgage products can also be helpful for people who desire temporary cash-flow for investments or to pay off other higher 

interest rates and those who expect a future increase in earnings. 

Payment option loans also provide flexibility for those with uneven 

income flows such as people who receive large bonuses or commissions. In utilizing a non-traditional mortgage, borrowers bet on the 

fact that mortgage rates will remain stable and home values will 

continue to rise. This is crucial for them to be able to refinance 

their loan before it resets and payment shock kicks in. 

As we learned at the last hearing, though, the cyclical nature of 

markets dictates that past rates of appreciation and record low interest rates cannot continue indefinitely. If interest rates have increased, a consumer may not be able to qualify for or afford the refinancing alternatives. Similarly, if home values have been stagnant or decreased, homeowners may have difficulty refinancing or 

even selling their home as they can owe more than what it is 

worth. 

This is exacerbated by situations in which the buyer made little 

or no down payment or used piggy-back mortgages. Homeowners 

with little or no equity have no cushion for financial hardships 

such as an illness, job loss, or divorce. It is no coincidence that recent Colorado home buyers have the Nation’s lowest home equity 

rate and the State also has the highest foreclosure rate. According 

to ‘‘Business Week’’, nationwide, more than 20 percent of the option 

ARM loans in 2004 and 2005 are upside down, meaning the homes 

are worth less than their debt. 

Non-traditional mortgages are not necessarily bad products as 

long as they are carefully utilized. In order for consumers to decide 

whether these products are appropriate for them, they must have 

adequate information. The information must also be clear and 

meaningful. Consumers should understand exactly what risks and 

benefits different products represent. 

I commend the regulators for taking steps to improve consumer 

disclosure. No one should face the situation of Colorado’s Lilly and 

India Hartz who thought they were refinancing with a 30-year 

fixed-rate mortgage, but instead got an option ARM. 

Today, we will also explore the implications of non-traditional 

mortgages for financial institutions. Because these are risker products, it is even more important that they are underwritten with 

care. Additionally, financial institutions must take appropriate 

steps to manage that risk. 

We have a distinguished lineup of witnesses today. While the 

witness list may be lengthy, each organization represented here 

today has an important perspective to share. 

First, we will hear from Ms. Orice Williams, the managing director for the GAO study on alternative mortgage products. She and 

her team have done an excellent job of researching this issue, and 

I would like to commend them for their work. I know we are all 

looking forward to hearing more about the findings and recommendations of the report that GAO is releasing today. 

The first panel will also include representatives from each of the 

four Federal financial regulators: Ms. Kathryn E. Dick, Deputy 

Comptroller for Credit and Market Risk at the OCC; Ms. Sandra 

F. Braunstein, Director of the Division of Consumer and Commusmartinez on DSKD5P82C1PROD with HEARING

4 

nity Affairs at the Fed; Ms. Sandra Thompson, Director of Supervision and Consumer Protection at the FDIC; and Mr. Scott 

Albinson, Managing Director for Examinations, Supervision, and 

Consumer Protection at OTS. 

In December 2005, the regulators issued draft interagency guidance regarding non-traditional mortgage products. Specifically, the 

guidance addressed the necessity for adequate and meaningful consumer disclosures. The guidance also addressed the need for financial institutions to properly manage the risks posed by the products. After receiving extensive comments, they are now working toward issuing final guidance. I commend them for taking up this 

issue and look forward to an update on their process as well as 

their ongoing individual agency efforts. 

Our final witness on the panel will be Ms. Felecia A. Rotellini, 

the Superintendent of the Arizona Department of Financial Institutions. The Conference of State Bank Supervisors has also been 

looking at non-traditional mortgage products. In addition, they are 

developing a national licensing system for the residential mortgage 

industry. The system will provide a uniform application, allow access to a central repository of licensing and publicity and adjudicated enforcement actions. This will be incredibly helpful so for 

States like Colorado where mortgage fraud has been a problem, 

bad actors will no longer be able to simply move to another State 

and continue to perpetrate their fraudulent activities. 

Our second panel will explore the perspectives of industry and 

consumer groups. Witnesses will include: Mr. Robert Broeksmit, 

Chairman of the Residential Board of Governors for the Mortgage 

Bankers Association; Mr. George Hanzimanolis, President-Elect of 

the National Association of Mortgage Brokers; Mr. William A. 

Simpson, Chairman, Republic Mortgage Insurance Company, on 

behalf of the mortgage insurance companies of America; Mr. Michael D. Calhoun, President, Center for Responsible Lending; and 

Mr. Allen Fishbein, Director of Housing and Credit Policy, Consumer Federation of America. 

You can tell from this list, we have many witnesses today. Therefore, I will ask our witnesses to be especially mindful of the 5- 

minute time limit. Similarly, I will also ask members to please respect the 5-minute time limit during the question and answer period. While I know that we all have many issues we wish to explore, Chairman Bunning and I want to ensure that all members 

and witnesses have an opportunity to be heard. We will leave the 

record open so that members have an additional opportunity to ask 

questions for which they may not have time at the hearing. I thank 

all of you for your cooperation. 

Chairman ALLARD. Now I will turn to the ranking member, Senator Reed. 

STATEMENT OF SENATOR JACK REED 

Senator REED. Thank you very much, Chairman Allard and 

Chairman Bunning, for holding this hearing. 

Homeownership has provided Americans with an avenue toward 

prosperity. Consumer Federation of America reports that home equity comprises 50 to 60 percent of an average American household’s 

net wealth; however, homeownership has become elusive for many 

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Americans. The Joint Center for Housing Studies at Harvard reported, in their words, ‘‘Affordability pressures are now spreading 

with median house prices in a growing number of large metropolitan areas exceeding median household incomes by a factor of four 

or more’’, proving that with the cooling real estate market, home 

prices in my State of Rhode Island are expected to jump an additional 6.3 percent this year. 

As housing affordability has weakened, the mortgage industry 

has made available to the average home buyer non-traditional 

mortgage products that were historically designed for the high net 

worth and financially-savvy borrower. Two of the most commonly 

utilized non-traditional mortgage products are interest only and 

payment option loans. According to First American Real Solution, 

IO and payment option loans comprised only 1.9 percent of the 

mortgage market in 2000, but represent 36.6 percent of the market 

by 2005. 

These loans pose significant dangers to the sustainability of 

homeownership for many American households. A recent ‘‘Business 

Week’’ article reported that 80 percent of the borrowers are making 

the minimum payment on their payment option loans, eroding 

their home equity with every payment. At a time where pricing are 

leveling or even decline in many parts of the country, many borrowers with option adjustable rate mortgages, ARMS, may soon be 

left with few options. Borrowers with other non-traditional product 

also may soon be facing significant higher payments in the near future, leading Goldman Sachs to estimate that non-traditional mortgage products are at a, quote, very high risk of default. 

In fact, foreclosure rates are escalating. Indeed, non-traditional 

mortgages default at a higher rate than fixed-rate mortgages. In 

Rhode Island, for example, default on prime ARMs are 21 percent 

higher than prime fixed-rate loans. Subprime ARMs have almost a 

forty percent higher default rate than fixed-rate loans. As a result, 

according to ‘‘Fitch Ratings 2006 Finance Outlook’’, mortgage delinquencies which increased by 53 percent over the last year are expected to rise by an additional 10 to 15 percent in 2006. 

The Federal banking regulators issued proposed guidance in December 2005 that attempts to address the potential for heightened 

risk levels associated with non-traditional mortgage lending and 

recommended practices for communicating with and providing information to consumers. Guidance in this area is necessary to be 

finalized promptly to ensure that lenders and financial institutions 

take responsibility for the long-term sustainability of the loans they 

originate and ultimately to ensure safety and soundness of our financial system and protect consumers. 

I look forward to the witnesses’ testimony. Thank you, Mr. Chairman. 

I will call on Chairman Bunning for his opening statement. 

OPENING STATEMENT OF CHAIRMAN JIM BUNNING 

Chairman BUNNING. Thank you, Chairman Allard. 

Last week, we had a very good hearing on the state of the housing market. I think everybody knows there are reasons to be concerned about the coming months in locations that have seen dramatic price increases over the last few years. Just yesterday, it was 

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announced that housing starts declined another 6 percent in August for a total a 26.5 percent since the peak in January. 

Other indicators are continuing to show a slow-down as well. 

Hopefully, we are just seeing a pull back to a more reasonable 

growth level and not a crash. 

This week, we are going to examine non-traditional mortgages 

and how they have contributed to the housing boom. We are also 

going to look into risks posed by the popularity of these products 

over the last few years. The two mortgage products, as has been 

said before, are interest only and payment option adjustable rate 

mortgage loans. Those products were relatively rare. As Senator 

Reed said, only 1.9 percent of the mortgages in 2000 had those 

types of rates. Last year, they accounted for over 35 percent. 

These products were first used by wealthy and sophisticated borrowers as a cash-flow management tool, but today, they are being 

marketed as an affordability product to ordinary and even 

subprime borrowers. Early reports for this year showed even further increases in the share of non-traditional mortgages being written. 

These product have some benefits for consumers, such as a low 

initial payment, the ability to purchase more expensive homes, and 

more flexible repayment terms. Even Former Fed Chairman Greenspan suggested borrowers should get an adjustable rate mortgage. 

That is quite a few years back, and that was before he started raising interest rates at the Fed. 

There are significant risks that come with those benefits and it 

is not clear that borrowers understand those risks. The prime risk 

to borrowers has been described as payment shock, as Senator Allard said, as payments reset to a higher level. Most borrowers have 

not yet experienced significant payment shock, but experts believe 

over $2 trillion of these mortgages will reset in the next 2 years, 

and because of rising interest rates, those payment increases could 

easily total 100 percent by the fifth year of the loan. 

Financial institutions are at risk also. In order to write more 

loans, lenders have relaxed their underwriting standards. This is 

troubling because of payment resets. If the borrower is unable to 

make those new payments, they will have to refinance, sell, or default. Due to higher interest rates and a slow-down in the housing 

market, many borrowers may wind up with negative equity in their 

homes. If lenders are forced to foreclose, they could end up owning 

properties that are worth less than the outstanding loan value. 

While regulators have stated that banks have taken steps to reduce their risks, they have issued draft guidance to Federally regulated institutions on how to better reduce that risk. Further steps 

may be necessary by Federal and State regulators to ensure borrowers understand what they are getting into when they sign up 

for one of these mortgages. 

The GAO report being released at this hearing highlights these 

concerns, and I thank them for their work to raise awareness. 

Thank you again, Mr. Chairman. I have enjoyed working with 

you on this set of hearings, and I look forward to hearing from our 

many witnesses. 

Senator Sarbanes. 

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STATEMENT OF SENATOR PAUL S. SARBANES 

Senator SARBANES. First of all, I want to commend the Chairman 

Allard and Chairman Bunning, respectively the heads of our Subcommittee on Housing and Transportation and the Subcommittee 

on Economic Policy, and Ranking Members Reed and Schumer for 

holding this second hearing to examine the housing markets and 

the economy. Last week, we have a very good hearing that focused 

on the overall housing market. Today’s hearing is designed to explore the challenges posed by new and highly complex mortgage 

products. 

It is obvious, of course, that the mortgage market that a borrower confronts today is vastly different from the market that existed even five or 6 years ago. In 2000, 85 percent of all mortgages 

were fixed-rate obligations. Borrowers generally understood these 

mortgages and the risks, generally speaking, were transparent. 

Today, just 6 years later, nearly half of all loans are adjustable 

rates mortgages, 46 percent. Moreover, about 37 percent of all 

loans originated in 2005, last year, are what many now call exotic 

mortgages, either interest only loans or option ARMs where the 

borrower has the option to make a payment that is not sufficient 

to cover even the interest due. Such loans, of course, result in negative amortization. 

Now, the regulators tell us, and I am pleased to join the chairman in welcoming the representatives of the various regulatory 

agencies to this panel, tell us that these exotic mortgages were designed as niche products for wealthier borrowers. As such, they 

may, perhaps, have been appropriate; however, over the past 3 

years, lenders and mortgage brokers have been selling these more 

complex loans to middle class and lower income borrowers as affordability products. In other words, they are being used to enable 

borrowers to deal with steadily escalating housing prices. 

These mortgages are characterized by significant payment shocks 

that hit borrowers some years into the term of the loan. In my 

view, these new products may be helpful in expanding consumer 

choices and creating opportunities to create homeownership, but I 

think this is true only if they are used very judiciously. The loans 

must be underwritten so as to reasonably ensure that borrowers 

can afford the payments over the life of the loan, not just during 

the introductory period. Loans where there are new exotic programs, or a more traditional mortgage for that matter, should be 

underwritten with this in mind. 

Unfortunately, evidence seems to indicate that this careful approach has not been followed in recent years. Too often, according 

to what the regulators tell us, loans have been made without the 

careful consideration as to the long-term sustainability of the mortgage. Loans are being made without the lender documenting that 

the borrower will be able to afford the loan after the expected payment shock hits without depending on rising incomes or increased 

appreciation. 

We are seeing the consequences of this. The cover story of Business Week September 11th says that more of a fifth of option ARM 

loans in 2004 and 2005 are upside down, more than a fifth, meaning borrowers’ homes are worth less than their debt. If home prices 

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drop another 10 percent, which the realtors expect to happen, that 

number will double. 

An economic report by Merrill Lynch entitled ‘‘House of Horrors’’, 

September 18th, indicates that problems are already beginning to 

surface as some of the early option ARMs are being reset. Merrill 

Lynch, citing data from ‘‘Realty Track’’ notes that foreclosures nationwide surged 53 percent year on year in August and spiked 24 

percent month over month. They go on to say the culprit is the 

resets on option ARMs. The report also notes a high concentration 

of delinquencies among subprime ARM borrowers in States that 

have both hot and flat housing markets. 

The guidance proposed by the regulators, which requires that 

lenders carefully and fully analyze a borrower’s ability to repay the 

loan by final maturity based on the fully indexed rate assuming a 

fully amortized repayment schedule, should help to curb some of 

the abuses we are seeing. I strongly support this guidance as an 

important first step to setting in proper perspective what I perceive 

to some troubling aspects of the mortgage industry. It is not the 

final step, but it is a good start. 

I also support the provisions of the proposed guidance that will 

require lenders to monitor third-party originators, such as mortgage brokers, to ensure that the loans they originate meet the 

standards of the guidance and of the regulated entity. These third 

parties originate as many as 80 percent of the mortgage loans 

made in this country. If they are not held to the same standard as 

regulated retail lenders, if that standard is not effectively enforced, 

the rules will not result in better outcomes for borrowers. 

Likewise, we need to urge the States and the regulators to act 

to adopt consistent rules for unregulated lenders if they expect 

progress to be made in this area. This is particularly true in the 

subprime market. According to the 2004 HMDA data, 58 percent, 

58 percent, of first lien subprime loans were made by unregulated 

lenders. These are the borrowers that are especially vulnerable and 

we need to address their situation. 

Mr. Chairman, this is an important problem that you are addressing, and I want to thank the chairmen, in the plural. I want 

to thank both Senator Allard and Senator Bunning for scheduling 

this hearing. Thank you very much. 

Senator Carper, do you have an opening comment? 

STATEMENT OF SENATOR THOMAS R. CARPER 

Senator CARPER. Just very briefly. 

A couple of my colleagues have already spoken to this. When I 

read my briefing materials, I saw the number 1.9 percent of mortgage market in 2000 was interest only and payment option loans. 

Then I saw that it jumped to over a third in six short years. I said 

that is a pretty good reason for holding the hearing and I am very 

glad that we are doing that. 

I have to go to another hearing. I apologize to the witnesses. I 

thank you for coming today, and I especially want to welcome one 

whose mother lives in Wilmington, Delaware, only a few blocks 

from where my family now wells. 

Sandra, welcome. I am glad to hear from you and all these people who you brought with you. Thank you. 

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9 

STATEMENT OF ORICE WILLIAMS, DIRECTOR, 

GOVERNMENT ACCOUNTABILITY OFFICE 

Ms. WILLIAMS. Chairman Allard, Chairman Bunning, and Subcommittee Members, I am pleased to be here this morning to discuss the finding of our just released report on alternative mortgage 

products. As you well know, these products can offer benefits from 

a flexibility and affordability perspective. They also can pose significant risks for some borrowers because of the potential for large 

increases in monthly payments or payment shock and features 

such as negative amortization. 

This morning, I will briefly discuss the findings from our report, 

specifically, trends in alternative mortgage products, the risks 

these products can pose to borrowers and lenders, current disclosure practices, and the actions of Federal and State regulator. 

While alternative mortgage products have been around for decades, 

interest only and payment option ARMs have only become part of 

the mainstream real estate lending landscape in the past few 

years. 

For example, in 2003, interest only and payment option ARMs 

comprised about 10 percent of mortgages originated. Today, that 

number is over 30 percent, and in certain parts of the country, particularly on the east and west coast, this number can be even higher. As housing prices have increased, so has the demand for mortgage products that can make the dream of home ownership more 

affordable even if only temporarily. While once marketed to the 

wealthy and financially sophisticated, these products are now being 

mass marketed to a wider range of potential borrowers. 

This change in focus poses risks that lenders must manage. In 

addition to the products being more complex than traditional mortgage products, some lenders are layering on additional risks by 

combining alternative mortgage products with underwriting practices such as low or no documentation loan features. Although 

banking regulators expressed some concerns about underwriting 

standards, they told us that they generally believe that federallyregulated institutions have generally managed these risks well 

through portfolio diversification, selling or securitizing these loans, 

and holding an adequate level of capital. 

For borrowers, these products raise concerns about the extent 

that current borrowers fully understand the risks they may face 

such as payment shock and negative amortization. Although these 

products pose risks, they can also provide many borrowers with 

flexibility that they would not have had with more conventional 

products. Moreover, for borrowers that understand the risks and 

are able to refinance, sell, or absorb the higher payments, these 

products can be beneficial; however, for other less savvy and less 

informed borrowers, the experience can be very different. 

Alternative mortgage products illustrate the importance of adequate disclosures to help borrowers understand the product’s terms 

and risks. To gain some insight into the disclosures borrowers receive, we reviewed a sample of alternative mortgage products disclosures used by some of the largest federally-regulated lenders in 

this market. What we found was both troubling and revealing. 

While we found that these lenders generally complied with the letter of the law and that they provided the federally-required disclosmartinez on DSKD5P82C1PROD with HEARING

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sures, most did not fully or clearly discuss the risks and the terms 

of these products. 

Federal and State regulators have been and are focusing attention on these developments in the real estate lending market. Specifically, Federal banking regulators are in the process of finalizing 

interagency guidance, and individually they have taken a variety 

of other steps aimed at ensuring that lenders are acting responsibly. Likewise, State regulators have begun to focus on alternative 

mortgage products. 

In closing, I would like to thank you for your attention to this 

issue. While we found no evidence of widespread problems to date, 

it is too soon to tell what the future holds for these borrowers and 

much will depend on a variety of economic factors. Finally, we 

would like to stress the importance of the interagency guidance 

being finalized by the bank regulators and hope that it is issued 

in the future. 

Mr. Chairman, this concludes my oral statement and I will be 

happy to answer any questions. 

Chairman ALLARD. Thank you. 

Ms. Kathryn Dick, Deputy Comptroller of Credit and Market 

Risk in the Office of the Comptroller of the Currency. 

STATEMENT OF KATHRYN E. DICK, DEPUTY COMPTROLLER 

FOR CREDIT AND MARKET RISK, OFFICE OF THE COMPTROLLER OF THE CURRENCY 

Ms. DICK. Chairman Allard, Ranking Member Reed, Members of 

the Subcommittees, I appreciate the opportunity to appear before 

you today to discuss non-traditional mortgage products and the 

proposed interagency guidance on those products. 

Mr. Chairman, thanks in part to the highly competitive and 

highly innovative mortgage market, we have achieved near record 

levels of homeownership across our country. Our goal as Federal 

regulators is to preserve and expand upon this important accomplishment while avoiding unwarranted risks to financial institutions and consumers. 

In recent years, a combination of market forces, especially the 

rapid increase in housing prices, has led to the increased popularity of so-called non-traditional mortgages. This category includes 

interest-only mortgages, where a borrower makes no payment on 

principal for the first several years of the loan, and payment-option 

adjustable-rate mortgages, where a borrower has several payment 

options each month, including one with a potential for negative amortization, which occurs when a certain portion of the interest due 

is deferred and added back to the principal balance of the loan. 

In addition, many non-traditional mortgages are made under relaxed underwriting standards—with less stringent income and 

asset verification requirements, and sometimes in combination with 

simultaneous second mortgage loans to reduce down payment requirements, frequently so that borrowers can dispense with private 

mortgage insurance. 

Non-traditional mortgages have gained a prominent place in the 

marketplace. According to one trade publication, 30 percent of all 

mortgages originated in 2005 were interest-only or payment-option 

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ARMs. In the highest-price housing markets, the number was even 

higher. 

Yet despite their popularity, these loans pose special risks to borrowers and to lenders. Payment-option ARMs expose borrowers to 

the likelihood of payment shock, which occurs when the payment 

deferral period ends, usually after 5 years, and the loan resets to 

the market rate of interest. At that point, the borrower must amortize the entire amount outstanding over the shorter remaining 

term of the loan. In the example that was attached to my written 

testimony, which assumes a modest 2 percent rise in interest rates, 

the monthly payment would double. 

In an active real estate market characterized by rapid home price 

appreciation, such a mortgage can be refinanced and paid off by extracting the increased equity from the appreciated property. But 

what happens if interest rates rise or home prices fall, or both? 

Evidence shows that these risks are often not adequately disclosed and less well understood in the wider population to which 

these products are increasingly marketed. Marketing materials we 

have reviewed emphasize the initial low monthly payment and 

gloss over the likelihood of the much higher payments later on. 

Increasingly, when borrowers opt for a payment-option ARM, 

they aren’t thinking about how much their payment will be 5 years 

down the road and whether they will be able to make that payment—or what will happen if they can’t. But they should be thinking about it and lenders should be thinking about it, too. It is that 

kind of thinking that our proposed interagency guidance on nontraditional mortgages is designed to stimulate. 

It does this by directing financial institutions to ensure that loan 

terms and underwriting standards are consistent with prudent 

lending practices, with particular attention to the borrower’s repayment capacity. It requires that when banks rely on reduced documentation, particularly unverified income, they do so with caution. 

It requires that banks adopt vigorous risk management practices 

that provide early warning systems on potential or increasing 

risks. And it requires that consumers are provided with timely, 

clear, and balanced information about the relative benefits and 

risks of these products, sufficiently early in the process to enable 

them to make informed decisions. 

It may be useful to think of a payment-option ARM as the functional equivalent of a loan coupled with a separate home equity 

line of credit, except that, instead of using a check to draw down 

the line of credit, the borrower does so by choosing the minimum 

payment option. The real difference, for our purposes, is in the underwriting. Whereas an applicant for a home equity line has to 

show adequate income to service the entire amount of the line, no 

similar qualification requirement is imposed on the payment option 

borrower for the additional debt that could be incurred by electing 

to make only the minimum monthly payment, and the minimum 

monthly payment is what most borrowers make. 

Under the proposed guidance, lenders would be required to conduct a credible underwriting analysis of the borrower’s capacity to 

repay the entire debt, including the potential amount of negative 

amortization that the loan structure and initial terms permit. 

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Chairman ALLARD. Ms. Dick, I must ask you to wrap up your 

comments, if you would, please. 

Ms. DICK. Very good. 

Chairman ALLARD. Thank you. 

Ms. DICK. In proposing this guidance, Mr. Chairman, we had two 

goals in mind: One, to ensure that non-traditional mortgage products and the risks associated with them are managed properly in 

our institutions, and, the other, to ensure that consumers are provided the information they need, when they need it, to make informed decisions about these products. 

Chairman ALLARD. Okay. Ms. Sandra Braunstein, Director of the 

Division of Consumer and Community Affairs, Federal Reserve. 

STATEMENT OF SANDRA BRAUNSTEIN, DIRECTOR OF THE DIVISION OF CONSUMER AND COMMUNITY AFFAIRS, FEDERAL 

RESERVE 

Ms. BRAUNSTEIN. Thank you. 

Chairman Allard, Chairman Bunning, Senator Reed and Members of the Subcommittees. 

Chairman BUNNING. Thank you for pulling your mike up. 

Ms. BRAUNSTEIN. I appreciate the opportunity to appear today to 

discuss consumer issues related to non-traditional or alternative 

mortgage products. These products have increased the range of financing options available to consumers and have grown in popularity over the past few years. Some consumers benefit from these 

products and the more flexible payment options, but these loan 

products are not appropriate for everyone. Thus it is important 

that consumer have the information necessary to understand the 

features and risks associated with these types of mortgages. 

The Federal Reserve engages in a variety of activities to ensure 

that consumers understand credit terms and the options available 

to them when they are shopping for mortgage credit. We have a 

role as a rule writer in which the Board issues regulations implementing the Truth-in-Lending Act, or TILA, and its required disclosures. TILA is the primary Federal law governing disclosures for 

consumer credit, including home mortgage loans. 

TILA requires the uniform disclosure of costs and other terms to 

consumers at various stages of the mortgage transaction. This allows consumers to compare more readily the available terms and 

avoid the uninformed use of credit. The disclosures required by 

TILA and its implementing Regulation Z are discussed in greater 

detail in my written testimony. 

We recognize that required disclosures alone cannot address 

these complex issues. Thus we engage in complementary activities 

to ensure that consumers understand credit terms and the options 

available to them when they are shopping for mortgage credit. I 

would like to highlight five significant activities that we currently 

have underway. 

First, we have begun a comprehensive review of the Board’s Regulation Z which implements TILA. A review of Regulation Z specifically focuses on improving the format, content, and timing of consumer disclosures. In considering how to improve disclosures for alternative mortgage products, in addition to soliciting public comments and engaging in outreach, we will conduct extensive consmartinez on DSKD5P82C1PROD with HEARING

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sumer testing. This testing will help us to determine what information is most important to consumers, when that information is 

most useful, what wording and formats work best, and how disclosures can be simplified, prioritized, and organized to reduce complexity and information overload. 

Furthermore, in reviewing the disclosure requirements, we will 

be mindful that future products might differ substantially from 

those we see today. Thus any new disclosure requirements must be 

sufficiently flexible to allow creditors to provide meaningful disclosures even if these products evolve over time. 

Second, the Federal Reserve and the other bank and thrift regulators issued draft interagency guidance on alternative mortgage 

products at the end of last year which is currently being finalized. 

Third, in conjunction with our Regulation Z review, the Federal 

Reserve recently held four public hearings on home equity lending. 

A significant portion of these hearings was devoted to discussing 

consumer issues regarding non-traditional mortgage products. 

Lenders testified that when loans are prudently underwritten, consumers are able to benefit from the flexibility these products provide without being at risk of default. On the other hand, consumer 

advocates and State officials testified that aggressive marketing 

and the complexity of these products put borrowers at additional 

risk for obtaining mortgages that they do not understand and may 

not be able to afford. 

Fourth, since 1987, the ‘‘Consumer Handbook on Adjustable Rate 

Mortgages’’, or the CHARM booklet as we refer to it, a product of 

the Federal Reserve and the Office of Thrift Supervision, has been 

required by Regulation Z to be distributed by all creditors to consumers with each application for an ARM. Board staff is currently 

working with OTS staff to update the CHARM booklet to include 

additional information about non-traditional mortgage products. 

This revised CHARM booklet will be published later this year. 

And fifth, the Federal Reserve will soon publish a consumer education brochure on these mortgage products, and we are developing 

an interactive mortgage calculator for the Internet. These items are 

designed to assist consumers who are shopping for a mortgage 

loan. 

In conclusion, the Federal Reserve is actively engaged in trying 

to ensure that consumers understand the terms and features of 

non-traditional mortgage products. Improving federally required 

disclosures under TILA is an important aspect of this endeavor, but 

we are also pursuing other opportunities, for example, through consumer education and by issuing industry guidance. We expect the 

Board will continue these efforts over time as mortgage products 

evolve in response to consumers’ changing needs. 

Thank you very much. 

Chairman ALLARD. Ms. Sandra Thompson, Director of Supervision and Consumer Protection, Federal Deposit Insurance Corporation. 

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STATEMENT OF SANDRA THOMPSON, DIRECTOR OF THE DIVISION OF SUPERVISION AND CONSUMER PROTECTION, FEDERAL DEPOSIT INSURANCE CORPORATION 

Ms. THOMPSON. Chairman Allard, Chairman Bunning, Senator 

Reed, and Members of the Subcommittee, I appreciate the opportunity to testify on behalf of the Federal Deposit Insurance Corporation regarding the growth in non-traditional mortgage products 

and the Federal agencies’ draft guidance to address this issue. 

Non-traditional mortgage products have existed for many years; 

however, they were primarily a niche product used by financially 

sophisticated borrowers as a cash-flow management tool. Since 

2003, there has been a growing use of non-traditional mortgage 

loans among a wide range of borrowers. Non-traditional mortgage 

products have been especially popular in States with strong home 

price growth. With the surge in home prices, non-traditional mortgage products have been marketed as an affordable loan product. 

Some borrowers, often first-time home buyers, use these products 

to purchase higher-priced homes than they could have qualified for 

using more traditional mortgage loans. 

Consumers can benefit from the wide variety of financial products available in the marketplace; however, non-traditional mortgage products can present significant risks to borrowers because 

the product terms are complex and can be confusing. The primary 

risk to borrowers is payment shock, which may occur when a nontraditional mortgage loan is recast and the monthly payment increases significantly, sometimes doubling or tripling. The risk 

grows as interest rates rise and as home appreciation slows. This 

is especially true in the case of payment option ARMs where the 

loan negatively amortizes, sometime to the point of exceeding the 

value of the property. 

Because of the potential impact on their payments, it is critical 

that borrowers fully understand both the risks and the benefits of 

the mortgage products they are considering. Current disclosure requirements were not designed to address the characteristics of nontraditional mortgage products. Some borrowers do not receive information regarding the risks of non-traditional products early enough 

in the loan shopping process to allow them to fully compare available products. In addition, marketing materials for these loans 

often emphasize their benefit and downplay or omit the risks. Once 

the loan is made, some of the loan payment statements encourage 

borrowers to make the minimum payment by highlighting only that 

option. 

Borrowers will clearly benefit from receiving information with 

their payment materials that explains the various payment choices 

as well as the impact of those choices such as payment increases 

or negative amortization. 

Non-traditional mortgage loans pose risks to lenders as well. As 

these products have become more common, there have been indications that competition is eroding underwriting standards. For products that permit negative amortization, some lenders fail to include 

the full amount of credit that may be extended when analyzing a 

borrower’s repayment capacity. In addition, there is growing evidence of non-traditional mortgage products being made to borrowers with little or no documentation to verify income sources or 

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financial assets. In effect, some institutions are relying on assumptions and unverifiable information to analyze the borrower’s repayment capacity. 

Financial institutions that effectively manage these risks do so 

by employing sensible underwriting standards and strong management information systems. Other institutions are managing risk by 

securitizing their non-traditional mortgage originations and spreading the risks of these products to investors. In light of the growing 

popularity of non-traditional mortgage products to a wider spectrum of borrowers, the agencies have crafted guidance to convey 

our expectations about how financial institutions should effectively 

address the risks associated with these loan products. We have 

been reviewing the comments and are near completion on the final 

guidance. 

In conclusion, the FDIC will continue to monitor insured institutions with significant exposures to non-traditional mortgage products, and we will ensure that FDIC-supervised institutions follow 

the final guidances when they are issued. The FDIC expects institution to maintain qualification standards that include a credible 

analysis of a borrower’s capacity to repay the loan and they should 

provide borrowers with clear, understandable information when 

they are making mortgage products and payment decisions. 

Thank you for the opportunity to testify, and I am happy to answer questions. 

Chairman ALLARD. Thank you. 

Mr. Scott Albinson, Managing Director for Examinations, Supervision, and Consumer Protection, Office of Thrift Supervision. 

STATEMENT OF SCOTT ALBINSON, MANAGING DIRECTOR FOR 

EXAMINATIONS, SUPERVISION, AND CONSUMER PROTECTION, OFFICE OF THRIFT SUPERVISION 

Mr. ALBINSON. Good morning, Chairman Allard, Chairman 

Bunning, Senator Reed, and Members of the Subcommittees. 

Thank you for your continued leadership on issues affecting the 

mortgage markets and the important topic of non-traditional mortgage products. We appreciate the opportunity to discuss the views 

of the Office of Thrift Supervision on alternative mortgage products 

and the risks these products may present to consumers, financial 

institutions, and other financial intermediaries. 

Consistent with market development and the expansion of these 

products in the mortgage marketplace, OTS has implemented a 

comprehensive supervisory approach that focuses on credit, compliance, legal operational, reputational, and market risks associated 

with offering alternative mortgage products to consumers. We pay 

careful attention to underwriting practices, internal controls, portfolio and risk management, marketing, consumer disclosure, loan 

servicing, and mortgage banking activities. Our examination staff 

is well-trained to monitor and adjust to trends in mortgage markets to identify and ensure weaknesses in underwriting and risk 

management are promptly corrected and to mine consumer complaint information and to prevent or end abusive lending practices. 

We updated and reissued detailed examiner guidance on mortgage lending activities and mortgage banking operations in June 

2005 and made it publicly available. To augment our existing guidsmartinez on DSKD5P82C1PROD with HEARING

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ance and to provide further clarity to thrift institutions in the 

broader mortgage markets, OTS has been actively engaged and 

fully supports recent interagency efforts to finalize and issue joint 

guidance addressing the range of safety and soundness and consumer protection concerns with respect to offering these products. 

I believe concerns regarding alternative mortgage products generally fall into two broad categories. One is consumer confusion as 

to how the products are structured and how they function, and two, 

that the products are being used as affordability tools to enable 

borrowers to become overextended on their debts. OTS and interagency initiatives on a variety of areas are designed to specifically 

address these areas of concern. 

To address the first broad area of concern, the problem of potentially inadequate information and consumer understanding of the 

risks of alternative mortgage products, OTS is active on several 

fronts. Together with the Federal Reserve, we are diligently working on updating the Consumer Handbook on Adjustable Rate Mortgages, the CHARM booklet, a disclosure that is made available to 

all borrowers seeking an adjustable rate mortgage. We feel efforts 

to communicate with and educate the consumer concerning the features, benefits, and risks are particularly important. 

We are steadfastly working on proposed guidance with the other 

agencies regarding supplemental consumer disclosures for alternative mortgage products that include recommended narrative descriptions of the products as well as sample illustrations for use by 

lenders. Our objective is to stimulate clear, balanced, and conspicuous disclosure of the benefits and risks of alternative mortgage products at the time the borrower is considering loan options, 

at settlement, and on monthly borrower statements indicating the 

effects of any negative amortization and other key aspects of the 

mortgage instrument. 

On a simultaneous and parallel track, we are participating with 

the other agencies in drafting a consumer information booklet specifically addressing features of interest only and pay option ARM 

loans. Furthermore, OTS will continue its efforts to promote awareness and understanding of alternative mortgages among consumers 

in a variety of venues. 

To address the second broad area of concern, that some products 

are being inappropriately used as affordability mechanisms to 

stretch borrowers beyond their means, OTS is focused on loan underwriting and risk management among thrift institutions. We expect thrift institutions to implement a prudentially sound system 

of underwriting policies, standards, and practices that include 

qualifying borrower at the fully indexed, fully amortizing amount 

for option ARM loans. This helps insulate borrowers from the potential for payment shock as well as curbs the ability of institutions 

to use alternative mortgage products as affordability products, ensuring borrowers have the ability and capacity to prepay the loan, 

including principal, at the outset. 

Lastly, the requisite infrastructure to support lending activities 

must be present within thrift institutions, including robust risk 

management practices and management information and reporting 

systems to screen loans and monitor portfolio conditions and originations made through third parties. 

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Chairman ALLARD. Mr. Albinson, I must ask your to wrap up 

your testimony, please. 

Mr. ALBINSON. Thank you. 

The potential risks of alternative mortgage product have in the 

past and can in the future be appropriately managed by informed 

consumers and well-run institutions. We do not want to stifle innovation or unjustifiably restrict the flow of credit, especially during 

the current challenged housing market. Promptly addressing problems and poor risk management practices will ensure a steady flow 

of credit to deserving borrowers in the future. 

Thank you. 

Chairman ALLARD. Ms. Rotellini, you are next. You are with 

States. You are the Superintendent, Arizona Department of Financial Institutions, and you are here on behalf of the Conference of 

State Bank Supervisors. 

STATEMENT OF FELECIA A. ROTELLINI, SUPERINTENDENT, 

ARIZONA DEPARTMENT OF FINANCIAL INSTITUTIONS 

Ms. ROTELLINI. Yes, Mr. Chairman. Thank you. 

Good morning to both Chairman Allard and to Chairman 

Bunning, Ranking Member Senator Reed, and to the Members of 

the Committee. 

Like most of my State counterparts, in addition to supervising 

banks, I am also responsible for the regulation of State-licensed 

mortgage brokers and lenders. In fact, 49 States plus the District 

of Columbia currently provide regulatory oversight of the mortgage 

industry. Under State jurisdiction, there are more than 90,000 

mortgage companies with 63,000 branches and 280,000 loan officers and other professionals. 

In recent years, CSBS has been working with the American Association of Residential Mortgage Regulators, known as ARMOR, of 

which I am a member of the board of directors, to improve State 

supervision of the mortgage industry. Regulation of the mortgage 

industry originated at the State level, and while the industry has 

changed dramatically, State supervisors maintain a predominant 

changing role. Because of the nature of the industry, effective supervision now requires an unprecedented level of State and Federal 

coordination. 

State supervision of the residential mortgage industry is rapidly 

evolving to keep pace with the changes occurring in the marketplace. State standards for licensure are quickly improving and 

adapting. Through CSBS and ARMOR, the States are working together to improve coordination of State supervision as well as to 

provide best practices and more uniformity. 

The residential mortgage industry has changed dramatically over 

the past two decades. The majority of residential mortgages are no 

longer originated in Federal- and State-regulated savings and 

loans, but by mortgage brokers and State-licensed lenders. Riskbased pricing has allowed more consumers than ever to qualify for 

home financing by trading a lower credit score or down payment 

for a higher rate. 

Mortgage lenders have developed a number of products, including the non-traditional mortgage products that are the subject of 

today’s hearing, that offer home buyers a wide and ever-expanding 

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variety of loan choices. Increasingly, many of these products are 

quite complex, providing both opportunities and perils for consumers. The sophisticated nature of these products requires an elevated level of professionalism in mortgage originators and robust 

oversight of the companies and the people offering such products. 

The increasing role that brokers play in the residential mortgage 

process, concerns about predatory lending, the explosion of product 

choices offered by the private sector, and the realignment of the 

Federal role in housing finance has required the States to develop 

new tools to protect consumers and to ensure that mortgage markets operate in a fair and level manner. It is within this context 

that my fellow State regulators and I find ourselves compelled to 

develop policies and initiatives that raise professionalism and increase coordination. 

In order to do so, CSBS and ARMOR have created a residential 

mortgage licensing initiative designed to create uniform national 

mortgage broker and lender licensing applications in a centralized 

data base to house this information. The uniform applications will 

significantly streamline processing of licenses at the State level. 

The national data base will contain licensing information, final outcomes of enforcement actions, and background data for every Statelicensed mortgage broker, mortgage lender, control person, branch 

location, and loan originator. 

The CSBS–ARMOR residential mortgage licensing initiative is 

the cornerstone for a new generation of coordination, cooperation, 

and effective supervision in the State system. The changes in the 

mortgage industry over the past 20 years require this robust licensing system. Given the changes in mortgage products and the increased role of broker, CSBS believes it is in the regulators’, consumers, and mortgage industry’s best interest to move to the coordinated oversight the CSBS–ARMOR licensing system and data 

base will provide. 

CSBS commends the Federal regulators for drafting guidance on 

non-traditional products. This guidance has done much to draw attention to the threats these products may pose to consumers, especially if the underwriting is done improperly or the consumer does 

not understand product. When the guidance is implemented, however, it will not apply to the majority of mortgage providers in the 

country. Therefore, CSBS and ARMOR are developing parallel 

model guidance for the State to apply to State-licensed residential 

brokers and lenders. The parallel guidance is intended to hold 

State-licensed mortgage brokers and lenders to effectively the same 

standards developed by the Federal regulators. 

Finally, the States have proactively worked to increase the expertise and knowledge of our examiners. It is critical for our examiners to understand the function of the mortgage market and its 

various products. These examiners are the individuals who will see 

firsthand and who do see firsthand the practices of the industry 

and its impact on consumers and have the opportunity to counsel 

and advise these companies. 

I commend the subcommittees for addressing this matter. On behalf of CSBS, I thank you for the opportunity to testify, and I look 

forward to any questions you may have. 

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Chairman ALLARD. We will now move into the question and response period. I am going to try to enforce the 5-minute rule, for 

the Member’s benefit, very strictly. And my plan is I will have my 

5 minutes. I should get down there to vote 5 minutes before the 

vote comes up. It is scheduled for 11:15. Then I will have Senator 

Bunning run the committee, and I will get back and other members 

can go vote whenever it is convenient for them. 

Okay. To the Federal regulators, the question is what do you expect to issue the final guidance on non-traditional mortgage products? 

Yes, Ms. Thompson. 

Ms. THOMPSON. It is my understanding our principals met earlier 

this week and they are very close to finalizing it. I am hopeful that 

we will finalize it in the very near term. 

Ms. DICK. I would just echo the comments of my colleague at the 

FDIC. My understanding is we will have the guidance issued in a 

matter of weeks, not months. 

Chairman ALLARD. OK. 

Senator SARBANES. How about the other two? 

Chairman ALLARD. Federal regulators? 

Ms. BRAUNSTEIN. I concur with what Ms. Dick said. 

Mr. ALBINSON. I concur as well. 

Chairman ALLARD. Nothing too specific for the committee. We 

were hoping for something more specific. 

Consumer groups and others have questioned the extent to which 

guidance as opposed to a law or regulation can be enforced to truly 

protect consumers and bring about changes to non-traditional mortgage lending. What can Federal regulators do to ensure lenders follow guidance principles? I would like to have the regulators respond again. 

Yes, Ms. Thompson. 

Ms. THOMPSON. Our institutions are used to guidance because 

that establishes what the regulators’ expectation are. When our examiners go in to examine for safety and soundness or consumer 

protection issues, guidance has been very effective over the years 

in providing a specific road map as to what we are going to examine these institutions for. 

With regard to non-traditional mortgage loans and the guidance 

that will be issued, we will certainly issue examiner guidance that 

will be distributed to our institutions so that they have a very clear 

expectation of what we are looking for in our examination process. 

Chairman ALLARD. So we are putting discretion in the examiner 

in your case. We feel certain that the examiner will treat these 

guidance principles almost as a regulation. Is that right? 

Ms. THOMPSON. Well, these guidance procedures are used to establish what our expectations are, and we do have regulations that 

they have to adhere to, but it is very useful for the examiners and 

the institutions to quickly understand what our expectations are in 

this area. 

Chairman ALLARD. Others regulators? 

Ms. BRAUNSTEIN. Yes. We think guidance can be a very effective 

starting place for having conversations on examinations about 

these issues. It is there, as Ms. Thompson said, to give some guidance, some direction to the financial institutions, and also to our 

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examiners, in addition to the examiner guidance that we will develop. And that it is a very good place for us to have conversations 

about these issues and to see what the institutions are doing. 

Chairman ALLARD. Ms. Dick. 

Ms. DICK. I would supplement the comments of my colleagues by 

first echoing the fact that at the OCC, we also use guidance to 

make our supervisory expectations very clear. However, certainly, 

if we have a situation where we believe abusive practices are taking place with respect to consumer lending, we do have a full menu 

of regulations and, laws that we can bring into play. An arsenal, 

if you will, to take forward an enforcement action. So we have safety and soundness standards and other directives, regulations, and 

laws that we can use to carry things forward in an enforcement capacity, if necessary. 

Chairman ALLARD. Mr. Albinson. 

Mr. ALBINSON. I would agree with everything my colleagues have 

said. The guidance establishes a baseline of supervisory expectations. We have a very intensive supervisory process that includes 

annual on site examinations at thrift institutions. Our examiners 

by virtue of that on-site examination process get to see a wide 

range of practice, and over time, as you might expect, the markets 

innovate. They evolve as well as institutions. Risk management 

practices evolve, and the examiners can take that and communicate 

the range of practice they see as well as leading and best practices 

within institutions. 

We also have internal processes within our organizations to be 

able to receive that data and assimilate it within the organization 

and update our examination guidance and the other supporting infrastructure that exists behind the guidance that we will issue on 

an interagency basis. 

Chairman ALLARD. The way I understand guidance, it is a warning, that you are concerned about certain practices and whatnot. If 

they don’t follow the guidance, the industry meets certain thresholds and it could be looking at rules and regulations, basically. Is 

that the approach? Where is that threshold? 

Mr. ALBINSON. I think it would depend on the individual institutions as to what—we look in a holistic fashion at the risk management practices. 

Chairman ALLARD. Yes, but a rule and regulation is for all the 

institutions under your purview. So I don’t hear a threshold number. I think you need to think a little bit about that. I don’t expect 

anybody can answer that. 

My time has run out, but I do think you need to think about 

where that threshold is and what is going to create that threshold. 

I will yield to Senator Reed, and Chairman Bunning will now 

run the committee. 

Senator REED. Well, thank you very much, Chairman Allard. 

First let me thank Ms. Williams for the GAO report, which is 

very insightful, and then ask the regulators each a general question. To what extent are these loans securitized to a secondary 

market so they are not getting held by the financial institutions, 

in a way mitigating the risk? Ms. Dick, do you have an idea? 

Ms. DICK. Actually, my understanding is a large number of the 

non-traditional mortgages are, in fact, delivered into the 

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securitization market. Much of that takes place through what we 

call private label securitizations, which are packages put together 

by investment firms and other dealers. 

Senator REED. So, in effect, in this case, the bank, the financial 

institution, regulating institution, is taken out of the risk as soon 

as they sell into the secondary market. Is that accurate? 

Ms. DICK. The securitization market is used, really, as a liquidity 

vehicle for large financial institutions to sell assets and provide additional credit. There are risks that are retained by financial institutions that securitize assets. 

Senator REED. Right. Sometimes they have these puts. People 

can put back the security. 

Ms. DICK. Reps and warranties, exactly, as well as reputational 

risk associated with it. A borrower generally is going to remember 

who they got the loan from, not the fact that that loan has been 

sold into a secondary market. 

Senator REED. Right. And you are also looking systemically at 

these reserve risks that the institutions might hold even if they 

securitize? 

Ms. DICK. Absolutely. 

Senator REED. Ms. Braunstein, can you comment on that same 

question? 

Ms. BRAUNSTEIN. I concur with what Ms. Dick said. We don’t 

have data on how much of it is going into the secondary marks, but 

our understanding is that a large part of it is. 

Senator REED. Ms. Thompson. 

Ms. THOMPSON. Yes. We do know that some of these institutions 

are securitizing the mortgages, which means that the loans are off 

the books and that they are placed into the securities and then sold 

to investors. So the risk is dispersed. 

We are also concerned about the amount of these types of 

securitizations that banks hold. It hasn’t been that much, but this 

is something that we are looking at. 

Senator REED. The other side is they are actually buying into 

these pools of securitized mortgages. 

Ms. THOMPSON. They have the ability to, yes, sir. 

Senator REED. And you are going to pay attention to that? 

Ms. THOMPSON. Absolutely. 

Senator REED. Thank you. 

Mr. Albinson. 

Mr. ALBINSON. Likewise, we not only look at purchases of 

tranches of CMO instruments that our institutions may put into 

their portfolios, but we also look for those that do securitize, at 

their retained risks, and we do have rules, specific rules, requiring 

a careful analysis by the institution, including an analysis of the 

capital adequacy and support needed behind that retained risk; 

and, of course, as Ms. Dick indicated, the reputational risk is not 

insignificant for these institutions too. 

Senator REED. Thank you. 

Ms. Rotellini, from the perspective of a State regulator, do you 

have more of a problem with State institutions holding these themselves? Is that something or can you comment upon this line of 

questioning? 

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Ms. ROTELLINI. Senator Reed, most of our mortgage brokers 

would not be holding onto them. The mortgage lenders, many of 

them are using wholesale lines and do not hold onto those mortgages either. 

Senator REED. Very good. 

You have issued at least preliminary guidance and you are finalizing it. There are, I think, several areas which are critical, if you 

want to quickly each comment upon it. How do you treat negative 

amortization, reduced documentation, and then the layering of the 

secondary loans or special sort of combinations of lending, risk 

layering in general? And Ms. Dick, again, if we could go just go 

down. What is your advice right now, even though it is not is formalized, to institutions about these factors? 

Ms. DICK. With respect to the negative amortization, we have 

tried to make clear that the standard in the industry needs to be 

changed such that the economic equivalent of a line of credit is included in the analysis that is done at underwriting, so the borrower 

understands the full amount of the debt they will owe and the borrower’s repayment capacity is analyzed by the financial institution. 

Reduced documentation loans, again, introduce an element of 

risk to the financial institutions. We have provided our supervisory 

expectations in the guidance and want to make sure that the regulated institutions use strategies such as reduced documentation in 

underwriting in a very clear and thoughtful manner. 

As to the layering of risk, that is a practice that we are very concerned about, and certainly one that is associated with some of 

these non-traditional mortgages, because it reduces, potentially 

eliminates, the amount of equity a borrower has in their home. We 

don’t do anyone any favors—not banks, not consumers, not our 

communities—if we have situations where 5 years down the line, 

there is no equity left in the home and the borrower has excessive 

payments. 

Senator REED. Well, my time has expired, and I would ask for 

a nod of the head if you agree with Ms. Dick’s comment. 

I would note one other point, Ms. Thompson, is we are lucky in 

our office to have Ken Kilber, your colleague as a fellow. Thank you 

for that. 

Thank you. 

Chairman BUNNING. Thank you, Senator Reed. I am going to ask 

my questions for 5 minutes and then yield to my colleague, the 

ranking member of the full committee. 

It seems to me there has been a race to the bottom with underwriting standards for non-traditional mortgages over the last few 

years. Lenders have granted larger loans to borrowers who are less 

able to afford them and based on less documentation. I would like 

to ask each of you to answer this question quickly, if you can. 

Over the past two or 3 years, have lenders used adequate underwriting standards or did they get so loose with their money that 

significant numbers of borrowers are going to default unless they 

can refinance or sell in the current climate, rising interest rates, 

less equity in their homes? 

Ms. BRAUNSTEIN. I can start and just say that at this point in 

time, we have not seen any specific signs that lead us to conclude 

that there will be huge numbers of defaults. Of course, a number 

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of these loans still have not recast, and we will be watching very 

carefully in the next few years as they recast to see what happens. 

Chairman BUNNING. Ms. THOMPSON. I would say that we have been looking at some 

of the more vintage loans that have been originated in 2004 and 

2005, because this is when the payment option and interest only 

ARMs were prevalent in the market, and we have noticed that 

some of these loans are becoming more delinquent than the traditional mortgage loans. Even though the payments haven’t reset 

and we don’t have a real good understanding yet, we have noticed 

an increase. 

Chairman BUNNING. Some of the ARMs have not reached their 

expiration? 

Ms. THOMPSON. That is exactly right, but we have noticed an increase in the delinquencies, very slight, in the loans that were 

originated in 2004 and 2005, and we are keeping our eye on them. 

Chairman BUNNING. Ms. Dick, do you have anything to add to 

that? 

Ms. DICK. We have a process at the OCC of looking at underwriting standards more generally, and, certainly in the last few 

years, we have been seeing an easing in underwriting standards. 

Part of the responsibility of our examiners, then, is to go in on a 

case-by-case basis at the large lenders and look at how those underwriting standards have evolved and whether or not there are 

any supervisory concerns. 

Chairman BUNNING. With interest rates rising as they have in 

17 out of the last 18 meetings of the FOMC and ARMs not reaching their maturity yet, the three- to five-year ARM in most of the 

mortgages, you wouldn’t possibly see a great acceleration, but what 

happens when it hits? That is what I am interested in. What happens when the interest only and the ARMs hit and borrowers have 

to ante up and they don’t enough equity and they surely weren’t 

anticipating the huge increase in the interest rate of the original 

loan? 

Ms. DICK. Chairman Bunning, I would just say, from our standpoint, that is exactly why we issued this guidance and are working 

diligently to get it in final form. Right now, this is a very small 

part of the mortgage market, but it clearly has been the area that 

has been growing. 

Chairman BUNNING. Mr. Albinson. 

Mr. ALBINSON. I concur with my colleagues. The numbers as far 

as delinquencies and defaults for this product are rather low even 

compared to fixed-rate 30-year amortizing mortgages at this point 

in time, but one would expect that. These loans are relatively unseasoned. They have been originated in 2004 and 2005, and when 

you look at those cohorts and begin to plot them out on a graph, 

the trajectory is a little bit higher than other cohorts or other vintages that we have looked at. 

The question will be based on a combination of factors as these 

loans begin to recast in the coming years. It will be partly dependant on where interest rates are as well as macroeconomics factors, 

employment statistics, and real estate values, of course, as well. 

Senator BUNNING. I have a question for the Federal Reserve. Ms. 

Braunstein, in your testimony, you indicated the Fed is going to 

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update the Truth-in-Lending Disclosure Regulation Z to address 

newer non-traditional mortgages once you have complete revision 

for credit cards. If I am correct, that process started in December 

of 2004 and is still not done. Can you give us a realistic expectation 

when the Fed is going to act on these mortgages? 

Ms. BRAUNSTEIN. Well, we have already started the process, Senator Bunning. 

Senator BUNNING. I know you have started, in 2004, but when 

are you going to finish? 

Ms. BRAUNSTEIN. I don’t have an exact date for you, but I can 

tell you that it is a very time-consuming process. First of all, when 

TILA was issued and passed by the Congress, these kind of products were not envisioned, and we did choose some years ago to add 

disclosures for adjustable rate mortgages. We are looking at those 

in light of today’s marketplace, and one of the big things that we 

have to do with these is to try to minimize burden to the industry, 

while at the same time making sure that new disclosures are effective for consumers, because the worst thing we could do is to issue 

something that is not useful. 

So in order to feel comfortable we are doing that, we are engaging in pretty extensive consumer testing in focus groups to make 

sure that what we actually issue, consumers understand and can 

digest and utilize. 

Senator BUNNING. We surely don’t want to hurt the consumer 

with a regulation that is after the fact. 

Ms. BRAUNSTEIN. No. I understand that. It is a lengthy process, 

and that is one of the reasons why we are doing some other things. 

Issuing the new CHARM booklet is part of the TILA review. That 

is required by Regulation Z, and that will be out before the end of 

year. 

Senator BUNNING. And? 

Ms. BRAUNSTEIN. We also held hearings on these, as I mentioned, this summer and have gathered that information. I don’t 

have an exact date for you. 

Senator BUNNING. Thank you very much. 

Ms. ROTELLINI. Chairman Bunning, may I respond to those questions as well from the State’s perspective? 

Senator BUNNING. Yes, but I want to make sure that my colleague from Maryland gets his time in too. 

Ms. ROTELLINI. First, with respect to the scenario you described, 

the States are very concerned that default will increase and that 

the train has left the station with respect to many of the types of 

loan that are on the books right now. 

Secondly, with respect to State regulation, there are many 

States, including Arizona, that have prohibitions on the books right 

now that State-licensed brokers and lenders cannot misrepresent, 

cannot engage in deceptive practices, and State-licensed brokers 

and lenders are subject to State consumer laws, and those laws 

have been enforced in the past in situations such as Ameriquest 

and Household where the State Attorney Generals and regulators 

have looked at these very types of non-disclosures. 

Senator BUNNING. Senator Sarbanes, go right ahead. 

Senator SARBANES. Thank you very much. I am going to put one 

question to the regulators, and then I am going to have to depart 

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for the vote, but I do want to thank you all for your testimony and 

also that of the second panel. 

In looking through the proposed guidance as well as the witness’ 

testimony from the second panel this morning and the background 

material, it seems to me that the very fundamental issue here is 

that each lender must ensure that a borrower has the ability to 

repay the mortgage when it first underwrites the loan at the fully 

indexed rate assuming a fully amortizing repayment schedule. In 

other words, you have to look at the process and ensure its sustainability. 

This is important to maintain safe and sound operations at the 

financial institutions, although someone noted they are selling 

these things off, and it is important for the borrowers that their 

ability to repay the mortgage and keep their home should not turn 

on what amounts to a throw of the dice. If we do finalize this guidance, in particular requirements to establish the ability of the borrowers to fully repay the mortgages, we are in effect inviting lenders and mortgage brokers to make collateral-based loans, a practice 

which the guidance calls unsafe and unsound. 

In fact, let me quote from Ms. Dick’s testimony here this morning, quote: Underwriting standards that do not include a credible 

analysis of a borrower’s capacity to repay their entire debt violate 

a principle of sound lending and elevate risks to both the lender 

and the borrower, end of the quote. 

I want to ask each of you, therefore, if you agree that it is essential to move forward with a provision of the guidance requiring 

lenders to establish a borrower’s long-term ability to pay the mortgage. Ms. Dick, why don’t we start with you and come right across, 

and if you can give succinct answers, it would be helpful in this circumstance. 

Ms. DICK. Yes, Senator Sarbanes, I agree with your statement. 

It is important both for the borrower and the financial institution 

that the repayment capacity be considered based on the full 

amount that that borrower will be expected to repay. 

Senator SARBANES. Ms. Braunstein. 

Ms. BRAUNSTEIN. Yes. I concur with that also, and say that that 

is a critical part of the guidance, but other things in the guidance 

are also critical and it is important to move forward with the guidance in general. 

Senator SARBANES. I didn’t mean to suggest they weren’t. I was 

just focusing on that. 

Ms. Thompson. 

Ms. THOMPSON. Yes, Senator. That is a critical part of the guidance, to qualify the borrower at the fully indexed rate and at a 

fully amortized payment schedule. We want borrowers to not only 

get their homes, we want them to stay there. 

Senator SARBANES. Mr. Albinson. 

Mr. ALBINSON. Yes. I concur with the prior statements of my colleagues. That is a critical component of the guidance. 

Senator SARBANES. And, Ms. Rotellini, you are not a Federal regulator, but I am told or we have reports that you are a very good 

State regulator. What is your view on this issue? 

Ms. ROTELLINI. Thank you, Senator Sarbanes. The States are 

looking at this guidance and wanting to continue to make the playsmartinez on DSKD5P82C1PROD with HEARING

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ing field and the markets level, and we too are considering the 

same guidance and issuing something similar. 

Senator SARBANES. I have a quick moment here. I am going to 

pop another question. Thank you all for that answer. 

The issue has been raised regarding the fact that the proposed 

guidance applies to federally regulated institutions only, obviously. 

Many have pointed out there are many lenders and other originators who are not federally regulated, particularly in the subprime 

market. So let me ask the regulators if they agree that the proposed guidance will be more effective if the States adopt similar 

rules. 

We will go right across. 

Ms. DICK. Again, I agree with that statement. We applaud the 

efforts of the CSBS in attempting to do exactly that, take the principles of this guidance and make them into something that the 

States can use as well. 

Senator SARBANES. Ms. Braunstein. 

Ms. BRAUNSTEIN. Yes. I concur and would just add that our data 

shows that even though it won’t cover all regulators in terms of 

dollar amount, it will cover about 70 percent of the market. 

Ms. THOMPSON. Yes, Senator, and you know we work very closely 

with the State regulators in our examination program. 

Senator SARBANES. Mr. Albinson. 

Mr. ALBINSON. Yes. We welcome CSBS’s participation in this effort and continuing enforcement of the principles that are ultimately espoused in the final guidance. 

Senator SARBANES. And, Ms. Rotellini, what is your view about 

the States upgrading the standard to jibe with the Federal standards in this area? 

Ms. ROTELLINI. Senator, the States are doing that. They are committed to professionalism and ethics and a lending community 

under State regulation that considers the borrower’s repayment 

ability as well as all of the other concerns about disclosure. 

Senator SARBANES. Well, I thank the panel very much. 

Thank you. 

Chairman ALLARD. Thank you, Senator Sarbanes, and I want to 

also thank the panel. I know it is not always easy to get away from 

your jobs to testify, but it is important to support the issue. Thank 

you for taking the time to be here. 

We will go now to panel two: Mr. Robert Broeksmit, when you 

are ready, we will proceed, Chairman of the Residential Board of 

Governors, Mortgage Bankers Association. 

We are sticking to the 5-minute rule, gentlemen. 

STATEMENT OF ROBERT BROEKSMIT, CHAIRMAN OF THE RESIDENTIAL BOARD OF GOVERNORS, MORTGAGE BANKERS ASSOCIATION 

Mr. BROEKSMIT. Thank you, Chairman Allard and Members of 

the Committee. My name is Robert Broeksmit. I am the President 

and Chief Operating Officer of B.F. Saul Mortgage Company, a 

subsidiary of Chevy Chase Bank in Bethesda, Maryland. I also 

serve as the Chairman of the Mortgage Bankers Association’s Residential Board of Governors and I am pleased to be here today on 

their behalf, testifying before you. 

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The term ‘‘non-traditional mortgage products’’ encompasses a variety of financing options developed by the industry to increase the 

ability of borrowers to manage their own money and wealth. Borrowers have used these products to tap their home’s increased equity to meet an array of needs ranging from education to health 

care to home improvement and to purchase homes in markets 

where home prices have quickly appreciated. 

While these products have often been characterized as new, 

many of them actually predate long-term fixed-rate mortgages. The 

market’s success in making these products available is a positive 

development, although these products have been used to finance a 

relatively small portion of the Nation’s housing, they offer useful 

choices for borrowers who can benefit from them. 

As with all mortgage products, they must be underwritten by 

lenders in a safe and sound manner and their risks must be appropriately managed. It is equally important that lenders provide consumers with adequate explanations of the loans and their terms so 

that borrowers can make an informed choice about whether these 

products match their needs. 

I would like to put the market’s use of non-traditional products 

into perspective. More than a third of homeowners, approximately 

34 percent, own their homes free and clear. Of the 66 percent of 

remaining homeowners, three-quarters have fixed-rate mortgages 

and only one-quarter, or 16 and a half percent, have adjustable 

rate mortgages. Many of the borrowers with adjustable rate loans 

have jumbo loans and many have extended fixed-rate periods, such 

as five, seven, and 10/1 ARMs. 

You know, it wasn’t all that long ago that our industry was addressing concerns about the availability of credit to all borrowers. 

It seems we are victims of our own success to a degree as the discussion now concerns whether some of the many credit options 

available to borrowers are appropriate for them. Some have even 

suggested that the industry should take on an undefined responsibility to determine the suitability of products for particularly borrowers, a very difficult and dangerous undertaking at best. 

We as lenders know how to determine a borrower’s eligibility for 

a loan. Limiting choices to borrowers we would deem eligible but 

not suitable would not serve borrowers well, would increase lenders’ liability, and would raise all borrowers’ costs. Lenders have 

successfully offered these products for decades and should continue 

to do so. 

MBA and our members strongly believe that sound underwriting, 

risk management, and consumer information are essential for the 

public interest. It is equally critical to assure a regulatory environment that encourages rather than hinders innovation in the industry. Such an environment would continue to allow lenders to provide borrowers the widest array of credit options to purchase, 

maintain, and, as needed, draw equity from their homes to meet 

their financial needs. While expectations should be articulated, the 

details need not be proscribed, and any requirements in this area 

must balance all of these imperatives to truly serve the public interest. 

I can assure you the marketplace still works. Mortgage lenders 

want to lend money to those borrowers who are willing and able 

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to pay the loan back. When a homeowner goes to foreclosure, everybody loses: The consumer, the community, the lender, and the investor. We all win when the right loan keeps a family in its home. 

The mortgage market works and the data demonstrate that fact. 

The market is serving more borrowers who are benefiting today 

from unparalleled choices and competition, resulting in lower prices 

and greater opportunities than ever before to build the wealth and 

well-being that homeownership brings to their families and communities. The market must be permitted to continue to do so. Any 

consideration of new requirements in this area must be judicious 

and any requirements very carefully conceived. 

We must also do our best to assure that borrowers fully understand and can take advantage of the choices available to them. 

MBA stands ready to work with you on this important topic, and 

I look forward to answering your questions. 

Chairman ALLARD. Mr. Hanzimanolis, you are next. You are 

NAMB President-Elect and with Bankers First Mortgage, Incorporated. 

STATEMENT OF GEORGE HANZIMANOLIS, NAMB PRESIDENTELECT, BANKERS FIRST MORTGAGE, INC. 

Mr. HANZIMANOLIS. Good morning, Chairman Allard. I am 

George Hanzimanolis, President-Elect of the National Association 

of Mortgage Brokers. I commend the subcommittees for holding 

this important hearing to address the concerns and practices relating to non-traditional mortgage products. Thank you for inviting us 

here today. 

As you just heard from the first panel, approximately 85 percent 

of mortgage loans are brokered loans. With respect to the topic, 

there are a few critical points I would like to make. 

Today, non-traditional mortgage products can be effective financing tools, affording consumers the flexibility to invest, manage 

their wealth, and manage uneven income flows. We appreciate the 

concerns raised by this topic, such as risk layering and borrower 

knowledge, and welcome the opportunity to discuss and comment 

on these issues. 

Next, all mortgage originators should be knowledgeable about 

the benefits and the risks of the products they offer. Our lending 

industry has experienced significant growth, expanding product 

choice and distribution channels, adding robust competition, and 

great pricing options. In order for originators to keep pace with this 

growth, every originator should complete both pre-employment and 

continuing education requirements. We must also ensure that all 

the originators submit to a criminal background check so that bad 

actors are not able to move freely from one distribution channel to 

another. 

In support of this effort, NAMB has urged the States to implement minimum standards that call for licensing and education requirements for all mortgage originators. NAMB has taken steps to 

develop education courses for mortgage originators that focus solely 

on non-traditional mortgage products. 

While these initiatives have been largely successful in increasing 

professional standards for mortgage brokers, they have not increased standards for officers of banks and lenders who continue to 

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be exempt from any State licensing and consumer protection laws, 

which brings me to an important point. Consumers don’t know the 

difference between a broker, a bank, or a lender, or even a depository institution. When it comes to originating a mortgage, there is 

little difference between them. The large majority of loans today 

can be considered brokered loans, which includes brokers, correspondent lenders, and any lender that does not service a loan for 

a period longer than 3 months. In the end, they are all competing 

distribution channels, which means one channel should not be exempt from these important standards. 

Second is financial literacy. Regardless of how knowledgeable a 

mortgage originator is or becomes, educated consumers are always 

in a better position to make informed decisions when choosing a 

loan. NAMB urges Congress to allocate funds for financial literacy 

programs at the middle and high school level so that consumers are 

educated about the financial decisions they make and retain the 

decisionmaking ability throughout their life. The consumer, not the 

government and not the mortgage originator, is the best decisionmaker. 

The role of the consumer is to acquire the financial acumen needed to take advantage of the competitive marketplace. Shop, compare, ask questions, and expect answers. Consumer demand has 

driven the use of these loan products. These products can be an effective and useful financing tool that affords consumers flexibility; 

however, as with any loan, there is risk involved for both the consumer and the market. 

As a decisionmaker, the consumer decides where risk is appropriate and when it is not. Just as a mortgage originator cannot 

forecast the future or cannot anticipate when the Federal Reserve 

Board will raise interest rates 17 times, the mortgage originator 

cannot decide for the consumer what loan product is best. 

Third, to facilitate meaningful comparison shopping, disclosures 

should impart information that is useful and does not otherwise 

mislead or deceive the consumer. NAMB supports clear and concise 

consumer-tested disclosures that are accurate and uniform across 

all distribution channels. We look forward to working with the Federal Reserve Board to re-evaluate the current disclosure scheme to 

make it more useful for consumers, especially for non-traditional 

mortgage products. 

Last, it is also important that the government enforce existing 

laws to effectively eliminate deceptive or misleading marketing 

practices and communications with consumers with respect to any 

loan product type, traditional or non-traditional. We must protect 

the consumer choice by maintaining a competitive marketplace. We 

should not ban products from the market. Rather, it should be left 

to market forces, simple supply and demand, to determine the utility and longevity of any loan product. 

Again, thank you for the opportunity to appear before this joint 

subcommittee today to discuss this timely issue, and I am happy 

to answer any questions you may have. 

Chairman ALLARD. Thank you. 

Mr. Simpson, you are Chairman, Republic Mortgage Insurance 

Company. 

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STATEMENT OF WILLIAM SIMPSON, CHAIRMAN, 

REPUBLIC MORTGAGE INSURANCE COMPANY 

Mr. SIMPSON. Yes, and I am currently serving as Vice President 

of the Mortgage Insurance Companies of America, and we are 

pleased to be here today. Thank you. 

Chairman ALLARD. It is good to have you. 

Mr. SIMPSON. Let me start by first asserting that mortgage insurers play an important role in the home mortgage market. We 

cover the first tier of loss on defaulted home mortgage loans for 

lenders and investors such as Fannie Mae and Freddie Mac. Because of the high capital requirements and stringent regulation imposed on mortgage insurers, the industry is well-positioned to take 

on this risk. 

Currently, the members of MICA have $635 billion of insurance in force and approximately $17 billion in capital. Since the industry 

was founded in 1957, we have helped over 25 million families become homeowners usually when they could not otherwise afford a 

20 percent down payment. 

We take a conservative view of mortgage risk because of our 

first-loss exposure and because of our unique historical perspective. 

We were there when some regional markets in this country were 

in chaos during the mid-1980’s and early 1990’s and we covered 

losses for mortgage investors, paying out approximately $15 billion 

in claims. 

Data that we have on the size characteristics and rate of growth 

in the non-traditional market while somewhat sparse is also alarming. For example, one industry publication recently estimated that 

in the first half of 2006, non-traditional mortgages represented 37 

percent of all home mortgage originations, up from being almost 

nonexistent a few years ago. 

Second, the FDIC estimated in its testimony last week that interest only mortgages and option ARMs together made up as 40 to 50 

percent of all loans securitized by private issuers of mortgagebacked securities during 2004 and 2005. SMR, a private research 

firm, found that piggy-back mortgages comprise 48 percent of all 

purchase money mortgages originated in the first half of 2005 and 

that 38 percent of those loans had a combined loan-to-value ratio 

in excess of 95 percent. By piggy-back mortgage, we are referring 

to a structure where a first mortgage is usually made at about 80 

percent of the value of the property and then a 10 percent, up to 

a 20 percent, second mortgage is made on top of the first. 

One that should cause concern for the mortgage industry and 

policymakers is the combination of the size of the non-traditional 

mortgage market and the concentrated positions taken on these 

loans by some lenders such as the banks with holdings of piggyback seconds and/or option ARMs. Introducing the inherent risk of 

non-traditional mortgages into a soft housing market could be a 

recipe for another housing debacle as occurred in the eighties and 

early nineties. Certainly, concentrations should be avoided in lieu 

of such a scenario. 

Having witnessed these cross currents of risky mortgage instruments coupled with a retracting housing market, MICA supports 

the work being done by the bank regulatory agencies to set prudential standards for non-traditional mortgages. We urge that these 

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standards be finalized quickly and that they be backed by effective 

enforcement. We also hope that the FTC acts quickly to issue rules 

comparable to the banking agencies to ensure that all mortgage 

originators are required to operate under similar standards and 

thereby leveling the playing field. 

In addition, MICA supports the standards the banking agencies 

are setting for consumer disclosures. Vulnerable consumers may 

not know the real terms of their increasingly complex mortgage 

loans. This fact can lead to foreclosures which not only displace 

families and damage their credit, but also result in blighted neighborhoods with the foreclosed homes for sale. 

Mortgage insurers will continue to play the same role in the nontraditional market they have always played in the overall mortgage 

market. We are a highly capitalized, well-regulated intermediary 

who balances the interests of the lenders and borrowers. Mortgage 

insurers with capital at risk will continue to insert a critical underwriting discipline into many mortgage lending decisions, providing 

a safeguard against excessive foreclosures and evictions of sometimes innocent homeowners. 

Thank you for listening to our views, and I will be happy to answer any questions. 

Chairman ALLARD. Thank you. 

Mr. Calhoun, President, Center for Responsible Lending. 

STATEMENT OF MICHAEL CALHOUN, PRESIDENT, 

CENTER FOR RESPONSIBLE LENDING 

Mr. CALHOUN. Thank you, Chairman Allard, and thank you also, 

Chairman Bunning, for holding this hearing and allowing us to testify. 

I appear on behalf of the Center for Responsible Lending, which 

is a non-profit, non-partisan research and public policy center dedicated to supporting responsible lending and preventing predatory 

lending. We are an affiliate of Self-Help, which is a community development lender which has provided over $5 billion for first-time 

home financing to Americans across the country. We operate presently in 48 States. 

We do this lending because homeownership has been the traditional ladder to the middle class for Americans. We are concerned, 

though, that the development of many of these non-traditional 

mortgages has created a trap door to financial ruin for these families. 

Much of the discussion about non-traditional mortgages is focused on the prime market; however, today in the subprime market, which is nearly one-fourth of the overall mortgage market, the 

dominant product in that market is the non-traditional product, 

and it will inflict, in our view, far more harm than the other types 

of non-traditional mortgages that you have heard about today. 

These so-called subprime hybrid ARMs with low teaser rates are 

the leading product in the subprime market, and that is where I 

will direct my testimony today. I am going to first describe the nature of this product, then the impact that we see in the market and 

on the borrowers, and then add our policy recommendations. 

A subprime hybrid ARM has an initial short fixed-rate period. 

The typical one is 2 years, and then the remaining 30 years of the 

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mortgage, it is an adjustable rate. So they are often called 2–28 

mortgages. The key factor is that the initial payment is set far 

below the fully indexed payment. To give you an example of what 

typical rates would be in the market today, the initial payment 

would be based on an interest rate of maybe seven and a half or 

8 percent; however, after the end of that initial 2-year fixed-rate 

period, the fully adjusted rate would be in the range of 11 and a 

half to 12 percent even with interest rates remaining the same, the 

market rates remaining the same. 

This produces a payment shock typically of 40 to 50 percent for 

the borrower, and perhaps it is most dramatic that even if you take 

a very favorable scenario, if interest rates are reduced, market 

rates, by 200 basis points, these borrowers still would typically face 

a 20 to 25 percent payment shock. 

I would think the testimony today is that one of the common 

themes of the risk of the non-traditional mortgage has been payment shock and how most families are very ill-equipped to handle 

that. In the subprime market, this payment shock is exacerbated 

by several factors. First of all, the underwriting on these loans is 

done at a very high debt ratio, up to 50 to 55 percent, which means 

that that mortgage payment can be 50 to 55 percent the total debt 

of the borrowers, 50 to 55 percent of the borrowers’ gross income, 

before tax income. 

Second, the standard underwriting practice in the subprime market is to underwrite only to the initial payment. So they allow the 

initial payment to be 50 or 55 percent of the borrowers’ income. 

When you had add a payment shock of 20 or 40 percent, you end 

up with loans where the mortgage burden is more than the borrowers’ take-home pay. 

Third, in the subprime market, the practice is in the majority of 

the loans not to escrow for insurance and taxes, and the reason for 

that is it is a way to artificially depress that monthly payment, 

make it look lower, but you leave another financial shock out there 

for these borrowers. 

The impact of this is that many borrowers are threatened with 

losing their homes, and this impact is especially felt in minority 

communities. Recent HMDA data showed that the majority of African Americans have high interest subprime loans. More than a 

third of Hispanic borrowers have high interest subprime loans. 

My time is running out. So let me give you very quickly our policy recommendations. First, we support the guidelines of the joint 

agencies. We would emphasize in the subprime market, nearly 60 

percent of these are originated by non-regulated entities. There is 

already underway, though, the means to cover those entities. Both 

the FTC and the Federal Reserve held hearings this summer to address non-traditional mortgages. They both have existing authority 

to apply the joint guidance to the entire mortgage market under 

both the Homeownership Equity Protection Act and under the FTC 

Act. 

In conclusion, I want to thank you again for the opportunity to 

testify. We look forward to working with the committee on this important problem. 

Chairman ALLARD. Thank you. Mr. Fishbein. 

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Mr. Fishbein, I see you are the Director of Housing Policy, Consumer Federation of America. Thank you for being here. 

STATEMENT OF ALLEN FISHBEIN, DIRECTOR OF HOUSING 

POLICY, CONSUMER FEDERATION OF AMERICA 

Mr. FISHBEIN. Good morning, Chairman Allard and Chairman 

Bunning. We appreciate the fact that you have held these hearings 

on this important and timely subject. My testimony today is on behalf of Consumer Federation of America and also the National Consumer Law Center. We appreciate the opportunity to present our 

views. 

The purpose of today’s hearing is to assess the impact of non-traditional mortgage products on borrowers and the housing market. 

A sampling of the news stories from the past few weeks conveys 

a very disquieting picture. There is a ‘‘Business Week’’ article that 

referred to ‘‘How Toxic Is Your Mortgage?’’ 9/11/06, a Bloomberg article from earlier this week that the ‘‘U.S. Housing Slump May 

Lead to First Drop Since 1930’’ 9/11/06, a ‘‘USA Today’’ article from 

last week, ‘‘More Fall Behind on Mortgages’’ 9/14/06. According to 

the story, many homeowners with shaky credit are falling behind 

on their mortgage payments, especially in such States as Ohio, Alabama, Tennessee, Michigan, and West Virginia, and the ‘‘New York 

Times’’ editorial from earlier this week, ‘‘Who Bears the Risk’’ 9/17/ 

06, all of these are commenting on developments in the mortgage 

market. 

Non-traditional mortgages are complex loan products that have 

enabled lenders to maintain high numbers of loan originations even 

in a rising rate environment. Admittedly, this has helped additional borrowers qualify for home purchase in the face of rising 

home prices in certain areas. These loans, it should be indicated, 

also are used to refinance existing loans particularly in the 

subprime market. 

The initial low monthly payments are attractive to borrowers 

who want to leverage their purchasing power in a rapidly appreciating market. Unfortunately, many borrowers do not fully understand the changing payment schedules, especially the sharp monthly payment increases that are common with non-traditional mortgages. 

Federal banking regulators, consumer advocates, and increasing 

segments of the industry all have expressed concerns that nonmortgages, or exotic mortgages as they are known, may be too exotic for many that have taken them out. The delinquencies and 

foreclosures that result from the unsustainable loans will have extremely negative implications on the credit ratings of borrowers 

that could prevent or make refinancing of a subsequent home purchase prohibitively expensive. 

Although these products have been around, what has changed in 

today’s market is that they are aggressively mass-marketed to a 

much broader spectrum of borrowers. These borrowers could be 

vulnerable to payment shock and rising loan balances, making 

their homes suddenly unaffordable and potentially ruining their finances. 

My written testimony goes into detail on this, but I do want to 

point out a few things. One, indications are of higher problem loans 

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stemming from the recent lending boom. The rise in non-traditional 

and hybrid adjustable rate mortgages may increase defaults and 

foreclosures over the next few years. Some in the industry already 

are predicting that higher monthly payments resulting from these 

resets are to mean that one in eight or more of these loans will end 

up in default. 

There was a lot of talk this morning about numbers. At CFA and 

NCLC, we care also about the homeowners and the families behind 

these numbers. A recent study by First American Real Estate Solutions has reported that $368 billion in adjustable rate mortgages 

originated in 2004 and 2005 are sensitive to interest rate adjustments that would lead to default, and $110 billion of these are expected to go into foreclosure. Now, this translates into 1.8 million 

families at risk as a result of the possibility of default, with half 

million of these likely to go into foreclosure. So the numbers are 

quite large. 

Second, indications are that many borrowers may be more vulnerable to payment shock resulting from non-traditional mortgages 

though often portrayed. Research cited in my testimony indicates 

that a significant percentage of people taking out interest only 

mortgages and option ARMs have credit scores below the median 

and incomes at the median or below. 

Third, it appears that many consumers do not fully understand 

the risks associated with non-traditional mortgage products. This is 

understandable given the dizzying array of products that are available in the marketplace. My testimony discusses research indicating that many borrowers who have taken out these loans do not 

fully appreciate the payment adjustments and the potential of payment shock that could occur. 

Since my time is nearing an end, let me say, in conclusion, we 

believe that more needs to be done to ensure that consumers are 

adequately aware of financial risks associated with these complex 

and potentially risky products. Yet the plain fact is that exotic 

mortgages products simply may not be appropriate for all borrowers who receive them. In my written testimony I offer a number 

of specific policy recommendations to address this problem. This 

quick adoption of the proposed Federal interagency guidance on 

non-traditional mortgage products and also the establishment of 

suitability standards to ensure that borrowers receive loans that 

are truly appropriate for them. 

I would be glad to answer any questions that you may have. 

Chairman ALLARD. I want to thank all of you for your testimony. 

I think at least a lot of the consumers that take these exotic-type 

loans in order to avoid the payment shock try to refinance that 

loan before they hit the adjustment or reset period. According to 

‘‘The Denver Post’’ article, this can be an expensive proposition. For 

example, the couple that I mentioned in my opening comments, 

Lilly and India Hartz, they have an option, an ARM, with a growing balance. They would like to refinance the loan, but face a prepayment penalty of $11,000. 

The question is this: What percentage of non-traditional mortgages include a prepayment penalty? And to follow up on that, 

what is the range and average amount of such a penalty and what 

are the terms? 

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Mr. Broeksmit. 

Mr. BROEKSMIT. I don’t have a percentage for you. I can say that 

I know the terms of most prepayment penalties are a couple of varieties. One is a 1-year prepayment penalty that is often 2 percent 

of the loan’s principal, and there are 3-year prepayment penalties 

that are typically on a sliding scale of 3 percent, 2 percent, 1 percent. So the penalty recedes as the loan stays on the books. There 

is another variant. 

Chairman ALLARD. Up to the preset date? 

Mr. BROEKSMIT. It expires in the thirty-seventh month. It is a 3- 

year penalty. 

Chairman ALLARD. I see. Okay. 

Mr. BROEKSMIT. There are other penalties where the penalty is 

constant for the term of the penalty. A common one is 6 months 

interest on 80 percent of the principal. 

So there are different flavors, and some State regulations affect 

what is given State by State. I don’t have a percentage for you in 

terms of the percentage of non-traditional loans that have a penalty. 

Chairman ALLARD. Mr. Hanzimanolis. 

Mr. HANZIMANOLIS. I do not have a percentage for you either, unfortunately, but I can tell you my experience. I have seen most 

common prepayment penalties as probably a 3-year with 3–2–1. 

Each year, it will decrease. Also keep in mind that there is also the 

option of no prepayment penalty. So the prepayment penalty is put 

out there for the consumer and they will have a cheaper interest 

rate or the margin may be cheaper if they have a prepayment penalty in place to ensure that the lender is receiving the compensation that they need, but there is always the option to not choose 

a prepayment penalty. 

Chairman ALLARD. Can you give a guess on what percentage in 

your experience have a prepayment penalty? It is 90 percent? 

Mr. HANZIMANOLIS. I couldn’t even guess. I know in my daily 

business, if I offer a product that has a prepayment penalty, I will 

also offer the option of no prepayment penalty, depending on the 

customer’s feeling of where they expect to be in the next year, 2 

years, or 3 years. They may opt to take that. So across the board, 

I think it is probably a 50–50 percentage is what I see. 

Chairman ALLARD. Mr. Calhoun, can you cite some numbers for 

us? 

Mr. CALHOUN. Yes. There is a great disparity between the prime 

and subprime market. In the prime market, less than 10 percent 

of loans have prepayment penalties, and part of that is because of 

historically, Fannie and Freddie didn’t buy traditional loans with 

prepayment penalties, and that has carried on some. We are seeing 

increasing prepayment penalties with the non-traditional mortgage. 

In the subprime market, it is totally flipped. Over 80 percent of 

those loans have prepayment penalties, and industry studies show 

that the majority of borrowers with prepayment penalties end up 

paying the penalty, and I think you really hit the nail on the head 

with how these loans really work. They essentially are forced 

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ating as 2-year balloon loans because no one can afford to make the 

payment when the reset happens. 

It is very, very difficult for a borrower to avoid the prepayment 

penalty, because to avoid the prepayment penalty and not get 

caught in the higher mortgage payment, you have to refinance in 

that 30-day period after the lower payment ends. If you finance it 

before that, if you are proactive, then you get the prepayment penalty, and to finance it later than that, you somehow had to be able 

to make the mortgage payments that have increased so dramatically. 

These loans put consumers in a real bind both with the payment 

shock and sort of the double whammy of these prepayment penalties. 

Chairman ALLARD. What cost is the prepayment penalty supposed to cover? Is it the re-processing of the loan or are there other 

factors that go into that prepayment penalty? 

Mr. CALHOUN. There are several factors. Initially, it was supposed to be an alternative way to cover the cost of originating the 

loan. Increasingly in today’s market, it is another fee. It adds more 

revenue to the whole loan package, and our organization did research looking at subprime loans throughout the country, using the 

largest industry data base, to see if consumers were getting a 

promised lower interest rate in exchange for the prepayment penalty, and our study which we made available to Federal regulators 

and everyone else found that in practice, they didn’t, that the prepayment penalty did not actually lower it. It tended to be an additional expense for them. 

Chairman ALLARD. Mr. Fishbein. 

Mr. FISHBEIN. Well, I would concur with what Mike has said. We 

certainly hear of stories of prepayment penalties that exceed the 

initial preset period, particularly for loans in the subprime market. 

I do not know whether that is standard practice, but certainly it 

appears some lenders are doing this. 

Chairman ALLARD. Now just one last question: How common are 

other types of refinancing penalties? For example, Monique and 

Anthony Amijo of Colorado have a mortgage that contains a 

$20,000 penalty if they refinance with anyone other than one particular broker. Is that common among brokers, Mr. Hanzimanolis? 

Mr. HANZIMANOLIS. I have never heard of that before, sir. I can 

absolutely say it is not commonplace. 

Chairman ALLARD. Would everybody else on the panel agree with 

that? 

Mr. CALHOUN. I will disagree. Most lenders have a practice of 

waiving prepayment penalties if you refinance with them. That is 

the common practice in the industry. A prepayment penalty of the 

size that you describe is not at all atypical. As described by our 

first witness, if you have a half-year’s interest on a loan, that that 

is your prepayment penalty, most of your mortgage payment goes 

to interest, particularly in the early years, and it is very easy for 

that prepayment penalty to be tens of thousands of dollars, and we 

find and the realtors have found that borrowers are trapped where 

they can’t sell the house because when you add on the prepayment 

penalty, the loan is upside down. They own more than what they 

can sell the house for, and so it is a concern there as well. 

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Chairman ALLARD. Any other comments from the panel on that 

last question? 

Mr. BROEKSMIT. I would just say that it is highly unusual that 

a mortgage broker can say there is a penalty by not coming back 

to me. The mortgage broker doesn’t even control the Note, and the 

prepayment penalty is an addendum to the Note. So there is something unusual about that circumstance. 

Chairman ALLARD. We will have our staff follow up on that. 

Senator Schumer. 

STATEMENT OF SENATOR CHARLES E. SCHUMER 

Senator SCHUMER. Thank you, Mr. Chairman, and thank you 

again for having this hearing on an issue of great concern to me, 

and I apologize. It is a busy time, but I want to thank you and Senator Bunning and Senator Reed. 

I have been troubled by alternative mortgages, which are often 

a synonym for risky mortgages, for quite a while. The saddest part 

of these mortgages is that the borrower usually doesn’t know what 

hit them. I have heard this from people. They feel like a ton of 

bricks have fallen on their head, and then they look up at the roof 

and it is still there, but their life is shattered in a million pieces 

because they can’t pay. 

I understand the need for these products and I understand when 

used in a responsible way, these products will help bring mortgages 

to people who don’t need them, but we all know what is going on. 

Too many people who sell these mortgages are not looking out for 

the well-being of the mortgagee. They are looking out, rather, for 

just selling as many as possible, and then those mortgages are 

gone and gone far away, and it is really, really troubling. 

The plethora of new products that flood the housing market, 

mainly the interest only loans and the payment option adjustable 

mortgages and the 2–28 ARMs, are destroying the lives of a whole 

lot of people whose lives didn’t have to be destroyed. In the old 

days, these type of loans were distinctly for either high net worth 

or sophisticated home buyers. What has happened is they have devolved and they are sold to people or the least experienced and the 

most vulnerable. 

So ‘‘Business Week’’ referred to these things on its September 

11th cover as ‘‘Nightmare Mortgages’’, and that is what they have 

done. Middle income people, lower income people are accessing 

complex and risky mortgages in the name of affordability, but they 

are often mortgages that they can’t afford. 

We also have a particular issue with young minorities being 

preyed upon. I have been involved with this issue in New York for 

a long time, and we even have some people who are radiologists 

who made $200,000 a year, but who didn’t believe that a bank 

would give them a loan, going with these products and paying far 

too high a rate, and I have worked in New York on trying to solve 

this problem by having our prime rate banks reach out to churches 

and other institutions to let people come in, but as I said, I have 

been really, really troubled. 

Here is the problem: You can get a mortgage without showing 

the ability to pay for it. When the loans are issued, they don’t look 

at when the rate bumps up, whether the family can afford it. They 

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rely on some ridiculous projection that they are going to be making 

a whole lot more money before, and people just don’t know what 

they are doing. 

So is the explosion of these exotic mortgages especially to borrowers who can’t demonstrate their ability to sustain their mortgage payments through the payment shock period at least in part 

the result of overly aggressive selling by brokers whose compensation is not tied to the successful outcome, but merely to the closing 

of the loan? 

Mr. HANZIMANOLIS. Well, let me first say that mortgage brokers 

for the most part are small business people. We live in the same 

communities where we originate loans. We shop at the same stores. 

We go to the same churches. We have the same scout troop and 

school functions. In order for us to be successful in business we 

have to reach out to our community and be fair in our lending. 

I can’t imagine anybody would be successful being the—— 

Senator SCHUMER. Sir, I am sorry to interrupt you. 

Chairman ALLARD. Let me interrupt both of you here. I am running a pretty tight time line on the members of this committee on 

their 5-minute limit. I would suggest that we go to—your time has 

expired. I would suggest that we go to Senator Bunning. We will 

get in his 5 minutes and come back to you. 

Senator SCHUMER. OK. I will just submit questions in the record. 

All I was saying, Mr. Chairman, is that may be true in a small 

town. In a borough like Queens or Brooklyn, that is not true at all. 

I will be happy to submit questions in writing. 

Chairman ALLARD. I have been treating all the members the 

same way. 

Senator SCHUMER. I appreciate that. Thank you, Mr. Chairman, 

and I apologize for coming and running. 

Chairman ALLARD. Thank you. 

Chairman Bunning. 

Chairman BUNNING. Mr. Simpson, mortgage insurers have an interest in seeing that lenders do not write loans that are too risky, 

I hope. 

Mr. SIMPSON. Yes, sir. 

Chairman BUNNING. Over the last 3 years, do you think that the 

relaxation of underwriting standards has been too risky or are the 

risks manageable? 

Mr. SIMPSON. Well, on your first question, yes, we have seen 

some deterioration in the underwriting criteria for these non-traditional mortgages. 

Chairman BUNNING. That is what we are talking about. 

Mr. SIMPSON. Many people have testified, and years ago, an option ARM was for a very high-quality borrower. Today, there are 

less than high-quality borrowers taking out these loans. 

Chairman BUNNING. So when the Federal Reserve Chairman is 

recommending that people look at this as a prime option—and he 

did exactly that before the Banking Committee. He said, If I were 

going to get a mortgage, I would get an ARM, because, you know, 

the interest rates at the time, the prime was 4 percent, and the 

short-term interest rates were much shorter, much lower than the 

long, and now, obviously, they have reversed. 

Mr. SIMPSON. Yes. 

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Chairman BUNNING. So now I am talking about the risks at this 

time. 

Mr. SIMPSON. Yes, sir. Well, I think that depends upon your forecast of interest rates. If you think interest rates are going down, 

you might want to get an ARM; but having been in this business 

all these years, I still think a six and a quarter 30-year fixed-rate 

loan is a mighty good loan. I fail to understand the wisdom of most 

people who don’t take that option rather than an option ARM. 

Chairman BUNNING. Well, most people that can do that would 

take that option. 

Mr. SIMPSON. Correct. 

Chairman BUNNING. But we are talking about people who want 

more for less. 

Mr. SIMPSON. But if we are qualifying people on an option ARM 

today, that rate would be very close to the six and a quarter 30- 

year fixed-rate payment. 

Chairman BUNNING. I understand that. 

Mr. SIMPSON. OK. The other thing I would like to point out that 

purveys all of this discussion is housing appreciation, and as long 

as homes are going up in value in your neighborhood or any neighborhood, you can probably get by with some relaxed underwriting, 

and that is what this mortgage finance system is this country tends 

to do. It gets more aggressive as homes are going up in value, but 

let me tell you. Today, they are not all going up in value. In fact, 

there are parts of the country where they are going down, and the 

overall rates have really subsided. We are looking now at 4 percent 

annual appreciation rates, not 13. 

Therefore, it only makes sense for the Federal regulators to come 

out with some reins and some tightening on the underwriting criteria. 

Chairman BUNNING. I would hope so. 

Mr. SIMPSON. We don’t have the appreciation to bail out mistakes. 

Chairman BUNNING. OK. Let me ask—I can’t pronounce your 

name. I am sorry. 

Mr. HANZIMANOLIS. That is quite all right. 

Chairman ALLARD. Mr. Hanzimanolis. 

Chairman BUNNING. Thank you. 

In your written statement, you emphasize consumer education, 

and certainly that is an area for improvement. Before we see results in improvement in consumer education efforts, there will be 

a period when brokers will still be dealing with what many people 

have classified as an overwhelmed consumer, a confused borrower. 

Brokers share little of that risk, that borrowers and lenders assume. In fact, many have a financial interest in getting the borrower into a loan regardless of whether the borrower can afford it 

or not, as Senator Schumer has said. 

Under current laws and regulations, are there strong enough 

protections for consumers and lenders? 

Mr. HANZIMANOLIS. I believe that the protections are in place. 

Keep in mind, as a mortgage broker, when I originate a loan, it 

still has to go to the mortgage lender who is going to fund it. That 

lender does a very detailed underwriting job at looking at that. So 

we have qualified and processed that loan application to their 

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guidelines, and they review it intently to make sure that everything have been gone through properly for that customer to be able 

to qualify. 

Chairman BUNNING. I just am worried that the consumer doesn’t 

really fully realize if they are in a sophisticated mortgage like we 

are talking about. It is easy to understand if it is a four and a half 

percent or a six and a half percent 30-year loan. You know what 

your payments are going to be and you know what they are going 

to be for 30 years, but if you get into a 3-year ARM or a 3–2–1 with 

a penalty, it is very difficult for some people to realize and grasp 

what happens at the end of the third year. 

Mr. HANZIMANOLIS. I agree, and as you know from my written 

testimony, NAMB has always suggested that we have clearer, more 

concise disclosures, disclosures where, in fact, as the originator sits 

down and explains everything to the customer, both the originator 

and the customer would initial at each section there. 

Chairman BUNNING. Yes, sir. I just recently refinanced. There 

were, I think, 36 pages, 36 documents that I had to either have my 

wife or myself initial. Now, how many people understand, unless 

there is a lawyer present, what the heck are they doing? 

Mr. HANZIMANOLIS. I think any good originator, be it a broker or 

a bank, lender, anyone, would sit down with the customer and explain each form in detail. 

Senator SCHUMER. It didn’t happen to me. 

Chairman BUNNING. It happened to me because I had a lawyer 

sitting right next to me, and he made sure when the paper was 

handed to me for a signature, that he said, OK, you can initial, OK, 

you can initial, because he understood. He had sat in on a lot of 

closings. So I felt very comfortable in doing that, but how many 

people do that? 

Mr. HANZIMANOLIS. It is always the customer’s right to bring an 

attorney. 

Chairman BUNNING. I understand that, but how many people do 

that? 

Chairman ALLARD. Chairman Bunning, I need to go to Senator 

Schumer. 

Chairman BUNNING. Go ahead. Thank you. 

Senator SCHUMER. I want to go back to Mr. Hanzimanolis. You 

know, you paint this apple pie picture of the mortgage broker who 

lives in the community and runs the Boy Scout Troop, goes to the 

same church. That may be true in Small Town America where 

there is one or two mortgage brokers for a thousand people. In the 

New York metropolitan area of 20 million people, that doesn’t happen. People don’t go to the same church as their mortgage broker 

98 percent of the time or have the kid in the Boy Scout Troop, and 

we have lots of unscrupulous people here. 

Do you understand that we should be regulating not the best 

who don’t it, but for the worst who rip people off, and have you 

heard of instances of mortgage brokers ripping people off? 

Mr. HANZIMANOLIS. I have heard of every business out there. 

Senator SCHUMER. No. I didn’t ask you that. Sir, have you heard 

of mortgage brokers ripping people off? 

Mr. HANZIMANOLIS. Yes, I have. 

Senator SCHUMER. Have you heard of it rarely? Frequently? 

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Mr. HANZIMANOLIS. I believe it is a small case, but it is something that happens. You hear about it. 

Senator SCHUMER. Let me tell you I hear about it frequently. 

OK? And I am a Senator and my job is to get to know all of my 

constituents. We all hear of it frequently. Do you think we should 

do more than simply rely on consumer education for those mortgage brokers, however there are, and you are going to have to take 

my word for it there are too many of them, who have no interest 

once the loan is closed in seeing whether the customer can pay 

back? Do you think we need to do more than customer education? 

Mr. HANZIMANOLIS. I think customer education is a wonderful 

start. I think helping educate the lenders regardless of the distribution channel—— 

Senator SCHUMER. How about some regulations of unscrupulous 

brokers; you don’t think there should be any? 

Mr. HANZIMANOLIS. I hope there are laws on the books already. 

Senator SCHUMER. Do you think they are adequate on the books? 

Mr. HANZIMANOLIS. I think we can always improve. It has always 

been NAMB’s position that if there is anyone out there doing anything that is illegal—— 

Senator SCHUMER. I can tell you that there are lots of people who 

do this and they prey on the people who know the least, and it 

would protect good brokers to have the other ones better regulated. 

So I would ask you to go back to your organization and tell them 

that there is a lot of upsetness here on both sides of the aisle about 

what is going on now, and a lot of it, I have found in my explorations. 

I used to think banks discriminated, but they don’t. It is much 

more the mortgage brokers who go into these areas and sign people 

up without telling them the whole consequences. I shouldn’t say 

the banks don’t. I should say the biggest problem we face in New 

York City, why so many say minority areas are subprime and areas 

that actually the same income level that are only a mile away, but 

are white, are prime is the mortgage brokers, not the banks. 

I will tell you, in my view, Mr. Chairman, we need a whole lot 

more attention here, and we have gotten very little because the industry is grown up quicker, because more people are getting 

homes, thank God, etc. 

Here is my next question: OK. I am asking everybody here. How 

would underwriting loans to the fully indexed—wouldn’t it be a 

good idea to underwrite loans to the fully indexed rate to make 

sure if the initial rate is 6 percent, but the rate 2 years later will 

be 9 percent, that at the time the customer signs up, that we are 

sure that they could pay at the 9 percent rate, and wouldn’t that 

help people keep people in their homes, particularly, as Mr. Simpson mentioned, in this uncertain time when housing values might 

be going down? 

Mr. BROEKSMIT. Senator Schumer, we make a lot of option ARM 

loans. We underwrite borrowers to the fully indexed rate at a fully 

amortizing payment. 

Senator SCHUMER. Right. 

Mr. BROEKSMIT. We think that is a smart idea, and we quibble 

with the guidance in some aspects of this because it runs the products together, and there are some interest only loans where I don’t 

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believe you need to qualify somebody at the fully amortizing payment on a 10/1 ARM. If you have got an interest only option for 

10 years, the average life of the loan is probably five. We quibble, 

but generally speaking, that is a very sound practice. 

Senator SCHUMER. Right. What do you think, Mr. Hanzimanolis? 

Mr. HANZIMANOLIS. I think two things: One, better disclosures 

for the customers so they understand where the payment could 

possibly go; and two, you will be happy to hear that many of the 

lenders that I do business with are already asking the people to or 

requiring the people to underwrite that to the fully indexed and 

fully amortized payment. 

Senator SCHUMER. What about those who don’t; should we do 

more from a governmental point of view to make sure that happens? 

Mr. HANZIMANOLIS. I think that we, obviously, know listening 

today and before coming here today that this is an issue, and if it 

is an issue, we want to protect people with better disclosures and 

underwriting to that. 

Senator SCHUMER. What about beyond disclosure? Disclosure for 

many people doesn’t work, as we have all tried to make the point 

clear here. Caveat Emptor is a good concept, and about in 1890, the 

country realized it was in some areas not sufficient. 

Mr. HANZIMANOLIS. I think you are going to see more and more 

lenders going to that, and eventually that will—— 

Senator SCHUMER. Do you think we should regulate it or not? 

Mr. HANZIMANOLIS. I don’t know if a regulation is required. I 

think that we will see the market is going that way on its own. 

Senator SCHUMER. Mr. Simpson. 

Mr. SIMPSON. I definitely think we should underwrite to the fully 

indexed accrual rate, and I do think there is more enforcement 

needed to assure that that happens. I would also, as an insurer, 

say that loan should be underwritten as having an additional layer 

of risk as a result of the uncertainty of the structure of loan, as 

we do. 

Senator SCHUMER. All right. Mr. Calhoun. 

Mr. CALHOUN. Yes, and I am glad to hear the widespread agreement, but I think, more importantly, is what you have addressed, 

is how do you make that apply to the market. If it is just this advice, it doesn’t work, because if the good brokers or lenders are underwriting that way, they have to compete with the ones who 

aren’t. It gives the bad apples an unfair competitive advantage. 

Senator SCHUMER. That is exactly right. 

Mr. CALHOUN. That hurts both the borrowers and the industry, 

because in the lenders, if a broker comes to them with a loan not 

fully unwritten, if the lender says I don’t want it, the broker says, 

Well, this person down the street will buy it. See, you have got to 

make it apply to the whole market. 

Senator SCHUMER. Agreed. I agree with you. 

Mr. Fishbein. 

Mr. FISHBEIN. Certainly underwriting to the fully indexed rate is 

necessary, but in some cases, for some types of loans, it may not 

be sufficient. We know that the LIBOR rate, which is an index that 

is used for many subprime loans has been adjusting upward every 

month for the past 2 years. So if you had just underwritten a loan 

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in a subprime market to the fully indexed rate, it would not necessarily mean that the borrower 6 months or 2 years later would 

be in a position to be able to pay that loan. 

Senator SCHUMER. But, Mr. Fishbein, the jumps that most people 

get far exceed the change in LIBOR over the period of time they 

get the jump. Isn’t that true? 

Mr. FISHBEIN. Well, the point—— 

Senator SCHUMER. The early teaser rates that come in early, and 

then when it goes up to the full rate, that is usually far more than 

the LIBOR increase. 

Mr. FISHBEIN. That is certainly a significant part of the problem, 

and that is why I say I agree with underwriting to the fully-indexed. However, underwriting should also take into account the 

full extent that negative amortization is permitted. I would also 

say that, particularly in connection with more modest income people, it is important that underwriting also consider residual income, in other words, whether people when they pay all their debts 

still have income, regardless of how the percentages look, to be able 

to make the payments. This also should include taking into account 

taxes and insurance borrowers and be required to pay which some 

lenders do not do when deciding whether a loan is affordable to a 

borrower. 

Senator SCHUMER. Thank you, Mr. Chairman. 

Thank you. I thank the whole panel. 

Chairman ALLARD. Thank you, Senator Schumer. In fairness, I 

have given everybody their questions. 

Senator SCHUMER. You have been extremely fair, Mr. Chairman. 

I have no complaints with you, and we don’t need any regulation 

to make you a better chairman. 

Chairman ALLARD. Thank you, Senator. 

Okay. I just have one question, and then we will let you go. During the last several years, we have seen a dramatic rise in the 

number of inter only loans and payment option ARMs. Have these 

products peaked out in being offered to consumers, or do you think 

they will continue to popular, and can we expect increases in these 

non-traditional type of loans, and if they are discontinuing, do you 

see them being replaced by some other type of non-traditional loan? 

What can we expect in the future? 

Mr. BROEKSMIT. I would not expect them to—I don’t believe they 

have run their course. I believe they are a good product for a large 

segment of the population, but you will continue to see evolution. 

For instance, the option ARM has typically had four payment options, but the underlying interest rate adjusts. There is recently, 

within the past 6 months, introduced a product that continues to 

have different payment options, but the rate behind the scenes is 

fixed for 5 years. So it appeals to a borrower who likes the certainty of a period of fixed rates, but also likes the ability to match 

the mortgage payment with a fluctuating income and make a lower 

payment when that is convenient for them and then have the option to catch up later. 

So you will see an evolution, but I think we have seen a structural shift in consumer behavior where people don’t expect to live 

in the home for 30 years. Why pay a 30-year fixed-rate rate when 

you expect to move or refinance within three or 5 years? 

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So the notion that people want to borrower on the short end of 

the yield curve to match the length they really expect to have the 

loan versus paying the premium for a 30-year rate, I will continue, 

and the notion that you are going to pay off your mortgage by a 

certain point in your life, I believe in my generation and younger 

generations is a much less prevalent one than it was among the 

older generations. 

Chairman ALLARD. Do you want to look in the future, Mr. 

Hanzimanolis? 

Mr. HANZIMANOLIS. Well, I agree with Mr. Broeksmit. I don’t 

think it has peaked. I believe that there are still benefits to these 

programs. They have benefits in the right situations, and will other 

products develop? Absolutely. The needs of the consumer drive the 

market, and that is why we see the development of these new products. So I anticipate that we will see new products developing constantly. 

Chairman ALLARD. Mr. Simpson. 

Mr. SIMPSON. History shows that in the eighties when we had 17 

percent mortgage rates, that the mortgage market was very creative in trying to find solutions to that problem. When the houses 

depreciated in the oil patch and we had massive foreclosures, most 

of those experimental non-traditional mortgages of those days disappeared, and we went back to the fixed rate loans. Now we are 

back experimenting again, and I think essentially because houses 

have gotten so expensive and they have also appreciated so consistently that we are now seeing people take these non-traditional 

mortgages based on the past. 

But as I have said today and I will say it again, I think the past 

is the past. I don’t see housing appreciation in the next 5 years 

anywhere near the kind of rates we have seen. So a lot of these 

structures don’t make sense, but we will see experimentation, and 

as Bob was saying, I think you will see more flexibility in how the 

borrower interacts with their mortgage. I just hope that that is confined to people of means and we don’t put people in houses who 

can’t stay there. 

Chairman ALLARD. Mr. Calhoun. 

Mr. CALHOUN. Very quickly, I think these mortgages were developed for people, largely, to get into houses, and now we see once 

you are in one of these mortgages, it is very hard to get out, that 

as has been mentioned today, when you refinance, you typically 

incur significant additional expenses, both upfront fees and often 

the prepayment penalty, and just the financial truth is for far too 

many families, they cannot convert to a standard fixed mortgage at 

this point because if you underwrite—that is, in effect, underwriting to fully indexed, and if they didn’t qualify for that when 

they got the mortgage a couple years ago, they are probably not 

going to qualify for it now. 

I think it is incumbent on industry here to work with borrowers 

on a widespread basis for loan modifications and workouts that 

make the loans sustainable and do not extract additional fees 

which simply increase the debt load of American families. 

Chairman ALLARD. Mr. Fishbein. 

Mr. FISHBEIN. We have been surprised that the market appetite 

has continued for non-traditional mortgages products in the face of 

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cooling house prices. As I point out in my written testimony, the 

growth of these products has contributed to the housing boom. 

Home price appreciation has continued because these loan products 

enable borrowers to stretch further and further. In essence, the 

growth of exotic mortgages has created a chicken and egg situation, 

which in turn, has contributed to the problem. 

And as Mike pointed out, and I think it is a very important 

point, many who get into these highly leveraged loans wind up on 

a treadmill in which they get into progressively more costly loans, 

until their remaining home equity loans are refinanced in which 

they take equity out of home equity loans home as long as they 

have equity to continue with that. 

So I suspect we will continue to see variations of these products. 

This is all the more reason to take a hard look at developing a comprehensive approach to protecting consumers. This should include, 

certainly, improved disclosures. However, it also should include 

suitability standards requiring that mortgage brokers and loan 

originators place people into loans they can afford. Such a standard 

is necessary to discourage bad practices in the marketplace. 

Chairman ALLARD. Well, I would like to thank all of our witnesses again for testifying. We have heard a great deal of testimony from both panels, and Chairman Bunning and myself will 

both be watching this issue pretty closely in the following months. 

The record will remain open for 10 days. Should members wish 

to submit any additional questions to the witnesses, we would appreciate your prompt response to the question and would ask you 

to please respond to them within 10 days. I have some questions 

additionally that I will be submitting. 

I thank everyone for attending this joint hearing of the Housing 

and Transportation Subcommittee and Economic Policy Subcommittee. The hearing is adjourned. 

[Whereupon, at 12:38 p.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 

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STATEMENT OF SENATOR CARPER 

Thank you, Chairman Shelby and Ranking Member Sarbanes for holding this important hearing. 

Homeownership is a top priority for me. When people own their home, they are 

often healthier, more involved in their communities, and have children who do better in school. 

However, the process of buying a home can be daunting. Obtaining a loan is an 

intimidating and confusing process for the vast majority of people who participate 

in it. Today, there are many financing options for potential homebuyers. In our 

hearing today, the witnesses will comment on non-traditional mortgage products. 

While all of these products have helped to increase the national homeownership 

rate, they come with risks. 

While I am encouraged by increased homeownership rates, I want to ensure that 

financing options that get people into a home are not counterproductive. I want to 

see more Americans own their own homes, but I also want to make sure they can 

stay in their homes. 

An important component of increasing Americans’ homeownership is financial literacy. We must empower consumers with the knowledge they need to successfully 

purchase a home. The state of financial literacy in our country is terribly low. We 

need to educate our children and young adults on basic skills, such as personal 

budgeting, balancing a check book and checking their credit score. Increasing financial literacy will go a long way to protecting Americans from finding themselves in 

a financial situation they cannot afford. 

Mr. Chairman, I greatly appreciate that we are holding this hearing today, but 

I hope that next year, this Committee will turn its attention to the broader issues 

of predatory lending and financial literacy. 

Thank you. 

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RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM ORICE WILLIAMS 

Q.1. Mortgage brokers are playing a larger role in the market 

today. Recent statistics show that independent brokers are responsible for about 50 percent of all originations and over 70 percent 

of subprime originations. Brokers definitely serve the overall market by helping consumers work with multiple lenders; however, 

they share little risk. Many brokers find it in their financial interest to get the borrower into a loan, regardless of whether the borrower can afford it. Are current laws and regulations strong 

enough to protect both consumers and lenders? What can be done 

to better share risk and ensure brokers are not just looking out for 

their own best interests? 

A.1. GAO response 

Certain federal consumer protection laws, including the Truth in 

Lending Act and the act’s implementing regulation, Regulation Z, 

apply to all mortgage lenders and to those mortgage brokers that 

close loans in their own name. Regulation Z requires these creditors to provide borrowers with written disclosures describing basic 

information about the terms and cost of their mortgage. In our recent study on interest-only loans and payment-option adjustable 

rate mortgages (payment-option ARMs), we reviewed current Regulation Z requirements and found that they are generally not designed to address these complex alternative mortgage products 

(AMPs). For example, AMP disclosures that we reviewed did not always fully or effectively explain the risks of payment shock or negative amortization for these products and lacked information on 

some important loan features, both because Regulation Z does not 

require lenders to tailor this information to AMPs and because 

lenders do not always follow leading practices for writing disclosures that are clear, concise, and user friendly. As AMPs are more 

complex than conventional mortgages and advertisements sometimes expose borrowers to unbalanced information about them, it 

is important that the written disclosures that they receive about 

these products provide them with comprehensive information about 

the terms, conditions, and costs of these loans. Borrowers who do 

not understand their AMP may not anticipate the substantial increase in loan balance or monthly payments that could occur, and 

would be at a higher risk of experiencing financial hardship or 

even default. The Federal Reserve has recently initiated a review 

of Regulation Z that will include reviewing the disclosures required 

for all mortgage loans, including AMPs. We support this initiative, 

and in our report entitled ‘‘Alternative Mortgage Products: Impact 

on Defaults Remains Unclear, but Disclosure of Risks to Borrowers 

Could be Improved,’’ (GAO–06–1021), we recommended that the 

Federal Reserve consider as part of its reforms requiring (1) disclosures to include language that explains key features and potential 

risks specific to AMPs, and (2) effective format and visual presentation. 

We did not undertake a review of other federal or state laws and 

regulations that govern broker conduct as part of our work. However, the Conference of State Bank Supervisors and the American 

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295 

mitted to working with state regulatory agencies to distribute guidance to licensed residential mortgage lenders and brokers that is 

similar to the recently issued federal interagency guidance on nontraditional mortgages. The state-based guidance will focus primarily on residential mortgage underwriting and consumer protection. 

Q.2. How much risk do you see from borrowers who have used 

these mortgages to speculate in the housing market? If these investments cease to be worthwhile because of a housing slowdown, 

are we going to see large number of defaults on these loans? 

A.2. GAO response 

Mortgage delinquency and default rates are typically higher for 

borrowers who use mortgages for investment purposes than for borrowers who use them to purchase their primary residences. However, we are not in a position to comment on the likelihood of defaults related to AMPs for these borrowers in the event of a housing slowdown. Federal banking regulatory officials said that they 

are concerned that some recent borrowers who used AMPs to purchase homes for investment purposes may be less inclined to avoid 

defaulting on their loans when faced with financial distress, particularly in those instances where the borrower has made little or 

no down payment. Data on recent payment-option ARM securitizations indicate that 14.4 percent of AMPs originated in 2005 were 

used by borrowers to purchase homes for purposes other than use 

as a primary residence, up from 5.3 percent in 2000. However, 

these data did not show the proportion of these originations that 

were used to purchase homes for investment purposes as compared 

to second homes and did not indicate the size of the down payment 

the borrower had made. 

Q.3. Are borrowers who have taken non-traditional mortgages in 

recent years using these products to buy bigger and better homes 

than they otherwise could afford or are they using these products 

simply to be able to get into the market? In other words, are the 

mortgages being used to finance basic needs or luxury desires? 

A.3. GAO response 

No data are available that would allow us to discern the number 

of borrowers that were using AMPs for one purpose or the other. 

However, officials from the Federal Deposit Insurance Corporation 

have reported anecdotally that some borrowers, often first time 

homebuyers, used these products to purchase higher priced homes 

than they could have qualified for using conventional mortgages. 

As discussed in greater detail below, AMP lending has been concentrated in those regional real estate markets where homes are 

least affordable. 

Q.4. In our last hearing, Mr. Brown from the FDIC suggested that 

we are unlikely to see a nationwide crisis in the housing market, 

because the housing boom is concentrated in certain regions, and 

historically most housing failures have happened in areas of suffering from localized recessions. As we all know, there is increased 

risk of massive defaults on these loans in the coming years. Due 

to a nationwide trend of nontraditional mortgages being used as afsmartinez on DSKD5P82C1PROD with HEARING

296 

fordability products, would you disagree with Mr. Brown that upcoming housing problems will be isolated in certain regions? 

A.4. GAO response 

We found that AMP lending has been concentrated in the higherpriced regional markets on the East and West coasts, where homes 

are least affordable and prices have appreciated more rapidly than 

in other areas of the country. Although the inability to make higher monthly payments could cause AMP borrowers to default on 

their loans, job loss, divorce, serious illness, and a death in the 

family are commonly identified as the major reasons borrowers default on their mortgages, as in each of these examples, the borrower can experience a major drop in income, or a major increase 

in expenses. To the extent that any regional markets with high 

concentrations of AMP lending experience a local recession, local 

AMP borrowers may be more vulnerable to default than other borrowers. For example, these borrowers may not have funds to meet 

the higher monthly payments or enough equity in their homes to 

refinance or sell if local housing prices drop and they have borrowed with little or no down payment or have allowed their loans 

to negatively amortize. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM SANDRA BRAUNSTEIN 

Q.1. Mortgage brokers are playing a larger role in the market 

today. Recent statistics show that independent brokers are responsible for about 50 percent of all originations and over 70 percent 

of subprime originations. Brokers definitely serve the overall market by helping consumers work with multiple lenders; however, 

they share little risk. Many brokers find it in their financial interest to get the borrower into a loan, regardless of whether the borrower can afford it. Are current laws and regulations strong 

enough to protect consumers and lenders? What can be done to better share risk and ensure brokers are not just looking out for their 

own best interests? 

A.1. The Federal Reserve Board held hearings in 2006 on the 

home equity lending market, which included testimony from consumer advocates, mortgage brokers and lenders about consumers’ 

view of the role mortgage brokers play in offering mortgage products and whether consumers’ understanding of that role has been 

furthered by state-required mortgage broker disclosures. In answering your questions, I would like to share with you some highlights of the testimony and public comments regarding the adequacy of current and potential steps for improving consumer protection. Efforts to regulate mortgage brokers at the federal level 

should include a careful consideration of the issues raised at these 

hearings. 

At the hearings, many consumer advocates questioned the adequacy of current law governing mortgage brokers. They testified 

that while brokers may provide a valuable service to consumers 

and lenders, some brokers steer consumers to loans that provide 

the most compensation for the broker, regardless of the consumer’s 

needs. Furthermore, advocates testified, consumers generally do 

not understand that brokers are independent agents and are not 

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297 

required to find the best loans for consumers. They stated that in 

the subprime market, consumers tend to rely on a ‘‘trusted advisor’’ 

when making decisions about which loan to select, and may follow 

a mortgage brokers’ recommendation without doing independent 

research. Representatives of mortgage brokers testified that the 

growth of the mortgage broker industry has expanded product and 

pricing options for many consumers, but has also led to an increase 

in the number of uneducated and unlicensed loan originators, including brokers. Mortgage broker trade associations indicated that 

they have developed best practices and a code of ethics to address 

these concerns. Brokers also testified that state and federal agencies have not adequately enforced existing laws against the ‘‘bad 

actors’’ in the mortgage market, in part because funds for enforcement are inadequate. 

Consumer advocates offered varying solutions to revise laws to 

address concerns about mortgage brokers, including requiring brokers to be the exclusive agent of the borrower in all cases. Some 

advocated suitability standards to counter a broker’s incentive to 

sell consumers loans that do not necessarily fit the consumer’s 

needs and financial situation. Mortgage broker representatives rejected the notion that a broker should be the agent or fiduciary of 

the consumer and should select the best loan for the consumer. 

They noted that a broker may not have access to the best product 

available in a given market and argued that only consumers can 

determine the best loan for themselves. 

There was also testimony from state officials on state efforts to 

regulate and license mortgage brokers. For example, Pennsylvania 

officials described their efforts to regulate and license brokers and 

other loan originators and to cooperate with other states to monitor 

broker activity. Brokers expressed strong support for state licensing efforts and advocated criminal background checks for all mortgage loan originators including brokers and employees of banks 

and mortgage companies. Lenders testified that they support current efforts by the states to license and monitor brokers. State-required mortgage broker disclosures have helped somewhat, according to lenders who addressed the question, but they also noted that 

consumers are already confronted with too many documents 

throughout the mortgage process for disclosure to have much impact. 

Some lenders also stated that consumer education about the loan 

shopping process is the best way to overcome confusion about mortgage brokers’ roles. In addressing concerns about mortgage brokers, 

some lenders emphasized the need for a uniform federal response 

rather than enacting different state laws. 

Q.2. How much risk do you see from borrowers who have used 

these mortgages to speculate in the housing market? If these investments cease to be worthwhile because of a housing slowdown, 

are we going to see large numbers of defaults on these loans? 

A.2. The portion of home sales accounted for by investors, as opposed to owner-occupants, has risen in recent years. According to 

data collected under the Home Mortgage Disclosure Act, the share 

of reported mortgage loans (both traditional and nontraditional) associated with nonowner-occupied properties hovered between 5 and 

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298 

6 percent in the first half of the 1990s but has climbed fairly steadily since and reached 17 percent in 2005. 

Some of the recent increase in the investor share of the residential housing market has undoubtedly been spurred by the expectation that prices would continue to rise rapidly rather than by an 

interest in retaining the property over time for rental income. Past 

loan performance has indicated that investors are more likely than 

owner-occupants to default on a loan when house prices decline. As 

a result, there may be some deterioration in the credit quality of 

mortgages extended to investors now that house prices are no 

longer rising as rapidly as they had been. As yet, though, delinquency rates for mortgages (both traditional and nontraditional) on 

nonowner-occupied properties remain low. That said, the Board is, 

of course, watching for signs of an increase in defaults among investors, and we have urged lenders to recognize the risks associated with such an increase. 

Q.3. Are borrowers who have taken nontraditional mortgages in 

recent years using these products to buy bigger and better homes 

than they could otherwise afford or are they using these products 

simply to be able to get into the market? In other words, are the 

mortgages being used to finance basic needs or luxury desires? 

A.3. The required monthly payment associated with a nontraditional mortgage can be substantially lower than the payments 

would be for a more traditional mortgage loan of similar size, at 

least for some period. Thus, as I noted in my testimony, nontraditional mortgage products have allowed some borrowers to purchase 

homes that they otherwise might not be able to afford. However, 

the Board is not able to judge, nor should it judge, whether a particular home satisfies a basic need for a given household or whether it represents a luxury item for that household, as that question 

involves far-reaching issues about appropriate standards of living 

in our country. 

What is important to the Board is that consumers fully understand the commitments they make when taking on nontraditional 

mortgages and the risks they could face in light of deferring principal and/or interest payments. For this reason, the Board is actively engaged in efforts to enhance the information available to 

borrowers regarding these loans. The various initiatives I discussed 

in my testimony—the Board’s review of federally required disclosures on mortgages, its public hearings on home equity lending, its 

planned and completed revisions to consumer education publications, and elements of the interagency regulatory guidance on nontraditional mortgage products—are all examples of these efforts. 

Q.4. In our last hearing, Mr. Brown from the FDIC suggested that 

we are unlikely to see a nationwide crisis in the housing market, 

because the housing boom is concentrated in certain regions, and 

historically most housing failures have happened in areas suffering 

from localized recessions. As we all know, there is increased risk 

of massive defaults on these loans in coming years. Due to a nationwide trend of nontraditional mortgages being used as affordability products, would you disagree with Mr. Brown that upcoming 

housing problems will be isolated in certain regions? 

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299 

A.4. Many factors can contribute to borrowers defaulting on their 

mortgages, including house price declines, disruptions to income, 

and changes in required mortgage payments for which borrowers 

are unprepared. The first two of these factors are often concentrated in certain regions and thus mortgage-related distress has 

also often been concentrated. 

Nontraditional mortgages have become more prevalent throughout the nation. It is also the case that nontraditional mortgages are 

likely to lead some households into financial distress through the 

last of the channels mentioned above—large changes in required 

payments. However, changes in required payments on nontraditional mortgages are unlikely to pose a large threat to the national 

economy or to the financial system overall. One factor limiting the 

risks is that, in most cases, the payment changes will not occur for 

some time; for example, industry reports suggest that most interest-only mortgages do not start requiring repayment of principal 

for at least five years, if not ten or fifteen years. Many borrowers 

will have sold their homes or refinanced into a different mortgage 

by this time. In addition, efforts to raise consumer awareness of the 

terms and features of nontraditional mortgage payments, such as 

those being undertaken by the Board that I mentioned in my testimony, should encourage households who retain their nontraditional 

mortgages to make active efforts to prepare for major scheduled increases in their payments. 

Of course, certain nontraditional mortgages have not been tested 

in a stressed environment. Given this newness, the Board is closely 

watching for signs that household financial distress is becoming 

more widespread as more borrowers face increases in the required 

payments on their nontraditional mortgages. 

Q.5. Again, I would like each of you to answer this question quickly: Will the proposed guidance in combination with an update of 

Regulation Z be enough to stop overly risky lending practices? Or 

is something stronger needed? 

A.5. The nontraditional mortgage guidance advises institutions to 

ensure that their risk management and consumer protection practices adequately address the risks discussed in the document. 

Through the examination process, the Board and the other federal 

bank and thrift agencies will review institutions’ risk management 

and consumer protection practices, and institutions that do not 

adequately address these risks will be asked to take remedial action. An institution that follows the principles outlined in the guidance should be operating within acceptable boundaries of risk. 

However, many institutions that originate residential mortgages 

are not federally regulated and are not covered by the guidance. In 

an attempt to level the playing field between federally and non-federally regulated institutions, the Conference of State Bank Supervisors and American Association of Residential Mortgage Regulators released similar guidance. Each state banking agency must 

decide whether or not to enforce those guidelines or make changes. 

The nontraditional mortgage guidance’s recommended practices 

for marketing such mortgages to consumers should help consumers 

get the information they need at critical decisionmaking times so 

that consumers can make informed choices about mortgage prodsmartinez on DSKD5P82C1PROD with HEARING

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ucts. To supplement the guidance, the agencies are seeking comment on proposed illustrations that show how an institution might 

inform consumers about the features and risks of nontraditional 

mortgage products. 

The Board’s upcoming review of Regulation Z’s mortgage disclosure rules will aim to improve the information that lenders must 

provide to consumers. In addition, the Board’s staff is working with 

staff at the Office of Thrift Supervision to finalize revisions to the 

Consumer Handbook on Adjustable Rate Mortgages (the CHARM 

booklet) to include information about alternative mortgage products. The CHARM booklet is an effective means of delivering information to consumers, because Regulation Z requires that all creditors—not just those supervised by the bank and thrift agencies— 

provide the CHARM booklet or a suitable substitute to each consumer who receives an application for an ARM. The Board and the 

Office of Thrift Supervision plan to issue the revised CHARM booklet later this year. Finally, on October 19, 2006, the Board and the 

other federal bank and thrift agencies issued a brochure, InterestOnly Mortgage Payments and Payment-Option ARMs—Are They 

for You? to help consumers make more informed choices when considering nontraditional mortgage loans. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED 

FROM SANDRA BRAUNSTEIN 

Q.1. The importance of actual verification of a borrower’s income, 

assets, and outstanding liabilities increases as the level of credit 

risk increases. When is reduced documentation underwriting appropriate, if at all? What mitigating factors should be in place? 

A.1. Mortgage lenders are increasingly relying on reduced documentation, particularly unverified income, to underwrite nontraditional mortgages as well as other types of loans. The industry 

states that automated underwriting systems that incorporate credit 

scores, employment history, loan-to-value (LTV) and debt-to-income 

(DTI) ratios, among other borrower and product attributes have become a strongly predictive indicator of creditworthiness while 

eliminating the potential for bias in the underwriting decision. 

Through the development of technology, automated underwriting 

systems and other credit scoring models have become more robust 

and predictive allowing lenders to streamline the underwriting 

process and lower costs to borrowers while effectively managing 

risk. 

The final nontraditional mortgage guidance provides that when 

lenders rely on reduced documentation, automated underwriting 

systems, and credit scoring models, there should be mitigating factors that support the decision. Mitigating factors could include 

higher credit scores, lower LTV and DTI ratios, significant liquid 

assets, mortgage insurance or other factors. 

Q.2. How will the federal agencies implement this guidance in a 

consistent manner and how will you coordinate with your state 

counterparts? 

A.2. I anticipate that the agencies will coordinate their implementation of the guidance through the Federal Financial Institutions 

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Examination Council (FFIEC), which was created to ensure uniformity in supervision of federally supervised financial institutions. 

The Financial Services Regulatory Relief Act of 2006 requires the 

current State Liaison Committee to the FFIEC to elect a Chairperson, and to add this Chairperson as a full voting member of the 

FFIEC. This should help to ensure coordination with state agencies. 

Q.3. The proposed guidance strongly encourages institutions to increase monitoring and loss mitigation efforts (i.e., establishing portfolio limits, measuring portfolio volume and performance, providing 

comprehensive management information reporting). How do you respond to lenders who argue that such increases would restrict lender flexibility and reduce consumer choice? Will these increased efforts potentially drive up banks’ underwriting costs, which will 

hurt consumers? 

A.3. Because lenders do not have significant experience with nontraditional mortgage products in a stressed economic environment, 

they should have prudent risk management practices in place to 

ensure that these portfolios are administered in a safe and sound 

manner. As home price appreciation slows and interest rates increase, the potential for defaults caused by lack of sufficient borrower equity and payment shock is also increasing. Nontraditional 

mortgage portfolios may behave differently when compared to more 

traditional portfolios that do not contain as many embedded risks. 

Systems should be in place to determine how severely a stressed 

environment could affect borrowers and portfolios. Strategies 

should be developed to minimize the effect of deteriorating conditions on borrowers identified as at risk. Institutions involved in the 

origination and servicing of nontraditional mortgages should ensure that risk management practices keep pace with the growth 

and changing risk profile of their portfolios. These increased efforts 

should minimize defaults and losses which will benefit both lenders 

and borrowers and result in lower costs and increased product 

choice in the long run. 

Q.4. The GAO found federally-regulated institutions today already 

underwrite option ARMs at the fully indexed rate. That is good, 

but isn’t it better to also consider the potential balance increase associated with the negative amortization feature? How many of the 

institutions are considering this in their underwriting? 

A.4. While most institutions underwrite option ARMs at the fully 

indexed rate, very few, if any, institutions also consider the potential balance increase associated with the negative amortization feature. Institutions should maintain qualification standards that include a credible analysis of a borrower’s capacity to repay the full 

amount of credit that may be extended. The final nontraditional 

mortgage guidance advises institutions that their analysis of a borrower’s repayment capacity should also be based upon the initial 

loan amount plus any balance increase that may accrue from the 

negative amortization provision. 

Q.5. Should lenders be required to underwrite the borrower’s ability to repay the debt by final maturity at the fully indexed rate, 

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assuming a fully amortizing repayment schedule? If not, why and 

what circumstances would prevent them from doing so? 

A.5. Payments on nontraditional loans can increase significantly 

when the loans begin to amortize. Commonly referred to as payment shock, this increase is of particular concern for payment option ARMs where the borrower makes minimum payments that 

may result in negative amortization. An institution’s qualifying 

standards should recognize the potential impact of payment shock, 

especially for borrowers with high loan-to-value ratios, high debtto-income ratios, and low credit scores. To account for this, the nontraditional mortgage guidance advises that an institution’s analysis 

of a borrower’s repayment capacity should include an evaluation of 

the borrower’s ability to repay the debt by final maturity at the 

fully indexed rate, assuming a fully amortizing repayment schedule. Recognizing that an institution’s underwriting criteria are 

based on multiple factors that may vary by a product’s attributes 

and borrower characteristics, the guidance advises that an institution may develop a range of reasonable tolerances for each underwriting factor. 

Q.6. The GAO recommends improved consumer disclosure by requiring language with an effective format and visual presentation 

that explains key features and potential risks specific to nontraditional lending products. What else could be done to improve the 

clarity and comprehensiveness of nontraditional mortgage products 

to consumers? 

A.6. As part of its review of the effectiveness of closed-end credit 

disclosures under Regulation Z, including disclosures for nontraditional mortgages, the Board will be conducting extensive consumer 

testing to determine what information is most important to consumers, when that information is most useful, what language and 

formats work best, and how disclosures can be simplified, 

prioritized, and organized to reduce complexity and information 

overload. To that end, the Board will be using design consultants 

to assist in developing model disclosures that are most likely to be 

effective in communicating information to consumers. The Board 

also plans to use consumer testing to assist in developing model 

disclosure forms. Based on this review and testing, the Board will 

revise Regulation Z within the existing framework of TILA. If the 

Board determines that useful changes to the closed-end disclosures 

are best accomplished through legislation, the Board would develop 

suggested statutory changes for congressional consideration. 

Q.7. Most recently issued nontraditional lending products do not 

reset until 3 to 5 years after origination and have not yet reached 

their reset period. The payment shock for option ARMs can be substantial if interest rates stay flat and much worse if rates increase. 

When underwriting, what interest rate scenarios are banks using: 

flat, rising, declining, or all combinations? How are the various rate 

scenarios described to consumers during both the origination and 

repayment phases? 

A.7. Currently, our supervisory experience and research show that 

most institutions that originate option ARMs are underwriting 

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jection of future interest rates. However, and with respect to all 

types of ARMs, this practice can change based on lenders’ view of 

the future path of interest rates. In the past, during times of rapidly increasing interest rates, many lenders chose to underwrite 

ARMs at a rate above the then current fully indexed rate. Their decisions with respect to the appropriate underwriting rate are based 

on a number of factors including capital market preferences, the 

outlook for interest rate increases or decreases, and other lenders’ 

practices. Over time, underwriting practices have changed to conform to market conditions and it is reasonable to expect that this 

will continue. 

Q.8. What issues regarding nontraditional mortgage products have 

come up since your draft guidance was issued or do you believe 

have not been addressed by your guidance? What, if any, plans do 

you have to address these issues in the future? 

A.8. Following your hearing, the agencies issued final guidance on 

September 29, 2006. The agencies also supplemented the guidance 

by publishing for comment illustrations showing how institutions 

might provide consumers with information recommended in the 

guidance. The public comment period ended on December 4, 2006, 

and the agencies are reviewing the public comment letters. 

Since the guidance and illustrations were published, lenders and 

community groups have expressed concerns about whether the 

guidance applies to certain hybrid ARM products that are prevalent in the subprime market (i.e., ‘‘2/28’’ and ‘‘3/27’’ loans in which 

the rate is fixed for two or three years at a discount substantially 

below the current index and margin). The agencies are discussing 

whether those products warrant further guidance. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM SANDRA THOMPSON 

Q.1. Mortgage brokers are playing a larger role in the market 

today. Recent statistics show that independent brokers are responsible for about 50 percent of all originations and over 70 percent 

of subprime originations. Brokers definitely serve the overall market by helping consumers work with multiple lenders; however, 

they share little risk. Many brokers find it in their financial interest to get the borrower into a loan, regardless of whether the borrower can afford it. Are current laws and regulations strong 

enough to protect consumers and lenders? What can be done to better share the risk and ensure brokers are not just looking out for 

their own best interest? 

A.1. The FDIC also is concerned about protecting the interests of 

consumers and lenders. It is troubling that a broker may benefit 

from placing a borrower into a loan that he/she cannot afford, while 

both the borrower and the lender may suffer a loss. 

The Interagency Guidance on Nontraditional Mortgage Products 

(NTM Guidance) stresses, among other things, the need for federally regulated lenders to implement strong control systems over 

third parties involved in the lending process. Undertaking due diligence to ensure that mortgage brokers are properly licensed is a 

basic step in a control system. Also, oversight of third parties 

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should involve monitoring the quality of originations so that they 

reflect the institution’s own internal lending standards and are in 

compliance with applicable laws and regulations. To do this, institutions should track the quality of loans by mortgage broker, which 

will help management identify problems with a particular broker. 

If loan documentation, credit problems, or consumer complaints are 

discovered, the institution should take immediate action. Corrective 

action could include more thorough application reviews, more frequent re-underwriting, or even termination of the third party relationship. Finally, institutions are expected to design their third 

party compensation agreements in a way that will avoid providing 

incentives for originations that are inconsistent with the applicable 

guidance, laws, and the institution’s own lending standards. 

Mortgage brokers do not come under the purview of the federal 

banking agencies, but they are regulated by certain state organizations. The Conference of State Bank Supervisors (CSBS) and the 

American Association of Residential Mortgage Regulators (AARMR) 

have distributed guidance to state agencies that regulate residential mortgage brokers. The CSBS/AARMR guidance substantially 

mirrors the interagency NTM Guidance, except for the deletion of 

sections not applicable to non-depository institutions. 

This guidance will help state regulators promote consistent regulation in the mortgage market and clarify how non-depository institution providers, including mortgage brokers, can offer nontraditional mortgage products in a way that clearly discloses the risks 

that borrowers may assume. CSBS is working with the state regulatory agencies to adopt this guidance for the non-federally insured 

organizations they regulate. 

CSBS and AARMR also are developing a national licensing system for the residential mortgage industry that will enhance consumer protection and streamline the licensing process for regulators and the industry. Among other things, this system will provide public access to a central repository of licensing and publicly 

adjudicated enforcement actions. The system will increase the accountability of mortgage companies and mortgage professionals and 

assist the regulatory agencies in keeping bad actors out of the 

mortgage business. 

Q.2. How much risk do you see from borrowers who have used 

these mortgages to speculate in the housing market? If these investments cease to be worthwhile because of a housing slowdown, 

are we going to see large numbers of defaults on these loans? 

A.2. At this point, it is impossible to predict which of these loans 

may default since many factors affect loan performance. To date, 

these types of loans have not resulted in large numbers of defaults. 

However, many of the loans have low initial interest rates and 

reset dates in later years that may create payment stress for some 

borrowers in the future. There is a greater risk of default by investors than by individuals financing their residence. 

Q.3. Are borrowers who have taken non-traditional mortgages in 

recent years using these products to buy bigger and better homes 

than they otherwise could afford or are they using these products 

simply to be able to get into the market? In other words, are the 

mortgages being used to finance basic needs or luxury desires? 

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A.3. Both the rate of homeownership and levels of new home construction have reached all-time highs in recent years. It is reasonable to conclude that low mortgage interest rates and greater flexibility in mortgage terms and structures allowed more households 

to buy their first homes and allowed others to afford larger and 

higher-quality homes than would otherwise have been the case. 

However, trying to differentiate these purchases into ‘‘needs’’ 

versus ‘‘wants’’ is a more difficult question. 

Q.4. In our last hearing, Mr. Brown from the FDIC suggested that 

we are unlikely to see a nationwide crisis in the housing market, 

because the housing boom is concentrated in certain regions, and 

historically most housing failures have happened in areas suffering 

from localized recessions. As we all know, there is increased risk 

of massive defaults on these loans in the coming years. Due to a 

nationwide trend of nontraditional mortgages being used as affordability products, would you disagree with Mr. Brown that upcoming 

housing problems will be isolated in certain regions? 

A.4. As Mr. Brown testified, FDIC analysts have found that true 

metro-area housing price ‘‘busts’’ resulting in severe credit losses 

for mortgage lenders have been relatively rare historical events. Almost exclusively, these episodes occurred in areas that have experienced severe local economic distress, such as the ‘‘oil patch’’ in the 

late 1980s. There is some indication that this historical trend is 

continuing. While the prevalence of nontraditional mortgages has 

generally been higher in the coastal boom markets, the most significant credit distress to this point has been observed in the upper 

Midwest, where home prices have not boomed and where nontraditional mortgages remain less prevalent. These observations tend to 

support the notion that local economic conditions will continue to 

be the most important determinants of home prices and mortgage 

credit defaults. 

The most common aftermath of local housing booms has been an 

extended period of price stagnation. This period of stagnation may 

be associated with small price declines and is usually stressful for 

homeowners, home builders, and real estate professionals. But 

stagnation is not usually associated with severe losses for mortgage 

lenders. In such an environment, most homeowners have little incentive to sell their home at a loss or default on their mortgage and 

will typically wait out the down market. 

While a further increase in delinquency and foreclosure rates can 

reasonably be expected over the next few years, massive defaults 

appear unlikely. A national analysis of mortgage payment resets 

undertaken by First American Real Estate Solutions puts the volume of potential loss associated with interest rate resets into perspective, finding that the volume of ARM defaults is likely to remain relatively small compared to overall mortgage originations. 

Q.5. Again, I would like each of you to respond quickly: Will the 

proposed guidance in combination with an update in Regulation Z 

be enough to stop overly risky lending practices? Or is something 

stronger needed? 

A.5. The NTM Guidance clarifies the federal banking agencies’ expectations with respect to underwriting these mortgages, as well as 

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stand the potential risks. In addition to the NTM Guidance, the 

agencies proposed Illustrations of Consumer Information for Nontraditional Mortgage Product Risks for comment. The Illustrations 

are intended to assist institutions in implementing the consumer 

information portion of the NTM Guidance. Coupled with strong supervisory oversight, the Illustrations, the NTM Guidance, and an 

updated Regulation Z should preclude the need for additional legislation or regulation, 

Q.6. In your testimony, you talk about lenders reducing their risk 

by selling mortgages on the secondary market. First, who has been 

buying these non-traditional mortgages on the secondary market? 

And second, have insured institutions reduced their risk to a safeenough level? 

A.6. A strong appetite for U.S. mortgage instruments on the part 

of U.S. and global investors has been a key to the expansion of this 

market. These investors have been willing to purchase mortgage 

asset-backed security issues all along the risk spectrum, which has 

been critical to banks’ ability to securitize nontraditional mortgage 

debt. This securitization has done a great deal to diversify the risks 

of nontraditional mortgage loans to investors around the world, including investors who are better able to bear these risks than are 

FDIC-insured institutions. At the same time, there is a risk that 

at some point this strong appetite for U.S. nontraditional mortgage 

paper could wane, which may make these mortgages less available 

to consumers. 

Banks and thrifts are actively engaged in virtually every facet of 

mortgage lending, as originators, as servicers, and as holders of 

mortgage loans. In this latter capacity, lending institutions can face 

significant challenges in managing both credit risk and interest 

rate risk. They typically address these challenges by applying 

strong underwriting guidelines, seeking geographic diversification, 

and, in some cases, by using interest-rate swaps and other tools to 

manage interest rate risk. 

Securitization represents an important tool that mortgage lenders can use to manage credit and interest rate risks. Moving mortgage assets off the balance sheet into structured pools allows 

securitizers to create credit enhancements, achieve geographic diversification, and more finely manage the maturity structure of 

mortgage obligations. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED 

FROM SANDRA THOMPSON 

Q.1. The importance of actual verification of the borrower’s income, assets, and outstanding liabilities Increases as the level of 

credit risk increases. When is reduced document underwriting appropriate, if at all? What mitigating factors should be in place? 

A.1. The NTM guidance does not limit reduced documentation 

loans to any particular set of circumstances. The final guidance recognizes that mitigating factors, such as higher credit scores, lower 

loan-to-value and debt-to-income ratios, significant liquid assets, 

mortgage insurance, or other credit enhancements may determine 

whether such loans are appropriate. 

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Q.2. How will the federal agencies implement this guidance in a 

consistent manner and how will you coordinate with your state 

counterparts? 

A.2. As deposit insurer, the FDIC works with all of the agencies 

to ensure that risk to the deposit insurance fund is minimized. We 

regularly coordinate our examinations closely with state banking 

supervisors and we are able to participate in any examination 

where risk to the fluid may be elevated. This close coordination 

with the other agencies allows us to ensure that the NTM Guidance is implemented consistently. 

Further, the FDIC, the Federal Reserve, and the state banking 

authorities utilize common examination procedures and documentation tools, which will aid in the consistent application of this 

guidance. Additionally, the Conference of State Bank Supervisors 

(CSBS) and the American Association of Residential Mortgage Regulators (AARMR) have issued similar guidance for non-bank financial service providers under state jurisdiction to address the potential for inconsistent regulatory treatment of lenders based on 

whether or not they are federally regulated. CSBS is working with 

states to adopt the guidance for the non-federally insured organizations they regulate 

Q.3. The proposed guidance strongly encourages institutions to increase monitoring and loss mitigation efforts (i.e. establishing portfolio limits, measuring portfolio volume and performance, providing 

comprehensive management information reporting). How do you respond to lenders who argue that such increases would restrict lender flexibility and reduce consumer choice? Will these increased efforts potentially drive up banks’ underwriting costs, which will 

hurt consumers? 

A.3. The regulatory agencies believe that the NTM Guidance provides adequate flexibility in the methods and approaches to mitigating risk while simultaneously promoting prudent underwriting 

practices and informed consumer decision-making. The principles 

in the guidance are basic tenets of sound underwriting, which the 

agencies have long emphasized. 

The NTM Guidance is intended to encourage institutions to communicate clearly with consumers. These increased efforts should 

not drive up underwriting costs and may minimize consumer complaints and foster good customer relations. In the long run, accurate communication may translate into reduced overall costs. 

Q.4. The GAO found federally-regulated institutions today underwrite option ARMS at the My-indexed rate. This is good, but isn’t 

it better to also consider the potential balance increase associated 

with the negative amortization feature? How many of the institutions are considering this in their underwriting? 

A.4. The NTM Guidance specifies that federally regulated institutions should qualify borrowers at the maximum amount of principal that could accrue through negative amortization. The amount 

of potential negative amortization depends on the spread between 

the introductory rate and the index or accrual rate. A small spread 

could cause the potential negative amortization to be less than the 

limit established by the negative amortization cap. The borrower 

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should be qualified based on this lower maximum loan balance 

than the full amount specified per the negative amortization cap. 

The Call Report information that institutions provide on a quarterly basis does not distinguish between traditional and nontraditional adjustable rate mortgage (ARM) home loans. Therefore, it is 

not feasible to identify with absolute certainty how many banks are 

offering these products. Beginning in March 2007, the Call Report 

will be changed to include information on payment option ARMs, 

which will allow us to identify with certainty the institutions that 

are offering those products. 

Based on examination activities, the FDIC has very few institutions offering payment option ARMs. A recent review of institutions 

with total assets of $1 billion or more and located in areas experiencing rapid home price appreciation identified only two FDIC supervised institutions that offer payment option ARMS. Both of 

these banks have conservative underwriting standards, adequate 

compliance programs, and overall satisfactory ratings. 

Q.5. Should lenders be required to underwrite the borrowers’ ability to repay the debt by final maturity at the fully indexed rate, 

assuming a fully amortizing repayment schedule? If not, why and 

what circumstances would circumvent them from doing so? 

A.5. Prudent lending practices generally dictate that borrowers 

should be qualified for a loan on the fully-indexed interest rate and 

on a fully amortizing basis. However, it also is reasonable to qualify borrowers for products and terms that meet their specific financial needs. For example, institutions may want to qualify borrowers 

with unique cash flow circumstances or short-term residency needs 

(i.e., anticipate moving in two to three years), on an interest-only 

basis. 

Q.6. The GAO recommends improved consumer disclosure by requiring language with an effective formal and visual presentation 

that explains key features and potential risks specific to nontraditional lending products. What else could be done to improve the 

clarity and comprehensiveness of nontraditional mortgage products 

to consumers? 

A.6. Efforts in several areas could help improve the clarity of information that consumers receive about nontraditional mortgages. 

The Federal Reserve Board’s review and update of the Truth in 

Lending regulation (Regulation B) will be a critical component for 

ensuring that consumers receive clear information about key features of these and other mortgage products. The current regulation 

was designed at a time when products were much simpler. An updated regulation is needed to address the complexities of new mortgage products and to provide for changes in the future. 

In addition, state regulation of mortgage brokers is essential. 

Many consumers rely on brokers for advice and assistance in obtaining and understanding home loans. The FDIC and other banking regulators will work with our state regulatory counterparts to 

find ways to ensure that brokers provide fair and accurate information. In addition, as we indicated in the NTM Guidance, we will ensure that banks properly oversee third parties with which they do 

business -including molt e brokers—to ensure that those parties 

adhere to the same standards we expect of banks. 

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Q.7. Most recently issued nontraditional lending products do not 

reset until 3 to 5 years after origination and have not yet reached 

their reset period. The payment shock for option ARMs can be substantial If Interest rates stay fiat and much worse if rates increase. 

When underwriting, what interest rate scenarios are banks using: 

Hat, rising, declining, or all combinations? How are the various 

rate senarios described to consumers during both the origination 

and repayment phases? 

A.7. Loan originators use current market interest rates when underwriting borrowers and do not forecast what the index rate will 

equal at the time the loan recasts. The NTM guidance specifies 

that federally-insured institutions should qualify borrowers on a 

fully-indexed, fully amortizing basis. This prudent underwriting 

practice ensures a borrower has the capacity to repay the loan 

based on the current index rate rather than the introductory rate 

rather than the introductory rate or a projected index rate. 

• Pursuant to the Truth in Lending Act, lenders must provide 

ARM pro disclosures when borrowers receive an application 

form or before they pay on-refundable application fee and then 

again during the repayment period. 

• An institution’s ARM program disclosures must provide an historical example (based on a $10,000 loan amount) illustrating 

how the payments and loan balance would have been affected 

by interest rate changes under the terms of the particular loan 

program. The illustration must be based on the program’s 

index values over the previous 15 years. 

• During the repayment period, disclosures must be provided 

when the interest rate adjusts, whether or not there is a payment change. Disclosures must be provided annually if there 

is not a payment adjustment. If there is a payment adjustment, disclosures must be provided at least 25 but no more 

than 120 days before a different payment amount is due. 

• These disclosures provide the current and prior interest rates, 

the index values on which he interest rates are based, the extent to which the lender may have foregone rate increases, and 

the contractual effects of the interest rate adjustment (including the new payment due and the loan balance). 

• If the payment due after the interest rate adjustment will not 

fully amortize the loan over the remainder of the loan team at 

the new interest rate, then there must be a statement of went 

would fully amortize the loan. 

Q.8. What issues regarding nontraditional mortgage products have 

come up since your draft guidance was issued or do you believe 

have not been addressed by your guidance? What, if any, plans do 

you have to address these issues in the future? 

A.8. At the September 20 hearing, the Center for Responsible 

Lending testified that certain loan products, particularly hybrid 

ARMs like so-called 2/28s, may carry the same potential for payment shock as nontraditional mortgages. While some of these loans 

do not seem to be included in our definition of nontraditional mortgages because there is some principal amortization, we nevertheless expect to direct our examiners to be alert for such products. 

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The agencies also are considering whether to issue additional guidance or other communications to address subprime products with 

the potential for significant payment shock such as 2/28s. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM SCOTT ALBINSON 

Q.1. Mortgage brokers are playing a larger role in the market 

today. Recent statistics show that independent brokers are responsible for about 50 percent of all originations and over 70 percent 

of subprime originations. Brokers definitely serve the overall market by helping consumers work with multiple lenders; however, 

they share little risk. Many brokers find it in their financial interest to get the borrower into a loan, regardless of whether the borrower can afford it. Are current laws and regulations strong 

enough to protect consumers and lenders? What can be done to better share risk and ensure brokers are not just looking out for their 

own best interests? 

A.1. Brokers are often the primary contact borrowers have when 

seeking a mortgage loan. Many federally regulated financial institutions rely on them to supplement their own loan production, and 

for some institutions, brokers are the primary production source. 

OTS requires savings associations to establish prudent written 

lending standards and to underwrite all loans in accordance with 

those standards. This is the requirement regardless of the origination source of a loan. 

For loans originated by mortgage brokers, institutions are also 

expected to monitor broker performance and consumer complaint 

activity associated with individual brokers on an ongoing basis. 

Federally-regulated financial institutions are expected to evaluate 

all loans supplied to them by brokers. For loans purchased from a 

broker, we expect institutions to ensure that the broker has abided 

by all applicable laws, regulations, and policy guidelines, including 

prudent underwriting standards as well as consumer protection 

and disclosure information (Regulation Z, RESPA, Fair Lending, 

and other disclosure requirements that all mortgage lenders must 

abide by). 

While we expect thrifts to monitor the lending activity of brokers 

with respect to the loans they purchase from a broker, institutions 

cannot monitor or control loans a broker originates for nonregulated lenders and brokers. State regulatory authorities typically supervise these activities. Better coordination between Federal and 

state regulators may be helpful in ensuring greater consistency in 

regulatory oversight and control of predatory mortgage brokers and 

serve to reign in self-serving brokers. To this end, OTS maintains 

working relationships with state regulatory authorities and frequently consults with the Conference of State Bank Supervisors in 

this and similar areas of regulatory and supervisory overlap. 

Q.2. How much risk do you see from borrowers who have used 

these mortgages to speculate in the housing market? If these investments cease to be worthwhile because of a housing slowdown, 

are we going to see large numbers of defaults on these loans? 

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A.2. Investors have played a role in the housing market for many 

years. In recent years, however, there has been an increase in less 

sophisticated investors purchasing properties with the intention of 

flipping them as prices increase. In some markets, this influx of 

‘‘new’’ investors has reportedly fueled part of the rise in home 

prices over the past few years. Although investor-owned mortgages 

have remained steady since 1991 at approximately 4 percent of 

total mortgages, that level has gradually increased from 3.93 percent in June 2002 to 4.76 percent in June 2006. 

Loan performance data show that investor-owned mortgages 

have performed on par with owner-occupied mortgages. For example, before the 2000–2006 real estate boom, owner-occupied properties performed somewhat better than investor properties. Since 

the boom, investor mortgages have outperformed owner-occupied 

mortgages. In June 2006, the ratio of seriously delinquent investorowned mortgages was 0.41 percent, and seriously delinquent 

owner-occupied mortgages was 0.46 percent of total mortgages, respectively. While the levels have varied since 1991, the variance 

has remained very low. 

The highest levels of investor-owned mortgages are in several 

Western states. The largest increases were in Nevada, Hawaii and 

Idaho. California investor-owned mortgages grew from 5.7 percent 

to 6.4 percent since 2000. Nevada, however, went from 4.7 percent 

to 8 percent in the same period. The Midwest region of the U.S. 

had the lowest overall levels of investor-owned mortgages. 

The states with the highest levels of investor-owned properties 

all experienced the lowest delinquencies. Nevada’s investor-owned 

mortgage delinquency was at 0.13 percent, Idaho’s was at 0.14 percent, Hawaii’s was at 0.05 percent, and California’s was at 0.07 

percent. 

While this data may seem counterintuitive, most federally regulated financial institutions, including thrifts, maintain more stringent underwriting requirements for loans secured by investorowned properties than they require for owner occupant properties. 

These may include requirements for higher down payments, higher 

minimum credit scores, higher interest rates, and higher borrower 

income and liquidity. 

Thus, on an industry wide perspective, we see minimal overall 

risk from investor-owed mortgages. Nevertheless, there are some 

regional variances and we are monitoring this activity carefully. 

Q.3. Are borrowers who have taken non-traditional mortgages in 

recent years using these products to buy bigger and better homes 

than they otherwise could afford or are they using these products 

simply to be able to get into the market? In other words, are the 

mortgages being used to finance basic needs or luxury desires? 

A.3. We do not have specific data that addresses borrower motivation. Loan documents typically only indicate the loan purpose 

(‘‘purchase’’ or ‘‘refinance’’). Borrowers have used non-traditional 

mortgages for different reasons: 

• To provide payment flexibility when borrower income is not 

evenly distributed throughout the year; 

• To purchase a more expensive home they would not have otherwise been able to afford; 

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• To purchase their first home in an expensive housing market; 

and 

• To refinance an existing mortgage and possibly roll into the 

new first mortgage a second mortgage or other household debt. 

The advantage to borrowers of most nontraditional mortgage 

loan products is the low initial monthly payments that can help 

with the borrower’s cash flow and give the impression that the loan 

is more affordable. A large portion of option ARM loans are secured 

by expensive homes. Since 2000, 76.8 percent of option ARMs, 66.3 

percent of ARMs, and 28.7 percent of fixed-rate mortgages were 

greater than $400,000, which is above the national median home 

price. 

Q.4. In our last hearing, Mr. Brown from the FDIC suggested that 

we are unlikely to see a nationwide crisis in the housing market, 

because the housing boom is concentrated in certain regions, and 

historically most housing failures have happened in areas suffering 

from localized recessions. As we all know, there is increased risk 

of massive defaults on these loans in the coming years. Due to a 

nationwide trend of nontraditional mortgages being used as affordability products, would you disagree with Mr. Brown that upcoming 

housing problems will be isolated in certain regions? 

A.4. To date, the economic data available to us support Mr. 

Brown’s statement that it is unlikely that we have a nationwide 

crisis in the housing market. Historically, systemic market crashes 

have been preceded by high interest rates, high unemployment, 

and decreasing home prices. High unemployment reduces consumer 

demand; high interest rates make homes less affordable; and both 

contribute to the lower demand for new and existing homes. While 

such a confluence of events is possible, there are no current indicators that it is likely to occur on a nationwide basis. 

Instead, it appears more likely that any upcoming housing market weakness will be limited to regions of the country where local 

housing prices have advanced beyond personal incomes and/or have 

overheated beyond where current buyers are willing to enter the 

market. Our loan performance data validates this. Except for the 

subprime mortgage market, mortgage loan performance has remained very strong throughout 2005 and 2006. For example, during the first half of 2006, delinquencies in prime mortgages were 

0.47 percent, the lowest point in our 1991–2006 database. However, 

subprime mortgage delinquencies were 5.2 percent in September 

2006, up from 3.6 percent a year ago. 

Q.5. Again, I would like each of you to answer this question quickly: Will the proposed guidance in combination with an update of 

Regulation Z be enough to stop overly risky lending practices? Or 

is something stronger needed? 

A.5. The Agencies issued the nontraditional mortgage guidance on 

October 4, 2006. It applies to all federally regulated financial institutions as well as their subsidiaries and affiliates. We believe the 

guidance, together with improved consumer disclosure and close 

supervision, will stem overly risky lending practices at federallyregulated financial institutions. The Conference of State Bank Supervisors (CSBS), whose members regulate state-licensed mortgage 

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companies, issued similar guidance, along with the American Association of Residential Mortgage Regulators (AARMR), to its members on November 13, 2006. Thus, guidance on nontraditional 

mortgage lending products has been issued and is applicable to 

both state- and federally-regulated mortgage originators. The effectiveness of the guidance, of course, will depend on the application 

of the guidance by all regulators. It is our hope that similar guidance issued by both federal and state regulatory authorities will be 

effective in curtailing overly risky lending by all mortgage lenders. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED 

FROM SCOTT ALBINSON 

Q.1. The importance of actual verification of the borrower’s income, assets, and outstanding liabilities increases as the level of 

credit risk increases. When is reduced documentation underwriting 

appropriate, if at all? What mitigating factors should be in place? 

A.1. We do not feel that reduced documentation loans are appropriate for many borrowers, especially salaried individuals and 

those with easily documented incomes. Reduced documentation was 

originally used for self-employed borrowers and those with irregular incomes who find it difficult to provide three years of tax returns, financial statements, and other documents typically needed 

for fully documented loans. Lenders found that it was less time 

consuming and less expensive to underwrite loans with less documentation, relying primarily on a borrower’s stated income, credit 

history and credit score, in addition to other risk factors, such as 

the loan-to-value ratio, loan purpose, and debt-to-income ratios. 

Some institutions also require minimal documents such as the borrower’s most recent payroll statement. 

We are concerned that some borrowers may be pushed into reduced documentation loans because it is easier (and more lucrative) 

for brokers. And if reduced documentation loans will cost more 

than full documentation loans, borrowers should be informed of the 

difference and given the option to select which is best option for 

them. 

Q.2. How will the federal agencies implement this guidance in a 

consistent manner and how will you coordinate with your state 

counterparts? 

A.2. The guidance will be applied consistently among all the Federal financial institution supervisory agencies. In addition, CSBS 

and the AARMR have adopted similar guidance for the lenders 

their members supervise. 

Q.3. The proposed guidance strongly encourages institutions to increase monitoring and loss mitigation efforts (i.e. establishing portfolio limits, measuring portfolio volume and performance, providing 

comprehensive management information reporting). How do you respond to lenders who argue that such increases would restrict lender flexibility and reduce consumer choice? Will these increased efforts potentially drive up banks’ underwriting costs, which will 

hurt consumers? 

A.3. These measures are typically required for most lenders based 

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ing on how the loans are underwritten and structured, nontraditional loans could add an extra element of risk. Such risk management measures are necessary to allow institutions to identify, 

measure, monitor and control these additional risks. 

Q.4. The GAO found federally regulated institutions today already 

underwrite option ARMS at the fully indexed rate. That is good, 

but isn’t it better to also consider the potential balance increase associated with the negative amortization feature? How many of the 

institutions are considering this in their underwriting? 

A.4. The Nontraditional Mortgage Guidance issued in October 4, 

2006 requires all institutions to underwrite option ARM loans 

based on the potential balance increase that could occur if the borrower chose only to make minimum payments during the option period. As such, all institutions should now be taking steps to implement this standard into their underwriting policies. 

Q.5. Should lenders be required to underwrite the borrowers’ ability to repay the debt by final maturity at the fully indexed rate, 

assuming a fully amortizing repayment schedule? If not, why and 

what circumstances would circumvent them from doing so? 

A.5. Yes. This requirement is a longstanding OTS policy. 

Q.6. The GAO recommends improved consumer disclosure by requiring language with an effective format and visual presentation 

that explains key features and potential risks specific to nontraditional lending products. What else could be done to improve the 

clarity and comprehensiveness of nontraditional mortgage products 

to consumers? 

A.6. The OTS and the other federal banking agencies continue 

work on important consumer protection standards for lenders, advising institutions to provide information to consumers that: (1) 

aligns with actual product terms and payment structures; (2) covers risks areas (such as payment shock and negative amortization) 

and potential benefits (such as lower initial monthly payments) in 

a clear and balanced way; and (3) provides clear, balanced, and 

timely information to consumers at crucial decision making points. 

Beyond the interagency guidance, the agencies are working on 

providing additional direction on ways financial institutions can 

provide useful information about the benefits and risks of alternative mortgages. Regulation X requires all lenders to provide the 

Consumer Handbook on Adjustable Rate Mortgages (CHARM brochure), which is published by the Federal Reserve Board and OTS. 

The OTS is collaborating with the Federal Reserve Board to update 

the CHARM brochures, which should be issued shortly. The updated brochure will continue to inform consumers about ARMs, including issues such as negative amortization and payment shock, 

and it will provide additional information on specific types of alternative mortgages, such as payment option and interest-only ARMs 

designed to help consumers make informed choices. 

OTS is also working closely with all the federal bank regulatory 

agencies to develop a consumer publication focused on interest-only 

and option ARMs mortgages. This publication advises consumers 

on how these products work, the potential for large payment increases, and the impact of negative amortization. Additionally, we 

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expect that the publication will provide consumers with a series of 

questions they can ask their lender to ensure that they clearly understand the terms of a mortgage loan product before agreeing to 

the mortgage. 

Together, these initiatives should improve consumer understanding of the risks and benefits nontraditional mortgage products. 

Q.7. Most recently issued nontraditional lending products do not 

reset until 3 to 5 years after origination and have not yet reached 

their reset period. The payment shock for option ARMS can be substantial if interest rates stay flat and much worse if rates increase. 

When underwriting, what interest rate scenarios are banks using: 

flat, rising, declining, or all combinations? How are the various rate 

scenarios described to consumers during both the origination and 

repayment phases? 

A.7. Institutions should underwrite adjustable-rate mortgages 

based on current interest rates. Regulation Z requires lenders to 

disclose interest rates and loan fees to borrowers based on current 

interest rate assumptions; however, disclosures inform borrowers of 

the adjustable rate nature of the loan, the index that adjustments 

will be based on, the margin above the index, and the historical 

performance of the index. Borrowers are also informed of any per 

year or maximum interest rate caps that apply. 

Q.8. What issues regarding nontraditional mortgage products have 

come up since your draft guidance was issued or do you believe 

have not been addressed by your guidance? What, if any, plans do 

you have to address these issues in the future? 

A.8. The guidance does not specifically address certain loans, such 

as 2-28 ARMs, which have a low interest rate for the first two 

years, then an adjustable market rate for the remaining 28 years 

of the 30-year term. We are currently discussing this issue with the 

other federal banking agencies and are considering a range of supervisory responses appropriate to address this concern. 

RESPONSE TO WRITTEN QUESTIONS OF SENATORS ALLARD 

AND BUNNING FROM FELECIA ROTELLINI 

Q.1. Mortgage brokers are playing a larger role in the market 

today. Recent statistics show that independent brokers are responsible for about 50 percent of all originations and over 70 percent 

of subprime originations. Brokers definitely serve the overall market by helping consumers work with multiple lenders; however, 

they share little risk. Many brokers find it in their financial interest to get the borrower into a loan, regardless of whether the borrower can afford it. Are current laws and regulations strong 

enough to protect consumers and lenders? What can be done to better share risk and ensure brokers are not just looking out for their 

own interests? 

A.1. Regulation of the mortgage industry is rapidly evolving and 

improving. In addition to regulating banks, 49 states and D.C. currently provide regulatory oversight of the mortgage industry (Alaska has introduced legislation to license mortgage providers, and it 

is expected to pass in 2007). The Conference of State Bank Supersmartinez on DSKD5P82C1PROD with HEARING

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visors (CSBS) has been working in close coordination with the 

American Association of Residential Mortgage Regulators (AARMR) 

to improve state supervision. State supervision of the residential 

mortgage industry is evolving to keep pace with the rapid changes 

occurring in the market place. At present, state regulation is limited in its consistency. CSBS, however, is spearheading the effort 

to improve supervision to ensure that both consumers and lenders 

are protected. 

The federal financial agencies released guidance on September 

29, 2006 that will help ensure that consumers better understand 

some of the nontraditional mortgage products that are in the marketplace today and help to curb some of the more abusive practices. 

CSBS and AARMR partnered together to issue parallel guidance on 

November 14, 2006. As of February 21, 26 states and D.C. have 

adopted the guidance. All 50 states are expected to adopt the guidance in some form. 

Additionally, CSBS and AARMR have been working together 

over the past two years to develop a national Residential Mortgage 

Licensing System that will create uniformity in mortgage licensing 

across states and improve state regulators’ ability to identify and 

track mortgage brokers, lenders, and individuals across states. In 

this effort, states are working together to be an effective gatekeeper on behalf of the mortgage brokerage industry and to counter 

the effects of currently inadequate private market controls. This effort will raise the professionalism in the mortgage brokerage industry and keep out those who wish to slip easily into the industry to 

harm consumers in the pursuit of short-term financial gain. 

Effective supervision, however, requires a coordinated effort 

among the federal financial agencies and the states. It is vital that 

the states are involved with coordinating policy, regulation and 

guidance. Therefore, the Regulatory Relief Bill which was recently 

signed into law is incredibly important, since it gave the states a 

vote on the FFIEC. 

Further, we believe a dialogue on suitability is worth having. For 

example, what does suitability mean in the mortgage industry? 

Currently, we do not have a policy position on this issue, but we 

believe further discussion among the industry and our fellow regulators would be beneficial. 

Q.2. How much risk do you see from borrowers who have used 

these mortgages to speculate in the housing market? If these investments cease to be worthwhile because of a housing slowdown, 

are we going to see large numbers of defaults on these loans? 

A.2. The borrowers who have used nontraditional mortgage products as speculative tools have made an investment decision, which 

is different than a consumer making a housing decision. If there is 

a housing slowdown, I believe the market will adjust to ultimately 

correct this problem. 

Q.3. Are borrowers who have taken nontraditional mortgages in 

recent years using these products to buy bigger and better homes 

than they otherwise could afford or are they using these products 

simply to be able to get into the market? In other words, are the 

mortgages being used to finance basic needs or luxury desires? 

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A.3. I think the products are being used for both purposes. In certain markets like D.C. where home prices are high, these products 

can legitimately be used to purchase a home. Certainly, some savvy 

and more knowledgeable consumers have used the nontraditional 

mortgage products to their advantage and have purchased larger 

homes. These consumers are aware of the inherent risks of nontraditional mortgage products, and have planned accordingly. A 

good portion of borrowers, however, have utilized nontraditional 

mortgage products to purchase their first homes, or homes that 

may be more expensive than they could afford with more traditional products. 

Q.4. In our last hearing, Mr. Brown from the FDIC suggested that 

we are unlikely to see a nationwide crisis in the housing market, 

because the housing boom is concentrated in certain regions, and 

historically most housing failures have happened in areas suffering 

from localized recessions. As we all know, there is increased risk 

of massive defaults on these loans in the coming years. Due to a 

nationwide trend of nontraditional mortgages being used as affordability products, would you disagree with Mr. Brown that upcoming 

housing problems will be isolated in certain regions? 

A.4. My fellow state supervisors and I are very concerned about 

the health and strength of the local economies of the communities 

we serve. A nationwide crisis in the housing market is a concern, 

of course, but my first priority is to the state of Arizona. I do not 

necessarily disagree with Mr. Brown regarding the possibility of a 

nationwide crisis, but my fellow supervisors and I are primarily 

concerned with localized recessions. It is the goal of CSBS to preserve the economic vigor of the local communities we serve. I believe we share that goal with every member of the Senate Committee on Banking, Housing, and Urban Affairs. 

Q.5. Again, I would like each of you to answer this question quickly: Will the proposed guidance in combination with an update of 

Regulation Z be enough to stop overly risky lending practices? Or 

is something stronger needed? 

A.5. The states recognize that something stronger than the guidance and an update of Reg. Z is needed. The interagency guidance 

and the parallel guidance developed by CSBS and AARMR and an 

update of Reg. Z are definitely steps in the right direction toward 

stopping risky lending practices, but more effective regulation of 

the mortgage industry is required. Industry licensing, effective supervision, examiner education, and improved disclosures are necessary to improve regulation. 

State supervision of the residential mortgage industry is evolving 

to keep pace with the rapid changes occurring in the market place. 

At present, state regulation is limited in its consistency. CSBS, 

however, is spearheading the effort to improve supervision to ensure that both consumers and lenders are protected. 

The parallel guidance released by CSBS and AARMR is one example of how the two organizations are working to improve supervision of the mortgage industry. As of January 25, 24 states and 

D.C. have adopted the guidance. All 50 states are expected to adopt 

the guidance in some form. 

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CSBS believes that the guidance, along with an update to Regulation Z, will be a major step towards protecting consumers. But 

these steps alone will only protect consumers if mortgage companies and loan officers abide by them. They will do nothing to stop 

those few bad actors who would knowingly ignore the guidance or 

Reg. Z or would intentionally manipulate consumers for financial 

gain. These bad actors require a mechanism that limits their entry 

to the industry, tracks them while they’re in the industry, and 

when identified as a bad actor, kicks them out of the industry and 

informs the public of this action. 

For this reason, the CSBS/AARMR Residential Mortgage Licensing System is crucial if consumers and communities are going to 

be afforded the protections they deserve when financing a home. 

The System will create a more level playing field in applying for 

a license, will track state-licensed lenders over time and across 

states, and will allow consumers to check the license status of any 

company or individual in the system and research any actions 

taken against them. 

This kind of information is completely lacking in today’s mortgage market. CSBS and AARMR are proud to be developing this 

project and providing state regulators and consumers with better 

information about the companies and individuals that finance one 

of the most important financial decisions families make. Such an 

effort ensures that those who decide to ignore the guidance or Reg. 

Z will have pay consequences that will stick with them for the rest 

of their corporate or professional life. 

CSBS also offers a Residential Mortgage Examiner School designed for inexperienced state personnel who are responsible for licensing, examining, and investigating state mortgage company licensees and three additional education programs to state regulatory personnel, including Basic Examiner Training School: Fundamentals of Mortgage Banking; Advanced Examiner Training 

School: Federal Regulation Update; and Fraud School. In addition, 

CSBS is developing a certification program for state personnel who 

perform examinations of state mortgage company licensees. 

Effective supervision, however, requires a coordinated effort 

among the federal financial agencies and the states. It is vital that 

the states are involved with coordinating policy, regulation and 

guidance. Therefore, the Regulatory Relief Bill which was recently 

signed into law is incredibly important, since it gave the states a 

vote on the FFIEC. 

Q.6. The importance of actual verification of the borrower’s income, assets, and outstanding liabilities increases as the level of 

credit risk increases. When is reduced documentation underwriting 

appropriate, if at all? What mitigating factors should be in place? 

A.6. Historically, reduced verification was used for a certain type 

of specialized borrower. It should not be used as a method to evade 

underwriting standards for borrowers who may not otherwise qualify to own a home. Reduced documentation should be accepted only 

if there are mitigating factors, such as high credit scores, lower 

LTV and DTI ratios, significant liquid assets, mortgage insurance 

or other credit enhancements. Also, borrowers should be aware that 

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they are very likely paying a higher rate for stated income loans 

and should consider if this higher rate is worth the cost. 

Q.7. How do you envision the federal agencies will implement their 

guidance in a consistent manner with their state counterparts? 

A.7. The CSBS-AARMR parallel guidance was developed to promote consistent supervision of the residential mortgage industry. 

Since the majority of mortgages are originated by state-regulated 

entities, it is of vital importance that the lenders originating mortgages are all held to the same supervisory standards. Effective supervision of the mortgage industry requires a coordinated effort 

among the federal agencies and the states. Therefore, we see recent 

legislation that made the states a voting member of the FFIEC as 

absolutely necessary to promote consistent, reasonable and effective supervision of all financial service providers. 

Q.8. The proposed guidance strongly encourages institutions to increase monitoring and loss mitigation efforts (i.e., establishing portfolio limits, measuring portfolio volume and performance, providing 

comprehensive management information reporting). How do you respond to lenders who argue that such increases would restrict lender flexibility and reduce consumer choice? Will these increased efforts potentially drive up banks’ underwriting costs, which will 

hurt consumers? 

A.8. The interagency guidance asserts sound lending principles 

that should be followed, not only to provide consumer protection, 

but for the institution’s benefit, as well. The guidance does not negatively impact consumer choice but will help to educate the consumer so they can make more informed choices and understand the 

risks associated with nontraditional mortgage products. It also encourages lenders to utilize sound lending practices. 

Q.9. The GAO found federally-regulated institutions today already 

underwrite option ARMS at the fully-indexed rate. That is good, 

but isn’t it better to also consider the potential balance increase associated with the negative amortization feature? How many of the 

institutions are considering this in their underwriting? 

A.9. I believe the guidance makes it clear the potential balance increases associated with negatively amortizing loans should be considered by lenders when underwriting a loan. Consumers must be 

fully aware of the characteristics of the product they are purchasing. The intent of the guidance is not to restrict consumer 

choice, but to ensure that lenders are providing information to consumers in a clear, concise manner and are utilizing sound underwriting principles. 

Q.10. Should lenders be required to underwrite the borrowers’ 

ability to repay the debt by final maturity at the fully indexed rate, 

assuming a fully amortizing repayment schedule? If not, why and 

what circumstances would circumvent them from doing so? 

A.10. The guidance asserts that a lender should underwrite the 

borrower’s ability to repay the debt by final maturity at the fully 

indexed rate. Ultimately, however, the consumer must have the 

ability to choose their product. In order to do so, it is vital that the 

lender provides the consumer with information they can utilize to 

make a decision that is beneficial for their unique situation. 

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Q.11. The GAO recommends improved consumer disclosure by requiring language with an effective format and visual presentation 

that explains key features and potential risks specific to nontraditional lending products. What else could be done to improve the 

clarity and comprehensiveness of nontraditional mortgage products 

to consumers? 

A.11. At the same time the federal agencies released the final 

guidance, they published proposed illustrations of consumer information for nontraditional products. CSBS, AARMR and NACCA 

support the proposed illustrations and believe they are a good first 

step towards improved disclosures across the financial industry. If 

the illustrations are finalized, CSBS, AARMR and NACCA believe 

they will also be suitable for use by state-supervised mortgage providers, and will encourage states to adopt the illustrations for use 

by their licensed entities. This is consistent with our determination 

to provide uniform supervision of mortgage lenders industry wide. 

Ultimately, however, the states hope to work with the federal agencies to develop a new system of disclosures that provides clear, easy 

to understand information to consumers. 

Q.12. Most recently issued nontraditional lending products do not 

reset until 3 to 5 years after origination and have not yet reached 

their reset period. The payment shock for option ARMS can be substantial if interest rates stay flat and much worse if rates increase. 

When underwriting, what interest rate scenarios are banks using: 

flat, rising, declining, or all combinations? How are the various rate 

scenarios described to consumers during both the origination and 

repayment phases? 

A.12. Consumers must be fully informed of the characteristics of 

their mortgage. Therefore, disclosures must be beneficial and 

should provide information regarding the possibility of payment 

shock, which would be magnified by an increase in the interest 

rate. 

Q.13. What issues regarding nontraditional mortgage products 

have come up since your draft guidance was issued or do you believe have not been addressed by your guidance? What, if any, 

plans do you have to address these issues in the future? 

A.13. 2/28s and similar types of loans were not specifically named 

in the guidance, and have recently received a great amount of attention. The mortgage industry is constantly changing and releasing new products. Trying to provide guidance for specific producttypes would be inadequate and quickly outdated. Therefore, we believe that the guidance discusses principles which may be applied 

to all consumer credit products, especially those products that may 

incur payment shock. It is our intent to work together with the federal agencies to issue a declaration of principles that would encourage institutions and mortgage providers to carefully underwrite 

and provide clear information to consumers on any loan that has 

certain characteristics. 

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RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM WILLIAM SIMPSON 

Q.1. In your written statement, you emphasize consumer education. Certainly that is an area for improvement. Before we seek 

the results of improved consumer education efforts, there will be a 

period when brokers will still be dealing with what many people 

have classified as an overwhelmed, confused borrower. Brokers 

share little of the risk that the borrowers or lenders assume. In 

fact, many have a financial interest in getting the borrower into a 

loan regardless of whether the borrower can afford it. Are current 

laws and regulations strong enough to protect consumers and lenders? What can be done to better share the risk and make sure brokers are not just looking out for their own best interests? 

A.1. The non-traditional mortgage guidance recently finalized by 

the banking agencies is an important step in addressing these concerns. However, as I noted during the hearing, it is important that 

state regulated institutions have similar standards applied to 

them. In this regard the state bank and mortgage lender supervisors announced this morning that they will take these needed 

steps. These efforts, if forcefully implemented by the respective regulators, should go a long way to protecting consumers. 

Q.2. Can you tell if borrowers who have taken non-traditional 

mortgages in recent years are using the mortgages more often to 

buy bigger and better homes that they otherwise could or are they 

simply using these products to be able to get into any housing? 

A.2. I have not seen any information breaking out these numbers. 

However, to an extent, these risky mortgages act to artificially 

stimulate the demand for housing, raising the price of housing for 

all home buyers regardless of whether or not they use a non-traditional mortgage. We know that in areas where house prices have 

been rising at very rapid rates at least some of the rapid price increases have been stimulated by greater demand from borrowers 

using these mortgages to qualify for larger loan amounts than they 

otherwise could afford. The problem arises when prices stop rising 

and the borrower is faced with higher mortgage costs resulting 

from the inherent risky nature of the non-traditional mortgage 

product. 

Q.3. How much risk do you see from borrowers who have used 

these mortgages to speculate in the housing market? Should these 

investments cease to be worthwhile because of a housing slowdown, 

are we going to see large numbers of defaults on these loans? 

A.3. Inevitably non-traditional mortgages pose risks to some borrowers when house prices stagnate or drop. When a borrower can 

no longer meet their mortgage payment because of readjustments 

built into the mortgage product itself—combined, perhaps, with 

personal hardship or loss of a job—then the market value of the 

house becomes a critical factor in determining whether a house sale 

or a mortgage default occurs. When the cost of keeping a mortgage 

becomes prohibitive to the borrower and the amount of the mortgage exceeds the market value of the house then mortgage defaults 

occur. To the extent that some high-risk non-traditional mortgages 

incorporate significantly higher interest rates or deferred payments 

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for which a borrower may not be prepared means that these borrowers will be at risk of losing their homes and any home equity 

they may have accumulated over time. 

RESPONSE TO WRITTEN QUESTION OF SENATOR REED 

FROM WILLIAM SIMPSON 

Q.1. In your comments to the proposed guidance, you indicated 

that additional enforcement mechanisms could be added to 

strengthen the guidance. What mechanisms would you recommend? 

A.1. First, as I noted in my testimony, I believe it important that 

state regulators quickly apply similar standards on state-regulated 

entities offering non-traditional mortgages to borrowers. The state 

bank and mortgage lender supervisors today released a similar 

guidance on non-traditional mortgages for the state institutions 

they regulate. Second, it is important that the bank and state regulators issue instructions to their examiners setting forth how the 

guidance should be enforced at the examiner level. Ambiguity exists in all government regulations and effective enforcement of the 

non-traditional mortgage guidance requires that bank and state examiners be given the necessary direction. Finally, I would hope 

that the banking agencies and state regulators effectively enforce 

the new guidance by bringing enforcement actions when a financial 

institution fails to comply with the details of the guidance as requested by its examiners. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM MICHAEL CALHOUN 

Q.1. In your written statement, you emphasize consumer education. Certainly that is an area for improvement. Before we see 

the results of improved consumer education efforts, there will be a 

period when brokers will still be dealing with what many people 

have classified as an overwhelmed, confused borrower. Brokers 

share little of the risk that the borrowers or lenders assume. In 

fact, many have a financial interest in getting the borrower into a 

loan regardless of whether the borrower can afford it. Are current 

laws and regulations strong enough to protect consumers and lenders? What can be done to better share the risk and make sure brokers are not just looking out for their own best interests? 

A.1. The Home Ownership and Equity Protection Act of 1994 

(HOEPA) was initially intended to address financial incentives that 

encourage lenders to put borrowers in home loans that they cannot 

afford and that strip equity from the home. In the twelve years 

since HOEPA was enacted, it has become clear that the law’s application needs to be broadened and its provisions strengthened. Fortunately, HOEPA permits states to build upon minimum federal 

protections to tailor laws that suit the needs of their citizens. Those 

state laws have protected consumers while permitting the explosion 

in subprime lending that has occurred in recent years. HOEPA 

should be amended to adopt the measures that states have employed successfully. One of the most vital provisions, critical provisions, is a prohibition on loan flipping, or refinances that lack a 

reasonable, tangible net benefit to the borrower. Another critical 

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1Gov’t Accountability Office, Alternative Mortgage Products: Impact on Defaults Remain Unclear, but Disclosure of Risks to Borrowers Could Be Improved, GAO–06–1210, 11 (Sept. 2006) 

(citing David Liu, Credit Implications of Affordability Mortgages (UBS Mar. 3, 2006)). 2 Inside Mortgage Finance Mortgage-Backed Securities Database (Oct. 27, 2006). 

element is a comprehensive definition of points and fees that includes the maximum prepayment penalty that the holder may 

charge a borrower and the yield spread premium—the amount the 

lender pays a broker in connection with an increase in the interest 

rate the borrower receives. In addition, new practices in the mortgage market require additional consumer protections in three key 

areas: (1) making it clear that mortgage professionals, including 

brokers, have a duty of good faith and fair dealing towards their 

customers; (2) requiring that loan originators ensure that a borrower is reasonably likely to be able to repay a loan as structured, 

without having to sell the home or refinance the loan; and (3) prohibiting brokers and lenders from steering borrowers into loans 

that are less advantageous than those for which the borrower 

qualifies. 

Q.2. Can you tell if borrowers who have taken non-traditional 

mortgages in recent years are using the mortgages more often to 

buy bigger and better homes than they otherwise could or are they 

simply using [these] products to be able to get into any housing? 

A.2. Housing affordability certainly is a concern nationwide. It is 

important to note, however, that much of the home loan market is 

a refinance market. In 2005, as many as 58% of securitized interest-only ARM originations were purchase loans, meaning 42% were 

refinance loans; 37% of securitized payment option ARMs were purchase loans, meaning 63% were refinance loans.1 Through the third 

quarter of 2006, 55.6% of securitized subprime originations were 

refinance loans.2 Though we do not know what percentage of these 

refinance loans provided a borrower with a reasonable, tangible net 

benefit, we do know that inappropriate refinance loans threaten, 

rather than promote, homeownership. 

Note that weak underwriting contributes to skyrocketing housing 

prices. Mortgage professionals distort home prices when they originate unsustainable loans with a higher principal amount than the 

borrower could qualify for using a 30-year fixed rate mortgage. As 

lenders comply with guidance on prudent underwriting of nontraditional mortgages and as the housing market ‘‘corrects,’’ borrowers 

may find that their homes are worth less than they owe on their 

home mortgage. This is especially the case for those consumers victimized by appraisal fraud. Unfortunately, the home loan market 

does not always operate at optimal efficiency. Reasonable regulation and oversight is necessary to ensure that consumers and the 

housing market as a whole are functioning appropriately. 

Q.3. The National Association of Mortgage Brokers has taken the 

stance that instead of limiting risk to consumers, regulators and 

lenders should better educate consumers about risk. To a certain 

degree, do you think that consumers have chosen not to educate 

themselves about these products focusing instead on that low initial payment? 

A.3. Certainly, the promise of low monthly payments is a key selling point for home loans. Still, CRL would not place blame for the 

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3 Id. at 21. 4Government Accountability Office, Consumer Protection: Federal and State Agencies Face 

Challenges in Combating Predatory Lending, GAO–04–280 at 6 (2004). 5 Calculated based on data provided in Glenn Canner et al., Higher-Priced Home Lending and 

the 2005 HMDA Data, Federal Reserve Bulletin at A135, tbl. 4 (2006) (Fed Bulletin). 

proliferation of unsustainable or abusive loans at the feet of consumers. The Government Accountability Office (GAO) reported recently that the ‘‘alternative mortgage product’’ disclosures it reviewed 

did not always fully or effectively explain the risks of payment shock or 

negative amortization for these products and lacked information on some 

important loan features, both because Regulation Z currently does not require lenders to tailor this information to AMPs and because lenders do not 

always follow leading practices for writing disclosures that are clear, concise, and user-friendly.3

Furthermore, the GAO also has reported that its ‘‘review of literature and interviews with consumer and federal officials suggest 

that while tools such as consumer education, mortgage counseling, 

and disclosures are useful, they may be of limited effectiveness in 

reducing predatory lending.’’ 4

CRL is pleased that the staff of the Board of Governors of the 

Federal Reserve System is working to revise Regulation Z’s disclosure requirements to better inform consumers about products they 

are offered. In the meantime, however, loan originators should act 

responsibly and fairly by clearly informing borrowers about the 

costs and benefits of the various loans available to them. Furthermore, loan originators should give borrowers loans that are appropriate given their goals, credit history, and other relevant characteristics. 

Consumers should be able to trust mortgage professionals to direct them to suitable loans. A consumer could read constantly and 

continuously without knowing all relevant information about the 

new products that financial institutions develop. Mortgage professionals themselves have trouble keeping up with the tremendous 

variety of products available on the market. Many such professionals learn to deal with a select few products—sometimes those 

that are most personally lucrative rather than most appropriate for 

a borrower—and deal only with those products. If we do not expect 

loan originators to know the intricacies of all available products, 

how can we expect more of consumers? Furthermore, loan officers 

and mortgage brokers use rate sheets to which the consumer lacks 

access, creating an information imbalance that leaves consumers at 

a disadvantage. 

Also, a consumer who receives a solicitation for a loan rather 

than seeking a loan is less likely to have prepared for a loan transaction. Understandably, since the consumer did not initiate a 

search for a loan, he or she may rely unduly on the representations 

of the party marketing a product or products. Push-marketing is 

particularly common with refinance loans. Data collected pursuant 

to the Home Mortgage Disclosure Act showed that 53.6% of reported conventional first lien home loans originated in 2005 were 

refinance loans, compared to 42.6% home purchase loans and 3.9% 

home improvement loans.5 Refinancing abuses hurt not only borrowers but also responsible lenders who see their borrowers refinance into riskier loans with worse terms based on misrepresentasmartinez on DSKD5P82C1PROD with HEARING

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6 Economic Conditions and Emerging Risks in Banking: Report to the FDIC Board of Directors 

(FDIC, Nov. 2, 2006) (FDIC Risk Report) at 6, available at http://www.fdic.gov/news/board/ 

nov062memo.pdf. 7FDIC Risk Report at 6. 

8FDIC Risk Report at 2. 

tions by untrustworthy lenders. It is important for consumers to 

have a general understanding of home loans; it is critical for mortgage professionals to use their knowledge to assist borrowers rather than mislead them. 

Q.4. In our last hearing, Mr. Brown from the FDIC suggested that 

we are unlikely to see a nationwide crisis in the housing market 

because the housing boom is concentrated in certain regions, and 

historically most housing failures have happened in areas suffering 

from localized recessions. As we all know, there is increased risk 

of massive defaults on these loans in coming years. Due to a nationwide trend of nontraditional mortgages being used as affordability products, would you disagree with Mr. Brown that upcoming 

housing problems will be isolated in certain regions? 

A.4. The FDIC recently reported that five out of six Regional Risk 

Committees expressed concern that slowing housing appreciation 

would impact future performance of prime residential loans.6 With 

respect to subprime home loans, the FDIC’s recent report stated 

the following: 

There are emerging signs of potential credit distress among holders of 

subprime adjustable-rate mortgages (ARMs). Nationwide, foreclosures started on subprime ARMs made up 2.0 percent of loans in the second quarter, 

up from 1.3% in mid-2004. Subprime ARMs are experiencing stress in 

states as diverse as California, which has had rapid home price gains and 

solid economic performance, and Michigan, where house prices have been 

stagnant and the economy is weaker. This suggests that national factors, 

like interest rate increases, are important factors behind subprime mortgage credit stress, in addition to local economic or housing market conditions.7

The report also noted that households’ high-leverage mortgages 

and use of nontraditional mortgage products could amplify the effects of a housing slowdown.8

In areas with housing appreciation, it may be possible for families with unaffordable loans to refinance if they have sufficient equity in their home. Such refinances are not costless, however; any 

prepayment penalties to exit one loan and points and fees paid to 

obtain a new loan are paid either out of borrowers’ cash or their 

home equity. In areas with little or no appreciation in housing values, CRL expects that distressed borrowers will be less able to refinance and more likely to enter foreclosure. 

Q.5. You both share a gloomy view of what is going to happen to 

many borrowers. Are the changes in the marketplace, particularly 

the rise of brokers and non-traditional mortgages, here to stay, and 

should we be worried about that? 

A.5. We need not worry not about brokers and nontraditional loans 

per se, but rather about brokers who do not deal fairly with borrowers and with mortgage professionals who originate loans—traditional or nontraditional—even though a borrower cannot repay the 

loan as structured. 

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The recently issued Interagency Guidance on Nontraditional 

Mortgage Product Risks directed institutions to avoid loan terms 

and underwriting practices that could heighten the need for a borrower to sell or refinance a loan when payments increase. The Conference of State Bank Supervisors and the American Association of 

Residential Mortgage Regulators issued similar guidance as a 

model for state banking regulators. Without stifling innovation or 

preventing borrowers from obtaining nontraditional mortgages, 

banking regulators highlighted commonsense, prudent lending 

practices that are critical to the sustained viability of the home 

loan industry. Both safety and soundness and consumer protection 

considerations demand that mortgage professionals act in accordance with the level of trust that consumers and regulators place in 

them. Mortgage brokers who care more about commissions than 

about a loan’s sustainability and those lenders who turn a blind 

eye to—or promote—abuses by brokers share blame for the loss of 

home equity or of a home itself that borrowers with an unaffordable loan experience. 

It is likely that subprime borrowers will experience the greatest 

losses from unsustainable loans. Adjustable rate mortgages whose 

rates are fixed for 2 or 3 years dominate the subprime market. 

Those who originate these loans generally underwrite loans to an 

interest rate far below the actual rate a borrower reasonably can 

expect to pay when the interest rate adjusts. Weak underwriting 

and a loan structure normally inappropriate for troubled borrowers 

thus add an unnecessary layer of risk to these borrowers’ loans. 

CRL urges regulators to require brokers and lenders to originate 

subprime loans that are sustainable and suitable for the borrower’s 

purposes. Such a requirement would lead to the origination of far 

fewer subprime 2/28 and 3/37 adjustable rate mortgages. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED 

FROM MICHAEL CALHOUN 

Q.1. Please comment on the assertion made during testimony at 

the hearing that interest only and option ARMs do not constitute 

greater risk for consumers than other mortgage products. 

A.1. As the federal agencies noted in their recent guidance on nontraditional mortgages, interest-only and option ARMs pose ‘‘concerns from a risk management and consumer protection standpoint.’’ The initial low monthly payment associated with these 

loans means that once the loan adjusts, the borrower can face significant payment shock. Additionally, the lack of principal amortization as well as the potential for negative amortization means 

that borrowers fail to build equity in their home. Taken together, 

these products present significant risk for borrowers in a slowing 

housing market, where a lack of equity will mean that borrowers 

cannot refinance in the face of payment increases. Of course, many 

of these risks exist with adjustable-rate mortgages that are not 

structured to allow deferment of principal or interest payments. 

Particularly risky are subprime 2/28 and 3/27 hybrid ARMs that 

are underwritten using weak standards that jeopardize subprime 

borrowers’ ability to sustain homeownership and its benefits. 

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9Option One Prospectus, Option One MTG LN TR ASSET BK SER 2005 2 424B5, S.E.C. Filing 05794712 at S–50 (May 3, 2005). 10Fed Bulletin at A156. 11 Brian Bucks & Karen Pence, Do Homeowners Know Their House Values and Mortgage 

Terms? (Federal Reserve Board of Governors Jan. 2006) at 36 tbl. 5. 12 Allen Fishbein & Patrick Woodall, Exotic or Toxic? An Examination of the Non-Traditional 

Mortgage Market for Consumers and Lenders 28–29 (May 2006). 

Q.2. What approximate percentage of nontraditional loan products 

are underwritten to the value of the home, rather than to the borrower’s ability to repay? Is this practice restricted to the subprime 

market? 

A.2. Current underwriting for nontraditional mortgages often is 

based on the value of the home, rather than the borrower’s ability 

to repay the mortgage when payment increases occur. This presents serious risks, especially in a stagnant or declining real estate 

market, when home resale proceeds may not be sufficient to pay off 

the loan. Of even more concern is the fact that the majority of 

subprime lenders making ARM and/or interest-only loans underwrite only to the initial rate and not to the fully indexed and/or 

fully amortizing rate. Lenders who make these exploding ARMs 

often do not consider whether the borrower will be able to pay 

when the loan’s interest rate resets, setting the borrower up for 

failure. Subprime lenders’ public disclosures indicate that they are 

qualifying borrowers at or near the initial start rate, even when it 

is clear from the terms of the loan that the interest rate, and therefore the monthly payment, will rise significantly. For example, a 

recent prospectus shows that a large subprime lender, Option One, 

underwrites to the lesser of the fully indexed rate or one percentage 

point over the start rate.9 For a loan with a typical 2/28 structure, 

the latter would always apply. This practice means that at the end 

of the introductory teaser rate on an ARM, borrowers face a shocking increase in costs, even if interest rates remain constant. 

Q.3. Approximately 15 percent of borrowers with interest-only and 

option ARMs earn less than $48,000. How do you expect the borrowers with lower incomes to be affected by the resets we expect 

to see over the next several years? 

A.3. Generally, low-income homeowners are less able to withstand 

increases in home loan payments. Even if the debt-to-income ratio 

is the same in a loan to a higher-income borrower and a loan to 

a lower-income borrower, high debt-to-income ratios may leave the 

lower-income borrower with insufficient residual income to pay for 

basic necessities. Furthermore, according to 2005 Home Mortgage 

Disclosure Act data, lower income borrowers were more likely than 

other borrowers to have high-cost loans.10 A Federal Reserve study 

found that 40% of borrowers with income less than $50,000 did not 

know the per-period caps for the interest rate changes on their 

ARMs and 53% did not know the lifetime cap.11 Low-income borrowers therefore may be more surprised by sharp payment increases. 

The Consumer Federation of America has noted that ‘‘the homeowners who will be most severely hurt by any downturn in the 

housing market are the nontraditional borrowers who have purchased the most recently with the least equity in their homes.’’ 12

Presumably, lower-income borrowers who have taken advantage of 

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13Thomas P. Boehm & Alan Schlottmann, Wealth Accumulation and Homeownership: Evidence for Low-Income Households 33 (U.S. Dept. of Housing and Urban Development Dec. 2004). 14Fed Bulletin at A139. The bulletin notes that HMDA data tends to understate secondary 

market sales, in part because some sales will occur in years subsequent to the reporting year. 

programs that allow lower down payments and higher loan-to-value 

ratios will have less equity to use to pay the costs of refinance or 

of real estate commissions and other costs associated with home 

sales. If housing values decline, low-income and higher-income 

homeowners may find that their homes are worth less than they 

owe. A study commissioned by the U.S. Department of Housing and 

Urban Development found a high likelihood that low-income families would return to renting after owning a home.13 Given those 

findings, the authors concluded that ‘‘policies designed to ensure 

that once households achieve homeownership, they remain homeowners (rather than reverting to rental tenure), and policies that 

enable families to transition to higher valued owned units over 

time will increase substantially their potential housing wealth accumulation.’’ The study focused on data gathered before the proliferation of nontraditional mortgage products and the increased 

use of ARMs in the subprime market. Homeownership remains just 

as important as before, but as the use of adjustable rate mortgages 

and nontraditional mortgage products increases, homeowners bear 

more of the risks associated with home loans. 

Q.4. What can Congress potentially do to protect consumers who 

may be unable to make their payments, refinance or sell? 

A.4. Congress should require all lenders and mortgage brokers to 

adhere to the principle of the Interagency Guidance on Nontraditional Mortgage Product Risks—that borrowers be provided loans 

they can reasonably repay over the life of the loan without having 

to refinance or sell the house. 

Second, Congress can ensure that any federal predatory lending 

law retains the assignee liability provisions of HOEPA. In 2005, almost 70% of HMDA-reported home loans originated were sold on 

the secondary market.14 Assignee liability entitles victimized borrowers to recourse even if the original lender has sold the loan to 

another party. Without assignee liability, borrowers who were 

abused would not be able to defend against foreclosure. 

Congress can also develop incentives that encourage lenders to 

provide loan modifications to borrowers who have received loans 

with significant payment shock, in lieu of foreclosing on or refinancing such loans. In conjunction with such incentives, it would 

be helpful to ensure that servicers do not impose unfair costs on 

borrowers when providing workout options. 

In addition, Congress could create a homeowner assistance program to assist borrowers who cannot repay their loans. Pennsylvania has implemented a successful program to help borrowers who 

are facing foreclosure through no fault of their own. The commonwealth’s Homeowners’ Emergency Mortgage Assistance Program 

(HEMAP) provides loans to borrowers who show a reasonable prospect of being able to resume full mortgage payments. The program 

is funded through a small fee on all residential mortgage loans. Assistance is available for 24 months or until a certain dollar cap is 

reached, whichever comes first. Congress could develop a program 

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15Press Release, National Association of Consumer Bankruptcy Attorneys, Survey: Bankruptcy 

Filings on the Rise Again, Likely to Return to Pre-2005 Law Levels During Next Year (Oct. 4, 

2006), available at http://nacba.com/files/mainlpage/100406NACBAsurveynewsrelease.doc. 

similar to the Pennsylvania HEMAP program to assist borrowers 

in need. 

Q.5. What has been the effect of the recent changes in the bankruptcy laws on a consumer’s ability to pay their reset mortgage 

payments? 

A.5. According to a recent survey of members of the National Association of Consumer Bankruptcy Attorneys, the new bankruptcy 

provisions have increased the costs and paperwork required to file 

for bankruptcy without resulting in significant increases in the 

number of filers put into Chapter 13 repayment plans.15 The creation of additional barriers to bankruptcy may push desperate people to deal with unscrupulous parties, such as those who perpetuate ‘‘foreclosure rescue’’ scams or lenders who refinance borrowers 

into less advantageous loans. In addition, the new law makes it 

much harder for families to use their limited resources to keep 

their mortgage current. Instead, credit cards and other unsecured 

debt require much of the families’ income. To date, however, we 

have not formally studied a link between the 2005 bankruptcy 

amendments and an increase in abuses of homeowners in dire 

straits. 

Even prior to the 2005 amendments, the Bankruptcy Code gave 

home mortgage lenders special treatment. Though bankrupt debtors have the right to modification of many secured claims, with 

some exceptions, they do not have a right to modification if the 

claim is secured by an interest in the debtor’s principal residence. 

Congress intended for the home mortgage preference to promote 

constructive, not destructive lending. Home mortgage lenders who 

abuse consumers should not be given preferential treatment over 

responsible non-mortgage lenders when their victims are pushed 

into bankruptcy. 

Q.6. Regarding non-traditional mortgage products, what issues do 

you believe have not been addressed in the proposed Guidance? 

A.6. Now final, the nontraditional guidance represents a clear 

statement of prudent lending practices for home mortgages that 

permit deferment of principal or interest. However, borrowers with 

fully-amortizing ARMs, such as subprime 2/28 ARMs (fixed rate for 

2 years and adjustable thereafter) and 3/27 ARMs (fixed for 3 years 

and adjustable thereafter), also can experience payment shock that 

leaves them unable to repay the loan. Likewise, subprime borrowers are vulnerable to risk layering through such practices as reduced documentation requirements. We urge the federal financial 

institution regulators to clarify the application of the underwriting 

standards set forth in the nontraditional mortgage guidance to 

subprime ‘‘exploding’’ ARMs such as 2/28s and 3/27s. 

In addition, we note that, in contrast to common practice in the 

prime market, in the subprime market, loan originators tend not 

to provide for escrow of payments for property taxes and insurance. 

Excluding the cost of property taxes and hazard insurance from estimates of monthly payments misleadingly lowers the monthly payments such lenders quote. This trick may enable a loan originator 

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to close a deal, but will leave borrowers who have not saved enough 

money to cover those costs with no option but to refinance or sell 

their home. Refinancing can cost homeowners valuable home equity, increasing the loan-to-value ratio on subsequent loans and 

thus increasing the interest rate, or even leaving borrowers unable 

to refinance. Frequent housing turnover destabilizes communities 

and increases opportunities for appraisal fraud. 

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ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

FORECLOSING ON THE AMERICAN DREAM / PART OF AN OCCASIONAL SERIES

/ NO MONEY DOWN: A HIGH-RISK GAMBLE

The Denver Post, Sunday, September 17, 2006 

By Greg Griffin, David Olinger and Jeffrey A. Roberts, Denver Post Staff Writers 

Monique Armijo expects to give birth to her fourth child, a girl, next month. She 

also expects to lose the house her family moved into just last year at an October 

foreclosure sale in Jefferson County. 

She cannot bear to tell her three children, two 7-year-old boys and a 5-year-old 

girl, about the auction. 

‘‘When we moved in, I told them, ‘We’re never going to move again; this is where 

we’ll stay,’ ’’ she said. ‘‘I love this neighborhood.’’ 

Monique and her husband, Anthony, are among the many Colorado residents who 

managed to acquire a house without a down payment, only to see it foreclosed on 

a year or two later. 

Anthony, an independent carpet installer, met a real estate agent who assured 

the couple that shaky credit and lack of cash for a down payment were no longer 

barriers to homeownership. They ended up signing a loan that required them to pay 

off a $44,000 second mortgage in 14 months. 

Once rare in the mortgage industry, nothing-down loans have become wildly popular in Colorado, where home prices rose rapidly during the late 1990s. And according to a computer-assisted Denver Post analysis, they are a leading cause of the 

state’s foreclosure epidemic. 

The Post examined nearly 1,000 foreclosures—every notice filed in August in 

three Colorado counties racked by troubled mortgages. 

In Adams, Arapahoe and Jefferson counties, more than half of all foreclosures on 

home purchases involved no-down-payment loans. Excluding federally insured loans 

that require a small down payment, no-money-down loans accounted for more than 

70 percent. 

‘‘Exotics’’ go mainstream 

Nothing-down loans lead the list of higher-risk, alternative mortgages that many 

Coloradans are substituting for traditional 30-year fixed loans with at least 10 percent down. Buyers often compound their risk by combining 100 percent financing 

packages with interest-only loans, adjustable-rate loans that allow the borrower’s 

debt to grow rather than decline and loans that require no proof of income. 

These loans, known among lenders as ‘‘exotics,’’ have moved from the fringes of 

the mortgage industry to the mainstream and now account for more than a third 

of all loans. 

The growth has fulfilled a desire of lenders, borrowers and regulators alike to 

make homeownership accessible to more people. But the risks—some have relatively 

high monthly payments, while others start low and adjust rapidly upward—are 

more than many homeowners can manage. 

In interviews with dozens of homeowners in foreclosure, The Post found that life 

events such as job loss, medical problems and divorce often precipitate a default. 

But lack of equity, which gives homeowners options when they face financial problems, was a factor in nearly all cases. 

For the past six months, Colorado has had the highest foreclosure rate in the nation, according to RealtyTrac, a California firm that tracks foreclosures. Repossession proceedings were underway for one of every 158 Colorado homes during the 

second quarter. 

It’s no coincidence that Colorado homeowners have less equity in their properties, 

on a percentage basis, than nearly any other state—the result of a number of factors 

including the popularity of 100 percent financing. 

‘‘The bottom line is, people in Colorado are borrowing too much money on their 

homes,’’ said Stuart Feldstein, president of SMR Research Corp., which tracks lending-industry trends. 

Aggressive lending practices and poor consumer education also play a role, consumer advocates say. 

‘‘Seventy percent of the people who come in here got the wrong loan,’’ said 

Zachary Urban, a counselor with Denver-based Brothers Redevelopment Inc., which 

helps people keep their homes. 

Lenders say they’re simply meeting customer demand for less restrictive loans. 

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‘‘There are very few people who have 5 or 10 or 20 percent cash to put down. Or 

if they do, who want to,’’ said Colorado Mortgage Lenders Association president 

Chris Holbert. ‘‘If you want 100 percent financing, and you qualify, can they turn 

you down because it’s not a good idea?’’ 

Many left second-guessing 

Jose Garcia and Maria Vanderhorst put no money down in October when they 

bought a $200,000 patio home in a quiet central Aurora neighborhood. 

Now fighting for their home as a foreclosure auction looms, the couple questions 

that decision. 

‘‘I had money to put down, but they came out with the idea of no money down. 

I did some research, and it looked good,’’ Garcia said. ‘‘Maybe it wasn’t the smartest 

decision.’’ 

Garcia and Vanderhorst, who immigrated to Colorado from the Dominican Republic in 2003, obtained what’s called an ‘‘80–20’’ mortgage package. 

One loan covered 80 percent of the purchase price, and the other covered 20 percent. The second loan carried a 9.7 percent interest rate—high, but not unusual for 

a second loan—and a monthly payment of $340, bringing the total to nearly $1,500. 

The couple, who have three children—13, 11 and 5—used their savings to finish 

their basement and send money to their parents. 

But Garcia, a car salesman, took a big pay cut in March when his dealership was 

bought out by a competitor. The family also didn’t receive an expected tax refund 

and faced some unexpected medical bills. 

Behind on their payments, they received a foreclosure notice from their bank in 

June. 

Garcia negotiated a deal with the current mortgage holder, Countrywide Home 

Loans, giving him eight months to pay the $7,000 he owes, including a $2,200 foreclosure fee. 

With some belt-tightening, he thinks the family can keep the house. 

‘‘When we went into foreclosure, it was like someone taking my dreams away,’’ 

Garcia said. ‘‘There was no way I was going to lose my house. It’s about pride.’’ 

The future is bleaker for Monique and Anthony Armijo. Their two loans came 

with a high interest rate and some unusual terms. 

Spectrum Funding, a Utah-based lender, supplied the $176,000 first mortgage toward the $220,000 purchase of a middle-class home in Arvada. Ad Two Inc., the 

company selling the house, provided the $44,000 second mortgage. 

The first started at 9.67 percent—more than $1,400 a month in interest alone— 

and can jump 3 percent after two years. The second let the Armijos pay just $100 

a month for a year—but required them to pay the entire balance in January 2007. 

They could refinance that loan but faced a $20,000 penalty if they didn’t use a particular broker. 

The Armijos’ sole source of income: about $30,000 a year from Anthony’s carpet 

work. Within months, they were behind on the first mortgage. 

Ad Two Inc. is an independent franchise of HomeVestors, which buys, repairs and 

resells houses. Terri Gallmeier, Ad Two’s president, said the Armijos’ real estate 

agent asked her to carry a second mortgage that could be refinanced a year later. 

‘‘I had nothing to do with the loan,’’ she said, ‘‘and I wasn’t privy to all the financial information’’ about the buyers. 

The foreclosure notice that came to the Armijos’ home was followed by a flood of 

mail from people offering everything from counseling to taking the house off their 

hands. Monique called one, Doug Ravdin, who explained the terms of their two 

home mortgage loans. 

‘‘He told me, ‘You’re going to be in debt for the rest of your life if you stay in 

that property.’ He was like, ’The best thing for you guys to do is get out of the 

house.’ ’’ 

She thanked him, hung up and wept. 

‘‘We run into this all the time,’’ Ravdin said. The Armijos bought a fix-and-flip 

house and ‘‘got loaded into it horribly, I mean horribly.’’ Housing counselors say borrowers need to be very careful when choosing a loan and to read the papers before 

signing. 

‘‘If it sounds too good to be true, then it probably is,’’ said Donald May, executive 

director of the Adams County Housing Authority. ‘‘The buyer has to be a lot more 

sophisticated and educated with all the mortgages available today.’’ 

Loans’ door wide open 

More choice and lower lending standards have made it easier than ever to buy 

a home, but has the trend gone too far? 

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The jury is still out. The U.S. rate of homeownership—the percentage of homes 

occupied by the owner—was 68.9 percent last year, up from 63.9 percent two decades ago, according to the Federal Deposit Insurance Corp. 

But foreclosures rose 39 percent from January to July compared with the same 

period of 2005, RealtyTrac reports. 

Beginning in the early 1980s, regulators allowed banks to sell their loans and 

offer homebuyers variable interest rates, stimulating capital investment and consumer demand. 

Securitization of mortgages helped lenders get the riskiest loans off their books. 

Investors were shielded because those mortgages were typically held in diversified 

loan portfolios. 

High-risk loans such as option-ARMs, in which payments on principal and some 

interest can be deferred, were introduced by savings-and-loan associations in the 

1980s to serve high-income borrowers. Only recently have they spread to less creditworthy consumers. 

Since 2003, the height of the refinancing boom, competition has stiffened among 

lenders fighting for a declining number of loans. 

Mainstream lenders and mortgage brokers say they’ve had to offer all of the alternative loans, at competitive terms, or risk losing business. 

‘‘If we don’t do it, they will go down the street,’’ said mortgage broker Mike Thomas of Hyperion Capital Group in Aurora. 

Loans without down payments have been around for a long time, but they’ve 

taken off in the past three years. 

In 2005, 43 percent of first-time homebuyers surveyed by the National Association 

of Realtors said they put no money down. Before last year, the group had never 

tracked that category. 

A common choice is the 80–20 because it allows buyers to avoid the costly mortgage insurance typically required when they put down less than 20 percent.Standard & Poor’s reported in July that 80–20s and other two-loan packages 

known as ‘‘piggybacks’’ are up to 50 percent more likely to go into default than comparable one-loan transactions. 

In Adams, Denver and Arapahoe counties, piggybacks were used in more than 50 

percent of home purchases in the second quarter of 2006, well above the national 

average of less than 40 percent, according to Hackettstown, N.J.-based SMR Research. 

As state housing prices doubled in the 1990s, homebuyers saw less need to invest 

their own money, said Holbert of the Colorado Mortgage Lenders Association. Equity accrued automatically. 

Now, if homeowners put no money down and prices remain stagnant, ‘‘what other 

option than foreclosure do they have if their income drops and they can’t make their 

payments?’’ Holbert said. 

‘‘The place was a mess’’ 

Mark Williford says his house in Northglenn was unsafe from the day he moved 

in. Yet he managed to borrow more than 100 percent of the sale price in 2003 from 

a bank that threw in $33,000 for renovations and accepted his shaky finances. 

Williford’s only steady source of income: permanent disability checks from a 1993 

neck injury. His mortgage was co-signed by a girlfriend he had never lived with before, and their loan application counted $809 a month in tips from her casino job 

as household income. 

‘‘Somehow we pulled it off,’’ said Williford, a 47-year-old disabled plumber who obtained a $161,000 loan from Wells Fargo Home Mortgage Inc. on a house 

Northglenn later tagged as uninhabitable. 

The city responded to a 2005 engineering report that a second-floor addition rests 

on decorative metal columns and its windows could shatter and fall out.When 

Williford and his girlfriend split up months after moving in, his mortgage payments 

exceeded his total income. In October he lost his first home. 

‘‘I bought a condemned house, which is all I could afford,’’ he said. ‘‘I was trying 

to save my house, my mortgage, my self-worth.’’ 

A mortgage expert said the bank should have known better. 

‘‘Bottom line, Wells Fargo should never have made the loan. The borrowers did 

not have the provable income and the property was unsafe,’’ said Jim Spray, a consumer-oriented mortgage broker Williford called for help. 

Dick Yoswa, the Wells Fargo loan officer, remembers ‘‘the place was a mess’’ when 

Williford bought it. ‘‘It was a borderline case,’’ he said. 

But Williford’s disability income and his girlfriend’s casino job were verifiable, a 

contractor estimated the house could be repaired for $33,000, and the appraiser 

sounded no alarms, Yoswa said. 

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‘‘From the information we received from everyone, we closed the loan,’’ he said. 

Today, Williford lives in a tiny portable trailer with a refrigerator, stove, bunkbed 

and a flat-screen TV he squeezed in after dismantling the door. ‘‘It could be worse. 

I’m just grateful that I have this,’’ he said. 

Option-ARMs next wave? 

Though 100 percent financing is involved in many Colorado foreclosures, the next 

wave of defaults may come from option-ARMs, experts say. Troubling stories about 

these loans are mounting. 

Louis and India Harts of east Park Hill refinanced last year into a loan they 

thought was a 30-year fixed-rate mortgage. 

But instead of a 30-year fixed, the couple in their 80s got an option-ARM with 

a low teaser rate of 2.6 percent that quickly shot up. They’re making a minimal 

monthly payment of $919 on the $180,000 loan, but that doesn’t even cover the interest. Since March 2005, the principal has grown to more than $183,000. 

The interest rate is now 8.1 percent, and according to their loan documents, can 

go as high as 9.95 percent. 

When the principal hits 115 percent of the original loan in a few years, the bank 

will force them to begin paying it off. 

‘‘I don’t know how we’re going to do it,’’ said Louis, a retired worker for Public 

Service Co. of Colorado. 

The loan has a ‘‘prepayment penalty’’ clause, making it difficult to sell or refinance during the first three years. When they called the lender, Countrywide Home 

Loans, they learned it would cost $11,000 to get out of the loan. 

The Hartses blame their mortgage broker, Team Lending Concepts in Greenwood 

Village, for putting them into a loan they didn’t understand—though they admit 

they signed papers spelling out the terms. 

Team Lending president Jeff Lowrey said the loan was the best option for the 

Hartses because it guarantees a low payment for four to five years until they refinance again. 

‘‘That type of minimum-payment option definitely helps those kinds of people,’’ 

Lowrey said. ‘‘We minimized their payment so they could afford things like medical 

expenses and gas.’’ 

Team Lending collected $3,900 in fees at closing and $4,200 more from the mortgage company for originating the loan. Lowrey said the fees are within the permissible range for such loans. 

Option-ARMs and other adjustable-rate mortgages could fuel a surge in foreclosures in the next few years as adjustable rates begin moving up on billions of 

dollars in loans, consumer advocates and public officials warn. 

‘‘We are just starting to hear about ARMs,’’ said Adams County trustee Jeannie 

Reeser. ‘‘That is what is going to drive foreclosures next year.’’ 

Staff writer Aldo Svaldi contributed to this report. 

Staff writer Greg Griffin can be reached at 303–954–1241 or 

ggriffin@denverpost.com. 

In trouble? Here’s what to do 

Foreclosure can cost you your home and your credit. Here’s what to do if you’re 

in financial trouble or have received a foreclosure notice. 

Act quickly 

Lenders usually are willing to help you devise a plan to keep your home. They 

may agree to a reduced or delayed payment schedule. Call as soon as you can. The 

further behind you are, the less your lender can help. 

Get help 

Housing counseling agencies approved by the Department of Housing and Urban 

Development can help you assess your financial situation and help you negotiate 

with your lender. Call HUD at 800–569–4287 to find counseling agencies near you. 

Consider your options 

If you simply can’t afford to keep your home, your lender may give you the time 

to sell it, even if the sales price is below what you owe. 

Beware of scams 

Homeowners in foreclosure are often targets of fraud. ‘‘Equity skimming’’ is when 

a buyer offers to repay the mortgage or sell the property if you sign over the deed 

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and move out. Phony counseling agencies also may offer help for a fee you don’t 

need to pay. 

Help on the web 

For more information about foreclosure, go http://www.hud.gov/foreclosure/ 

index.cfm 

Source: U.S. Department of Housing and Urban Development 

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