Financial Institution Letter

FIL-88-2008

September 4, 2008

BEST PRACTICES FROM THE FDIC’S FORUM ON MORTGAGE 

LENDING FOR LOW- AND MODERATE-INCOME HOUSEHOLDS 

Summary: The FDIC is issuing the attached document to highlight best practices that were 

discussed at the FDIC’s July 8, 2008, Forum on Mortgage Lending for Low- and Moderate-Income 

(LMI) Households. The purpose of the forum was to explore a framework for LMI mortgage lending in 

the future, in light of current problems in the mortgage market. The forum examined ways to 

encourage profitable, responsible and sustainable mortgage lending to lower-income households and 

strategies to rejuvenate the secondary market for these loans. 

Distribution: 

FDIC-Insured Institutions (Commercial and 

Savings) 

Suggested Routing: 

Chief Executive Officer 

Chief Loan Officer 

Chief Compliance Officer 

Board of Directors 

Attachment: 

Best Practices from the FDIC’s Forum on Mortgage 

Lending for Low- and Moderate-Income 

Households 

Federal Deposit Insurance Corporation 

550 17th Street NW, Washington, D.C. 20429-9990

Contact: 

Special Advisor Rae-Ann Miller at rmiller@fdic.gov

or 202-898-3898

Highlights:

The best practices listed below and in the attached 

document are not intended as supervisory guidance, but 

are being provided to banks for informational purposes as 

a summary of issues discussed at the forum. Banks are 

encouraged to review and consider the best practices in 

the context of their LMI mortgage lending programs. 

Back-to-Basics Underwriting – Basic, traditionally 

underwritten, 30-year fixed-rate mortgages are the most 

suitable mortgages for most LMI borrowers. 

Incentives/Compensation – Ensuring that all parties to 

mortgage transactions have a long-term stake in the 

outcome of the transactions will improve the quality of LMI 

mortgages. 

Transparency and Due Diligence – Improved transparency 

throughout the mortgage process is critical to reviving the 

secondary market for LMI mortgages. 

Expanding Existing Products and Innovations – A variety 

of existing and proposed products and processes may 

increase availability of LMI mortgage credit, including 

extending amortization schedules, expanding alternative 

underwriting processes for consumers with limited credit 

history, and creating innovative insurance products to 

address temporary income disruptions, among other 

things. 

Public/Private Partnerships – Partnerships with community 

organizations, nonprofit corporations, banks, borrowers, 

local government, and others facilitate credit 

enhancements and home ownership counseling that make 

responsible LMI mortgage lending possible.

Note: 

FDIC financial institution letters (FILs) may be 

accessed from the FDIC's Web site at 

www.fdic.gov/news/news/financial/2008/index.html. 

To receive FILs electronically, please visit 

http://www.fdic.gov/about/subscriptions/fil.html. 

Paper copies of FDIC financial institution letters 

may be obtained through the FDIC's Public 

Information Center, 3501 Fairfax Drive, E-1002, 

Arlington, VA 22226 (1-877-275-3342 or 703-562-

2200).
1

BEST PRACTICES FROM THE FDIC’S FORUM ON MORTGAGE LENDING FOR 

LOW- AND MODERATE-INCOME HOUSEHOLDS

On July 8, 2008, the FDIC held a Forum on Mortgage Lending for Low- and ModerateIncome (LMI) Households to explore a framework for LMI mortgage lending in the future, 

in light of current problems in the mortgage market. The availability of credit to mortgage 

borrowers has sharply contracted over the past year, with total originations in the first quarter 

down almost 30 percent from the first quarter a year ago.1 Origination volumes have fallen 

even more dramatically in the subprime and Alt-A segments, 90 percent and 80 percent, 

respectively, and private label securitizations of nonprime mortgages have nearly ceased.2

 

The disruptions in mortgage credit availability and in the secondary mortgage market 

disproportionately affect lower-income borrowers’ opportunities for homeownership, given 

their existing lower homeownership rates. The Census Bureau reports that the national 

homeownership rate was about 68 percent as of the second quarter 2008. However, the 

homeownership rate is only about 52 percent for those households with below median 

incomes. Moreover, data from the Federal Reserve's 2004 Survey of Consumer Finances, the 

latest income stratification information available, show that for households with incomes in 

the bottom fifth of all earners, homeownership rates are far lower - about 40 percent. 

The FDIC’s forum examined ways to encourage profitable, responsible and sustainable 

mortgage lending to lower-income households and strategies to rejuvenate the secondary 

market for these loans. The forum featured leading experts in banking, investment, 

government, academia and the nonprofit community, including the Honorable Henry M. 

Paulson, Jr., Secretary of the Treasury; the Honorable Ben S. Bernanke, Chairman, Federal 

Reserve Board of Governors; and James Dimon, Chairman of the Board and Chief Executive 

Officer of JPMorgan Chase & Co. The agenda for the forum can be found at 

http://www.fdic.gov/about/comein/agendaJuly808.html, and an on-demand version of the 

webcast of the forum is at 

http://www.vodium.com/MediapodLibrary/index.asp?library=pn100472_fdic_advisorycomm

ittee&SessionArgs=0A1U0100000100000101. 

The purpose of this document is to highlight best practices that were discussed at the forum, 

including “back-to-basics” underwriting, expanding existing products and innovations, 

compensation and other incentives, transparency and due diligence, and public and private 

partnerships. The best practices discussed below are not intended as supervisory guidance 

and are provided to banks for informational purposes as a summary of issues discussed at the 

forum. Banks are encouraged to review and consider these best practices in the context of 

their LMI mortgage lending programs. 

Best Practices 

Back-to-Basics Underwriting – A number of forum participants emphasized the advantages 

of basic, traditionally underwritten, 30-year fixed-rate mortgages for most LMI borrowers. 

They pointed out that fixed-rate mortgages, without prepayment penalties, provide payment 

stability, which is important for long-term affordability. According to these participants, 

 

1

 “Inside Mortgage Finance,” May 23, 2008. 

2

 Ibid. 
2

lenders, investors, and consumers have not fared well when loan pricing and house 

appreciation were used as substitutes for the underwriting process, and solid, traditional 

underwriting is essential to rebuild a healthy housing market. The following were 

emphasized as important best practices to consider when originating responsible fixed-rate 

mortgages for LMI borrowers: 

• Full Documentation: LMI mortgages must be underwritten using full documentation 

and traditional underwriting criteria. Full documentation reduces fraud, and the 

process of gathering and preparing documentation is very useful for consumers in 

understanding the responsibilities of home ownership. 

• Ability to Repay: The ability to repay must be documented using reasonable “frontend” housing debt-to-income analysis, including all housing related expenses, and 

“back-end,” total debt-to-income calculations incorporating the new, fixed mortgage 

payment. 

• Mandatory Escrows: Taxes and insurance should be escrowed for LMI borrowers 

and included in the analysis of their ability to repay. 

• Opt-Out Agreements: Some suggested that LMI borrowers who choose a variable 

rate product should sign an agreement indicating that they are aware that fixed-rate 

mortgages are available, having received comparative illustrations of fixed and 

variable costs. Variable rate products should be underwritten to the fully indexed rate. 

• Purpose of Homeownership: There should be a societal and industry-wide reemphasis on housing as shelter and a long-term investment, rather than as a shortterm source of cash through refinancing. 

Incentives/Compensation – A recurring theme at the forum was ensuring that all parties to 

mortgage transactions have something at risk and, therefore, a long-term stake in the 

outcome of the transactions. The following were suggestions for imposing liability at various 

stages in the mortgage process: 

• Required Down Payments: Prospective homeowners, including LMI borrowers, 

should have some capital invested. Borrowers who make no down payments are 

much more likely to default than those who invest just three percent. 

• Second Mortgages: Second mortgages are not appropriate substitutes for down 

payments, and in the current environment, these so-called “piggy-back” structures are 

making it much more difficult to restructure mortgage loans. Piggyback mortgages 

should be used only rarely, such as when the second mortgage is provided through a 

nonprofit or government program and accompanied by homeownership counseling. 

• Independent Fiduciary: The current compensation structure for servicers of 

mortgage-backed securities is not designed to address a material level of troubled 

borrowers. There should be independent surveillance of structured finance 

transactions, such as a special servicer or credit risk manager. The fiduciary should 

be compensated and indemnified to seek maximum returns for the investors, which 
3

could involve principal write-downs or other strategies to avoid the high cost of 

foreclosure. 

• Mortgage Broker Compensation: Mortgage brokers and other originators who are 

paid based on interest rate or other terms of the loan versus loan performance have no 

incentive to provide good loans to borrowers, lenders, securitizers, or ultimately, to 

investors. To realign incentives with performance, brokers should be compensated 

based on loan performance over time, or rated using a performance-based scorecard 

and dismissed if they provide poorly performing loans. Brokers should also be 

licensed and subject to minimum capital requirements. 

Transparency and Due Diligence – Several participants remarked that improved 

transparency throughout the mortgage process is critical to reviving the secondary market for 

LMI mortgages. The following were identified as best practices for improving transparency. 

• Consumer Disclosures and Counseling: It is difficult for consumers to understand the 

true cost of loans, especially with complex features like prepayment penalties and rate 

resets that were common in subprime mortgage loans. Disclosures should be as 

simple as possible and provided early in the process, and LMI consumers should have 

access to advisors to explain the mortgage process and documents. Standards should 

be established to ensure that mortgage financing is appropriate for the borrowers. 

• Bank versus Nonbank Lenders: Consumers may not know if their lender is a bank or 

nonbank, and accordingly, whether the lender is operating under an appropriate 

regulatory framework. Uniformity in consumer regulation between bank and 

nonbank mortgage lenders will improve consumer information and is an important 

step for restoring public trust in the market.3

• Bond Ratings: Confidence in the process of rating bonds backed by mortgages has 

been diminished by recent downgrades of previously highly rated bonds. To restore 

confidence, rating firms should increase the amount and usefulness of information 

published regarding structured finance transactions. Among other things, additional 

information should include underlying assumptions for various asset classes, stress 

tests for ratings and scenario analysis. 

• Investor Due Diligence: Bond ratings reflect credit risk only and do not address 

suitability, price, duration, volatility, or leverage in the underlying structure. 

Investors need to develop additional tools, beyond relying on ratings, for analyzing 

the bonds they buy. More granular information, such as loan level data, should be 

given to investors to develop their own models. 

 

3

 On July 14, 2008, the Federal Reserve Board approved a final rule for home mortgage loans intended to better 

protect consumers and facilitate responsible lending. The rule prohibits unfair, abusive or deceptive home 

mortgage lending practices and restricts certain other mortgage practices. The final rule, which amends 

Regulation Z (Truth in Lending) and was adopted under the Home Ownership and Equity Protection Act 

(HOEPA), also establishes advertising standards and requires certain mortgage disclosures to be given to 

consumers earlier in the transaction. Importantly, the new rules will apply to all mortgage lenders, not just 

those supervised and examined by the Federal Reserve. The rule can be found at

http://www.federalreserve.gov/newsevents/press/bcreg/20080714a.htm. 
4

Expanding Existing Products and Innovations – Participants discussed a variety of existing 

and proposed products and processes banks and others can use to increase availability of LMI 

mortgage credit, which included the following: 

• Encourage Savings: Provide a way to accumulate down payments through innovative 

savings products, such as deposit accounts with limited withdrawal features or 

Individual Development Accounts.4

 

 

• Extended Amortization: Longer amortization schedules such as 40-year, fixed-rate 

mortgages may be suitable for LMI borrowers who live in areas with high cost homes 

and/or need more affordable payments. 

• Full-Cycle Lending: “Full cycle” lending involves using financial education as an 

underwriting tool for LMI borrowers and others and consists of pre-purchase 

counseling, assistance at the time of closing, and early intervention if consumers have 

payment problems. Rebates or rate concessions could be given to households that 

complete financial education courses, since there is a link between performance and 

education. 

• “Thin-File” Underwriting: Originators can use alternative ways to verify payment 

history outside of the credit process, such as rent payments and utility bills. Some 

credit bureaus have developed, or are in the process of developing, alternative scoring 

processes for thin-file consumers. 

• Rent-to-Own: In the past, rent-to-own models have been successful for LMI 

borrowers lacking down payments. Particularly for foreclosed homes, these models 

allow renters to assume a mortgage after successfully making a series of rent 

payments equal to the mortgage payment. 

• Income Disruption Insurance: A home warranty-like program could provide 

borrowers the ability to build up a reserve for unforeseen expenses in exchange for a 

small increase in rate. Additionally, a “Life Event Clause” could be written into 

mortgage documents that would allow borrowers to defer one payment for every 18 

payments made in the event of an income disruption. 

• Covered Bonds: Covered bonds can be an innovative way to provide liquidity to the 

mortgage market as an alternative to securitization and can diversify a bank’s funding 

base. Covered bonds provide funding to an issuer, through a debt instrument 

collateralized by a pool of residential mortgage loans that remain on the issuer’s 

 

4

 Individual Development Accounts are matched savings accounts that enable low-income families to save 

money for a particular financial goal, such as buying a home, paying for post-secondary education, or starting or 

expanding a small business. 
5

 

balance sheet. A large covered bond market exists in Europe, but covered bonds are a 

relatively new innovation in the U.S., with only two issuers to date. The FDIC and 

the U.S. Treasury recently announced new initiatives designed to encourage the 

expansion of this market.5 

Public/Private Partnerships – Partnerships between community organizations, nonprofit 

corporations, banks, borrowers, local government and others were cited at the forum as a 

“bridge” that makes responsible LMI lending possible. Participants indicated that nonprofits 

have mechanisms to make LMI consumers more attractive to banks by educating consumers 

regarding homeownership and obtaining credit enhancements for the benefit of consumers. 

Strategies mentioned to leverage these relationships included banks working with nonprofit 

partners on product design, offering bank staff time for counseling prospective borrowers 

prior to establishing a lending relationship, and participating on local and national affordable 

housing initiatives. Some banks, foundations, corporations, and government programs also 

provide loss reserves or other forms of guarantees for secondary market programs sponsored 

by nonprofits. 

5

 On July 15, 2008, the Board of Directors of the FDIC approved a final covered bond policy statement to 

facilitate the development of the U.S. covered bond market by providing bondholders expedited access to 

collateral if the FDIC declines to continue the covered bonds after a bank failure. The policy statement can be 

found at http://www.fdic.gov/news/news/press/2008/pr08060.html. On July 28, 2008, the U.S. Treasury issued 

best practices to encourage the formation of a covered bond market in the U.S. The covered bond best practices 

can be found at http://www.treas.gov/press/releases/hp1102.htm.