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OCC BULLETIN 2006-41
To: Chief Executive Officers and Compliance Officer of All National Banks, Department and Division Heads, and All Examining Personnel

Description: Guidance on Nontraditional Mortgage Product Risks

The guidance attached to this bulletin continues to apply to federal savings associations.

The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, and the National Credit Union Administration (the agencies) have jointly issued the attached "Interagency Guidance on Nontraditional Mortgage Product Risks." The guidance discusses how institutions can offer nontraditional mortgage products in a safe and sound manner and in a way that clearly discloses the benefits and risks to borrowers.

Nontraditional mortgage products typically allow borrowers to defer payments of principal and, sometimes, interest. Among the more popular nontraditional products are interest-only and payment option adjustable-rate mortgages (ARMs). These products allow borrowers to exchange low monthly payments during a specified deferral period for substantially higher payments when amortization begins. Institutions are increasingly combining these types of products with other higher-risk practices, such as simultaneous second-lien mortgages and the use of reduced documentation in the evaluation of an applicant's creditworthiness.

While similar products have been available for many years, the number of institutions offering them has expanded rapidly. At the same time, these products are offered to a wider spectrum of borrowers who may not otherwise qualify for more traditional mortgages. The agencies are concerned that some borrowers may not fully understand, or be able to manage, the often sizeable payment shock that accompanies amortization periods for these products. Marketing materials and product disclosures typically focus the borrower on the lower initial payments and either discount the potential magnitude of subsequent payments or assume the borrower will be able to sell or refinance the property. In addition, since much growth and product evolution has occurred within the last 12 to 24 months, stabilized loss rates and delinquency levels remain uncertain.

The guidance expects financial institutions to recognize and mitigate the risks inherent in these products. This includes ensuring that loan terms and underwriting standards are consistent with prudent lending practices, including credible consideration of a borrower's repayment capacity. It also includes ensuring that consumers are provided clear and balanced information about the relative benefits and risks at a time that allows them to make informed decisions.

This guidance is applicable to all banks and their subsidiaries, bank holding companies and their nonbank subsidiaries, savings associations and their subsidiaries, savings and loan holding companies and their subsidiaries, and credit unions.

For further information, contact Credit & Market Risk (202) 649-6670.

Emory W. Rushton
Senior Deputy Comptroller and Chief National Bank Examiner

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