October 17, 2006
Comptroller Dugan Urges Key Principles of Federal Nontraditional Mortgage Guidance Apply to All Mortgage Originators
SAN DIEGO, CA -- Comptroller of the Currency John C. Dugan said today it is vital that the key principles of the federal nontraditional mortgage guidance not be watered down and that they should be applied to all mortgage originators.
In a speech to the annual convention of America’s Community Bankers, Mr. Dugan said that while the nontraditional mortgage guidance applies to federally regulated institutions, it does not apply to mortgage lenders and brokers regulated exclusively by the states, creating an unlevel playing field that plainly distorts competition in the nontraditional mortgage business. In addition, a consumer protection gap exists with respect to the nontraditional mortgage lending practices of a broad segment of mortgage lenders, he said.
"It cannot be, as some have suggested, that federal regulators should eliminate or lower standards that we believe are necessary for prudent and effective regulation," Comptroller Dugan said. "Instead, I believe that the standards must be raised in the part of the mortgage business that we do not regulate so that they are comparable to those applicable to federally regulated institutions."
Mr. Dugan said there is important work still to be done at the state level to apply standards comparable to federal guidance.
"It ought to be fundamental that all mortgage originators employ prudent lending practices, including credible consideration of a borrower’s ability to repay a loan—as structured—from sources other than the borrower’s home pledged as collateral," he said. "All mortgage originators should be providing prospective customers clear and balanced disclosures about the relative risks and benefits of nontraditional mortgages, including the risk of payment shock and negative amortization."
Although there is nothing inherently wrong with payment deferral products like nontraditional mortgages that have low early payments and high later payments, he said, they are riskier and will not work well in all circumstances. For many consumers, especially subprime borrowers, payment deferral products raise the real prospect of increased defaults and foreclosures when monthly payments reset at much higher rates, Mr. Dugan said.
Comptroller Dugan said that interagency guidance directs financial institutions to ensure that loan terms and underwriting standards are consistent with prudent lending practices, with particular attention paid to the borrower’s capacity to make the payments necessary to repay the full amount of the loan. The guidance sets forth the expectation that banks with a portfolio of nontraditional mortgages should adopt robust risk management practices that provide early warnings of potential or increasing risks, he said.
"In terms of consumer understanding, the guidance calls for lenders to provide borrowers with disclosures about the relative benefits and risks of these products that are short, clear, and free of legal and financial jargon," Mr. Dugan said. "This information needs to be provided to borrowers when they are shopping for loans, before they make the basic decision of what type of mortgage makes the most sense."
Mr. Dugan said that he is encouraged by the recent statements by the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators that they are working on a version of the nontraditional mortgage guidance.
"Indeed, the need for comparable action at the state level is perhaps even more acute given the volume of nontraditional mortgages made by non-federally regulated lenders to subprime borrowers," he said.
"Flexible features of nontraditional mortgages reflect the creativity and dynamism of our financial markets in finding ways to expand access to credit to facilitate home ownership," Mr. Dugan concluded. "But the last thing that any of us wants is for the American dream of home ownership to turn into an American nightmare of foreclosure. I worry about that happening if disparate standards applied by different lenders distort the markets of nontraditional mortgage loans."