Read this Federal Reserve document, by the Center for Responsible Lending, May 2006, with recommended guidelines. I just shake my head that these guidelines must even be suggested. I thought these are common sense!
Qualify borrower on PITI, instead of just PI or I.
Qualify borrower based on the fully indexed adjusted rate, not just on today’s teaser rate.
Don’t allow lenders to structure subprime ARMs , through the use of a prepayment penalty, to prevent borrowers from exiting the product when it becomes more difficult to repay.
Educate borrowers about payment shocks and teaser rates. Payments can go up 70%. 74% of 2/28 I/O ARMs have a teaser rate.
“At 2006 interest rates, as teaser rates expire on these 2004 loans, 97.5% of borrowers are likely to experiencof at least 25% and three of four (75%) could face a shock of 50% or more. These changes neglect additional shocks associated with repayment of principal.”
While lenders have marketed these as affordability problems, the document states that the borrower has only 2 options: refinance or default. Housing appreciation so far made refinancing an option, but this trend is not guaranteed to continue. “We believe it is unfair and deceptive to originate mortgages based on these assumptions.”
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