Fed Proposes New Lending Rules Affecting Alt-As

Yesterday the Federal Reserve proposed new guidelines that would prohibit certain lending and servicing practices. Barclays Capital analysts said that this move will have significant consequences for Alt-A mortgages. According to Barclays, because of the move, many ARM borrowers in Alt-A and, potentially, even in prime jumbo mortgages will have to fully document their income and assets. Aside from this, some fixed-rate loans would also be affected. Most Alt-A borrowers in recent years have had lower doc loans and if the Fed’s guidelines were adopted, analysts said it seems that only fixed-rate loans could be taken out as low doc loans as a result. These new rules, if actually adopted, would come into effect no earlier than Oct. 2008, allowing lenders time to alter their lending practices, Barclays stated. The proposal applies to all new loans for owner-occupied homes. Many of these changes are minor, although certain provisions, such as documentation requirements, apply only to higher-priced mortgages, Barclays said. This seems to include most hybrid and option ARMs, as well as some fixed-rate loans. The key details of the Fed’s proposal were highlighted in the Barclays report. In terms of higher-priced mortgages, lenders cannot offer loans without factoring in borrowers’ ability to repay on a widespread basis. Lenders also have to verify income and assets that are necessary to repay the loan. Also, the Fed said that prepayment penalties must end prior to the reset period, adding that these rules require tax and insurance escrows. Meanwhile, the other rules pertain to all mortgages. Mortgage brokers will not be paid beyond the amount originally agreed upon by the borrower. Lenders and brokers are also banned from pressuring appraisers to inflate home value estimates based on the proposal. Certain servicing practices, including late payment posting and late payment fees, aside from delinquent late payment fees, are banned. Meanwhile, servicers are requited to provide accurate and timely pay-off statements. The proposal defines higher-priced mortgages as those with annual percentage rates (APRs) that are 300 basis points or more over the comparable Treasury rate. For fixed-rate loans with at least a 20-year maturity, the APR will be linked to the 10- year Treasury. Also, under the new rules, hybrid ARMs will be likened to the Treasury rate closely matching the loan’s fixed-rate term. For instance, a 5/1 hybrid ARM will be compared with a five-year Treasury. Meanwhile, Alt-A and prime jumbo hybrid ARMs, as well as subprime mortgages, usually have relatively high margins — as high as 250 basis points — above the loan’s indexed rate (commonly six-month or one-year Libor). This is why it is not a stretch, especially in an inverted yield curve or in periods of low Treasury yields and wide mortgage spreads, for the APR on most ARMs to go over 300 basis points over Treasury. Fixed-rate jumbo mortgages now carry rates of roughly 6.6% below the threshold, Barclays noted. But, analysts said that if up-front points and fees are factored into the rate, some prime jumbo fixed-rates might alsofall into this higher-price category. Barclays concluded that if the changes are implemented, these could have significant ramifications for the Alt-A market’s size.