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Federal Reserve Bank of Dallas
2200 N. PEARL ST.
DALLAS, TX 75201-2272

January 4, 2006

Notice 06-01

TO: The Chief Executive Officer of each
financial institution and others concerned
in the Eleventh Federal Reserve District

SUBJECT
Interagency Guidance on
Nontraditional Mortgage Products
DETAILS

The Board of Governors, Office of the Comptroller of the Currency, Federal Deposit
Insurance Corporation, Office of Thrift Supervision, and National Credit Union Administration
(the agencies) have requested comment on a proposed Interagency Guidance on Nontraditional
Mortgage Products (guidance). The agencies expect institutions to effectively assess and manage
the risks associated with their credit activities, including those associated with nontraditional
mortgage loan products. Institutions should use this guidance in their efforts to ensure that their
risk management and consumer protection practices adequately address these risks.
The Board must receive comments by February 27, 2006. Please address comments to
Jennifer J. Johnson, Secretary, Board of Governors of the Federal Reserve System, 20th Street
and Constitution Avenue, N.W., Washington, DC 20551. Also, you may mail comments
electronically to regs.comments@federalreserve.gov. All comments should refer to Docket
No. OP-1246.
The public can also view and submit comments on proposals by the Board and other
federal agencies from the www.regulations.gov web site.

For additional copies, bankers and others are encouraged to use one of the following toll-free numbers in contacting the Federal
Reserve Bank of Dallas: Dallas Office (800) 333-4460; El Paso Branch Intrastate (800) 592-1631, Interstate (800) 351-1012;
Houston Branch Intrastate (800) 392-4162, Interstate (800) 221-0363; San Antonio Branch Intrastate (800) 292-5810.

-2ATTACHMENT
A copy of the agencies’ notice as it appears on pages 77249–57, Vol. 70, No. 249 of the
Federal Register dated December 29, 2005, is attached.
MORE INFORMATION
For more information, please contact Lynn Black, Banking Supervision Department, (214)
922-6069. Previous Federal Reserve Bank notices are available on our web site at
www.dallasfed.org/banking/notices/index.html or by contacting the Public Affairs Department
at (214) 922-5254.

Federal Register / Vol. 70, No. 249 / Thursday, December 29, 2005 / Notices
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
[Docket No. 05–21]

FEDERAL RESERVE SYSTEM
[Docket No. OP–1246]

FEDERAL DEPOSIT INSURANCE
CORPORATION
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
[No. 2005–56]

NATIONAL CREDIT UNION
ADMINISTRATION
Interagency Guidance on
Nontraditional Mortgage Products

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AGENCIES: Office of the Comptroller of
the Currency, Treasury (OCC); Board of
Governors of the Federal Reserve
System (Board); Federal Deposit
Insurance Corporation (FDIC); Office of
Thrift Supervision, Treasury (OTS); and
National Credit Union Administration
(NCUA).
ACTION: Proposed guidance with request
for comment.
SUMMARY: The OCC, Board, FDIC, OTS,
and NCUA (the Agencies), request
comment on this proposed Interagency
Guidance on Nontraditional Mortgage
Products (Guidance). The Agencies
expect institutions to effectively assess
and manage the risks associated with
their credit activities, including those
associated with nontraditional mortgage
loan products. Institutions should use
this guidance in their efforts to ensure
that their risk management and
consumer protection practices
adequately address these risks.
DATES: Comments must be submitted on
or before February 27, 2006.
ADDRESSES: The Agencies will jointly
review all of the comments submitted.
Therefore, interested parties may send
comments to any of the Agencies and
need not send comments (or copies) to
all of the Agencies. Please consider
submitting your comments by e-mail or
fax since paper mail in the Washington
area and at the Agencies is subject to
delay. Interested parties are invited to
submit comments to:
OCC: You should include ‘‘OCC’’ and
Docket Number 05–21 in your comment.
You may submit your comment by any
of the following methods:
• Federal eRulemaking Portal: http://
www.regulations.gov. Follow the
instructions for submitting comments.

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• OCC Web site: http://
www.occ.treas.gov. Click on ‘‘Contact
the OCC,’’ scroll down and click on
‘‘Comments on Proposed Regulations.’’
• E-Mail Address:
regs.comments@occ.treas.gov.
• Fax: (202) 874–4448.
• Mail: Office of the Comptroller of
the Currency, 250 E Street, SW., Mail
Stop 1–5, Washington, DC 20219.
• Hand Delivery/Courier: 250 E
Street, SW., Attn: Public Information
Room, Mail Stop 1–5, Washington, DC
20219.
Instructions: All submissions received
must include the agency name (OCC)
and docket number for this notice. In
general, the OCC will enter all
comments received into the docket
without change, including any business
or personal information that you
provide.
You may review comments and other
related materials by any of the following
methods:
• Viewing Comments Personally: You
may personally inspect and photocopy
comments at the OCC’s Public
Information Room, 250 E Street, SW.,
Washington, DC. You can make an
appointment to inspect comments by
calling (202) 874–5043.
• Viewing Comments Electronically:
You may request that we send you an
electronic copy of comments via e-mail
or mail you a CD–ROM containing
electronic copies by contacting the OCC
at regs.comments@occ.treas.gov.
• Docket Information: You may also
request available background
documents and project summaries using
the methods described above.
Board: You may submit comments,
identified by Docket No. OP–1246, by
any of the following methods:
• Agency Web site: http://
www.federalreserve.gov. Follow the
instructions for submitting comments at
http://www.federalreserve.gov/
generalinfo/foia/ProposedRegs.cfm.
• Federal eRulemaking Portal: http://
www.regulations.gov. Follow the
instructions for submitting comments.
• E-mail:
regs.comments@federalreserve.gov.
Include the docket number in the
subject line of the message.
• Fax: 202/452–3819 or 202/452–
3102.
• Mail: Jennifer J. Johnson, Secretary,
Board of Governors of the Federal
Reserve System, 20th Street and
Constitution Avenue, NW., Washington,
DC 20551.
All public comments are available
from the Board’s Web site at
www.federalreserve.gov/generalinfo/
foia/ProposedRegs.cfm as submitted,
unless modified for technical reasons.

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Accordingly, your comments will not be
edited to remove any identifying or
contact information. Public comments
may also be viewed in electronic or
paper form in Room MP–500 of the
Board’s Martin Building (20th and C
Streets, NW.) between 9 a.m. and 5 p.m.
on weekdays.
FDIC: You may submit comments by
any of the following methods:
• Agency Web site: http://
www.fdic.gov/regulations/laws/federal/
propose.html. Follow the instructions
for submitting comments on the Agency
Web site.
• E-Mail: Comments@FDIC.gov.
• Mail: Robert E. Feldman, Executive
Secretary, Attention: Comments, Federal
Deposit Insurance Corporation, 550 17th
Street, NW., Washington, DC 20429.
• Hand Delivery/Courier: Guard
station at the rear of the 550 17th Street
Building (located on F Street) on
business days between 7 a.m. and 5 p.m.
Instructions: All submissions received
must include the agency name. All
comments received will be posted
without change to http://www.fdic.gov/
regulations/laws/federal/propose.html
including any personal information
provided.
OTS: You may submit comments,
identified by docket number 2005–56,
by any of the following methods:
• Federal eRulemaking Portal: http://
www.regulations.gov. Follow the
instructions for submitting comments.
• E-mail address:
regs.comments@ots.treas.gov. Please
include docket number 2005–56 in the
subject line of the message and include
your name and telephone number in the
message.
• Fax: (202) 906–6518.
• Mail: Regulation Comments, Chief
Counsel’s Office, Office of Thrift
Supervision, 1700 G Street, NW.,
Washington, DC 20552, Attention: No.
2005–56.
• Hand Delivery/Courier: Guard’s
Desk, East Lobby Entrance, 1700 G
Street, NW., from 9 a.m. to 4 p.m. on
business days. Address envelope as
follows: Attention: Regulation
Comments, Chief Counsel’s Office,
Attention: No. 2005–56.
Instructions: All submissions received
must include the agency name and
docket number for this proposed
Guidance. All comments received will
be posted without change to the OTS
Internet site at http://www.ots.treas.gov/
pagehtml.cfm?catNumber=67&an=1,
including any personal information
provided.
Docket: For access to the docket to
read background documents or
comments received, go to http://
www.ots.treas.gov/

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pagehtml.cfm?catNumber=67&an=1. In
addition, you may inspect comments at
the OTS’s Public Reading Room, 1700 G
Street, NW., by appointment. To make
an appointment for access, call (202)
906–5922, send an e-mail to
public.info@ots.treas.gov, or send a
facsimile transmission to (202) 906–
7755. (Prior notice identifying the
materials you will be requesting will
assist us in serving you.) We schedule
appointments on business days between
10 a.m. and 4 p.m. In most cases,
appointments will be available the next
business day following the date we
receive a request.
NCUA: You may submit comments by
any of the following methods:
• Federal eRulemaking Portal: http://
www.regulations.gov. Follow the
instructions for submitting comments.
• NCUA Web site: http://
www.ncua.gov/
RegulationsOpinionsLaws/
proposed_regs/proposed_regs.html.
Follow the instructions for submitting
comments.
• E-mail: Address to
regcomments@ncua.gov. Include ‘‘[Your
name] Comments on Interagency
Guidance on Nontraditional Mortgages’’
in the e-mail subject line.
• Fax: (703) 518–6319. Use the
subject line described above for e-mail.
• Mail: Address to Mary Rupp,
Secretary of the Board, National Credit
Union Administration, 1775 Duke
Street, Alexandria, Virginia 22314–
3428.
• Hand Delivery/Courier: Same as
mail address.
FOR FURTHER INFORMATION CONTACT:
OCC: Gregory Nagel, National Bank
Examiner/Credit Risk Specialist, Credit
Risk Policy, (202) 874–5170; or Michael
S. Bylsma, Director, or Stephen Van
Meter, Assistant Director, Community
and Consumer Law Division, (202) 874–
5750.
Board: Brian Valenti, Supervisory
Financial Analyst, (202) 452–3575; or
Virginia Gibbs, Senior Supervisory
Financial Analyst, (202) 452–2521; or
Sabeth I. Siddique, Assistant Director,
(202) 452–3861, Division of Banking
Supervision and Regulation; Minh-Duc
T. Le, Senior Attorney, Division of
Consumer and Community Affairs, (202)
452–3667; or Andrew Miller, Counsel,
Legal Division, (202) 452–3428. For
users of Telecommunications Device for
the Deaf (‘‘TDD’’) only, contact (202)
263–4869.
FDIC: James Leitner, Senior
Examination Specialist, (202) 898–6790,
or April Breslaw, Chief, Compliance
Section, (202) 898–6609, Division of
Supervision and Consumer Protection;

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or Ruth R. Amberg, Senior Counsel,
(202) 898–3736, or Richard Foley,
Counsel, (202) 898–3784, Legal
Division.
OTS: William Magrini, Senior Project
Manager, (202) 906–5744; or Maurice
McClung, Program Manager, Market
Conduct, Consumer Protection and
Specialized Programs, (202) 906–6182;
and Richard Bennett, Counsel, Banking
and Finance, (202) 906–7409.
NCUA: Cory Phariss, Program Officer,
Examination and Insurance, (703) 518–
6618.
SUPPLEMENTARY INFORMATION:
I. Background
In recent years, consumer demand
and secondary market appetite have
grown rapidly for mortgage products
that allow borrowers to defer payment
of principal and, sometimes, interest.
These products, often referred to as
nontraditional mortgage loans,
including ‘‘interest-only’’ mortgages and
‘‘payment option’’ adjustable-rate
mortgages have been available in similar
forms for many years. Nontraditional
mortgage loans offer payment flexibility
and are an effective and beneficial
financial management tool for some
borrowers. These products allow
borrowers to exchange lower payments
during an initial period for higher
payments during a later amortization
period as compared to the level
payment structure found in traditional
fixed-rate mortgage loans. In addition,
institutions are increasingly combining
these loans with other practices, such as
making simultaneous second-lien
mortgages and allowing reduced
documentation in evaluating the
applicant’s creditworthiness. While
innovations in mortgage lending can
benefit some consumers, these layering
practices can present unique risks that
institutions must appropriately
measure, monitor and control.
The Agencies recognize that many of
the risks associated with nontraditional
mortgage loans exist in other adjustablerate mortgage products, but our concern
is elevated with nontraditional products
due to the lack of principal amortization
and potential accumulation of negative
amortization. The Agencies are also
concerned that these products and
practices are being offered to a wider
spectrum of borrowers, including some
who may not otherwise qualify for
traditional fixed-rate or other adjustablerate mortgage loans, and who may not
fully understand the associated risks.
Regulatory experience with
nontraditional mortgage lending
programs has shown that prudent
management of these programs requires
increased attention in product

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development, underwriting,
compliance, and risk management
functions. As with all activities, the
Agencies expect institutions to
effectively assess and manage the risks
associated with nontraditional mortgage
loan products. The Agencies have
developed this proposed Guidance to
clarify how institutions can offer these
products in a safe and sound manner,
and in a way that clearly discloses the
potential risks that borrowers may
assume. The Agencies will carefully
scrutinize institutions’ lending
programs, including policies and
procedures, and risk management
processes in this area, recognizing that
a number of different, but prudent
practices may exist. Remedial action
will be requested from institutions that
do not adequately measure, monitor,
and control risk exposures in loan
portfolios. Further, the agencies will
seek to consistently implement the
guidance.
II. Principal Elements of the Guidance
Prudent lending practices include the
maintenance of sound loan terms and
underwriting standards. Institutions
should assess current loan terms and
underwriting guidelines and implement
any necessary changes to ensure
prudent practices. In connection with
underwriting standards, the proposed
Guidance addresses:
• Appropriate borrower repayment
analysis, including consideration of
comprehensive debt service in the
qualification process;
• The potential for collateraldependent loans, which could arise
when a borrower is overly reliant on the
sale or refinancing of the property when
loan amortization begins;
• Mitigating factors that support the
underwriting decision in circumstances
involving a combination of
nontraditional mortgage loans and
reduced documentation;
• Below market introductory interest
rates;
• Lending to subprime borrowers;
and
• Loans secured by non owneroccupied properties.
The proposed Guidance also describes
appropriate portfolio and risk
management practices for institutions
that offer nontraditional mortgage
products. These practices include the
development of policies and internal
controls that address, among other
matters, product attributes, portfolio
and concentration limits, third-party
originations, and secondary market
activities. In connection with risk
management practices, the Guidance
also proposes that institutions should:

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• Maintain performance measures
and management reporting systems that
provide warning of potential or
increasing risks;
• Maintain an allowance for loan and
lease losses (ALLL) at a level
appropriate for portfolio credit quality
and conditions affecting collectibility;
• Maintain capital levels that reflect
nontraditional mortgage portfolio
characteristics and the effect of stressed
economic conditions on collectibility;
and
• Apply sound practices in valuing
the mortgage servicing rights of
nontraditional mortgages.
Finally, the proposed Guidance
describes consumer protection concerns
that may be raised by nontraditional
mortgage loan products, particularly
that borrowers may not fully understand
the terms of these products.
Nontraditional mortgage loan products
are more complex than traditional fixedrate products and adjustable rate
products and present greater risks of
payment shock and negative
amortization. Institutions should ensure
that consumers are provided clear and
balanced information about the relative
benefits and risks of these products, at
a time that will help consumers’
decision-making processes. The
proposed Guidance discusses applicable
laws and regulations and then describes
recommended practices for
communications with and the provision
of information to consumers. These
recommended practices address
promotional materials and product
descriptions, information on monthly
payment statements, and the avoidance
of practices that obscure significant
risks to the consumer or raise similar
concerns. The proposed Guidance also
describes control systems that should be
used to ensure that actual practices are
consistent with policies and procedures.
When finalized, the Guidance would
apply 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.
III. Request for Comment
Comment is requested on all aspects
of the proposed Guidance. Interested
commenters are also asked to address
specifically the proposed Guidance on
comprehensive debt service
qualification standards, which provides
that the analysis of borrowers’
repayment capacity should include an
evaluation of their ability to repay the
debt by final maturity at the fully
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amortizing repayment schedule. For
products with the potential for negative
amortization, the repayment analysis
should include the initial loan amount
plus any balance increase that may
accrue through the negative
amortization provision. In this regard,
comment is specifically requested on
the following:
(1) Should lenders analyze each
borrower’s capacity to repay the loan
under comprehensive debt service
qualification standards that assume the
borrower makes only minimum
payments? What are current
underwriting practices and how would
they change if such prescriptive
guidance is adopted?
(2) What specific circumstances
would support the use of the reduced
documentation feature commonly
referred to as ‘‘stated income’’ as being
appropriate in underwriting
nontraditional mortgage loans? What
other forms of reduced documentation
would be appropriate in underwriting
nontraditional mortgage loans and
under what circumstances? Please
include specific comment on whether
and under what circumstances ‘‘stated
income’’ and other forms of reduced
documentation would be appropriate for
subprime borrowers.
(3) Should the Guidance address the
consideration of future income in the
qualification standards for
nontraditional mortgage loans with
deferred principal and, sometimes,
interest payments? If so, how could this
be done on a consistent basis? Also, if
future events such as income growth are
considered, should other potential
events also be considered, such as
increases in interest rates for adjustable
rate mortgage products?
The text of the proposed Interagency
Guidance on Nontraditional Mortgage
Products follows:
Interagency Guidance on Nontraditional
Mortgage Products
Residential mortgage lending has
traditionally been a conservatively
managed business with low
delinquencies and losses and reasonably
stable underwriting standards. In the
past few years, there has been a growing
consumer demand, particularly in high
priced real estate markets, for
residential mortgage loan products that
allow borrowers to defer repayment of
principal and, sometimes, interest.
These mortgage products, often referred
to as nontraditional mortgage loans,
include ‘‘interest-only’’ mortgages
where a borrower pays no loan principal
for the first few years of the loan and
‘‘payment option’’ adjustable-rate
mortgages (ARMs) where a borrower has

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flexible payment options with the
potential for negative amortization.1
More recently, nontraditional mortgage
loan products are being offered to a
wider spectrum of borrowers who may
not otherwise qualify for more
traditional mortgage loans and may not
fully understand the associated risks.
Many of these nontraditional
mortgage loans are also being
underwritten with less stringent or no
income and asset verification
requirements (‘‘reduced
documentation’’) and are increasingly
combined with simultaneous secondlien loans.2 These risk-layering
practices, combined with the broader
marketing of nontraditional mortgage
loans, expose financial institutions to
increased risk relative to traditional
mortgage loans.
Given the potential for heightened
risk levels, management should
carefully consider and appropriately
mitigate exposures created by these
loans. To manage the risks associated
with nontraditional mortgage loans,
management should:
• Ensure that loan terms and
underwriting standards are consistent
with prudent lending practices,
including consideration of a borrower’s
repayment capacity;
• Recognize that many nontraditional
mortgage loans, particularly when
combined with risk-layering features,
are untested in a stressed environment
and, therefore, warrant strong risk
management standards, capital levels
commensurate with the risk, and an
allowance for loan and lease losses that
reflects the collectibility of the portfolio;
and
• Ensure that consumers have
information to clearly understand loan
terms and associated risks prior to
making a product choice.
As with all activities, the Office of the
Comptroller of the Currency (OCC), the
Board of Governors of the Federal
Reserve System (Board), the Federal
Deposit Insurance Corporation (FDIC),
the Office of Thrift Supervision (OTS)
and the National Credit Union
Administration (NCUA) (collectively,
the Agencies) expect institutions to
effectively assess and manage the
increased risks associated with
nontraditional mortgage loan products.3
1 Interest-only and payment option ARMs are
variations of conventional ARMs, hybrid ARMs,
and fixed rate products. Refer to the Appendix for
additional information on interest-only and
payment option ARM loans.
2 Refer to the Appendix for additional
information on reduced documentation and
simultaneous second-lien loans.
3 Refer to Interagency Guidelines Establishing
Standards for Safety and Soundness. For each

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Institutions should use this guidance
in their efforts to ensure that their risk
management practices adequately
address these risks. The Agencies will
carefully scrutinize institutions’ risk
management processes, policies, and
procedures in this area. Remedial action
will be requested from institutions that
do not adequately manage these risks.
Further, the Agencies will seek to
consistently implement this guidance.
Loan Terms and Underwriting
Standards
When an institution offers
nontraditional mortgage loan products,
underwriting standards should address
the effect of a substantial payment
increase on the borrower’s capacity to
repay when loan amortization begins.
Moreover, the institution’s underwriting
standards should comply with the
agencies’ real estate lending standards
and appraisal regulations and associated
guidelines.4
Central to prudent lending is the
internal discipline to maintain sound
loan terms and underwriting standards
despite competitive pressures.
Institutions are strongly cautioned
against ceding underwriting standards
to third parties that have different
business objectives, risk tolerances, and
core competencies. Loan terms should
be based on a disciplined analysis of
potential exposures and compensating
factors to ensure risk levels remain
manageable.
Qualification Standards—
Nontraditional mortgage loans can
result in significantly higher payment
requirements when the loan begins to
fully amortize. This increase in monthly
mortgage payments, commonly referred
to as payment shock, is of particular
concern for payment option ARMs
where the borrower makes minimum
payments that may result in negative
amortization. Some institutions manage
Agency, those respective guidelines are addressed
in: 12 CFR Part 30 Appendix A (OCC); 12 CFR Part
208 Appendix D–1 (Board); 12 CFR Part 364
Appendix A (FDIC); 12 CFR Part 570 Appendix A
(OTS); and 12 U.S.C. 1786 (NCUA).
4 Refer to 12 CFR Part 34—Real Estate Lending
and Appraisals, OCC Bulletin 2005–3—Standards
for National Banks’ Residential Mortgage Lending,
AL 2003–7—Guidelines for Real Estate Lending
Policies and AL 2003–9—Independent Appraisal
and Evaluation Functions (OCC); 12 CFR 208.51
subpart E and Appendix C and 12 CFR Part 225
subpart G (Board); 12 CFR Part 365 and Appendix
A, and 12 CFR Part 323 (FDIC); 12 CFR 560.101 and
Appendix and 12 CFR Part 564 (OTS). Also, refer
to the 1999 Interagency Guidance on the
‘‘Treatment of High LTV Residential Real Estate
Loans’’ and the 1994 ‘‘Interagency Appraisal and
Evaluation Guidelines.’’ Federally Insured Credit
Unions should refer to 12 CFR Part 722—Appraisals
and NCUA 03–CU–17—Appraisal and Evaluation
Functions for Real Estate Related Transactions
(NCUA).

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the potential for excessive negative
amortization and payment shock by
structuring the initial terms to limit the
spread between the introductory interest
rate and the fully indexed rate.
Nevertheless, an institution’s qualifying
standards should recognize the potential
impact of payment shock, and that
nontraditional mortgage loans often are
inappropriate for borrowers with high
loan-to-value (LTV) ratios, high debt-toincome (DTI) ratios, and low credit
scores.
For all nontraditional mortgage loan
products, the analysis of borrowers’
repayment capacity should include an
evaluation of their ability to repay the
debt by final maturity at the fully
indexed rate,5 assuming a fully
amortizing repayment schedule. In
addition, for products that permit
negative amortization, the repayment
analysis should include the initial loan
amount plus any balance increase that
may accrue from the negative
amortization provision. The amount of
the balance increase should be tied to
the initial terms of the loan and
estimated assuming the borrower makes
only minimum payments during the
deferral period. Institutions should also
consider the potential risks that a
borrower may face in refinancing the
loan at the time it begins to fully
amortize, such as prepayment penalties.
These more fully comprehensive debt
service calculations should be
considered when establishing the
institution’s qualifying criteria.
Furthermore, the analysis of
repayment capacity should avoid overreliance on credit scores as a substitute
for income verification in the
underwriting process. As the level of
credit risk increases, either from loan
features or borrower characteristics, the
importance of actual verification of the
borrower’s income, assets, and
outstanding liabilities also increases.
5 The fully indexed rate equals the index rate
prevailing at origination plus the margin that will
apply after the expiration of an introductory interest
rate. The index rate is a published interest rate to
which the interest rate on an ARM is tied. Some
commonly used indices include the 1-Year
Constant Maturity Treasury Rate (CMT), the 6Month London Interbank Offered Rate (LIBOR), the
11th District Cost of Funds (COFI), and the Moving
Treasury Average (MTA), a 12-month moving
average of the monthly average yields of U.S.
Treasury securities adjusted to a constant maturity
of one year. The margin is the number of percentage
points a lender adds to the index value to calculate
the ARM interest rate at each adjustment period. In
different interest rate scenarios, the fully indexed
rate for an ARM loan based on a lagging index (e.g.,
MTA rate) may be significantly different from the
rate on a comparable 30-year fixed-rate product. In
these cases, a credible market rate should be used
to qualify the borrower and determine repayment
capacity.

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Federal Register / Vol. 70, No. 249 / Thursday, December 29, 2005 / Notices
Collateral-Dependent Loans—
Institutions should avoid the use of loan
terms and underwriting practices that
may result in the borrower having to
rely on the sale or refinancing of the
property once amortization begins.
Loans to borrowers who do not
demonstrate the capacity to repay, as
structured, from sources other than the
collateral pledged are generally
considered unsafe and unsound.
Institutions determined to be originating
collateral-dependent mortgage loans,
may be subject to criticism, corrective
action, and higher capital requirements.
Risk Layering—Nontraditional
mortgage loans combined with risklayering features, such as reduced
documentation and/or a simultaneous
second-lien loan, pose increased risk.
When risks are layered, an institution
should compensate for this increased
risk with mitigating factors that support
the underwriting decision and the
borrower’s repayment capacity.
Mitigating factors might include higher
credit scores, lower LTV and DTI ratios,
credit enhancements, and mortgage
insurance. While higher pricing may
seem to address the increased risks
associated with risk-layering features, it
raises the importance of prudent
qualification standards discussed above.
Further, institutions should fully
consider the effect of these risk-layering
features on estimated credit losses when
establishing their allowance for loan
and lease losses (ALLL).
Reduced Documentation—Institutions
are increasingly relying on reduced
documentation, particularly unverified
income to qualify borrowers for
nontraditional mortgage loans. Because
these practices essentially substitute
assumptions and alternate information
for the waived data in analyzing a
borrower’s repayment capacity and
general creditworthiness, they should be
used with caution. An institution
should consider whether its verification
practices are adequate. As the level of
credit risk increases, the Agencies
expect that an institution will apply
more comprehensive verification and
documentation procedures to verify a
borrower’s income and debt reduction
capacity.
Use of reduced documentation in the
underwriting process should be
governed by clear policy guidelines.
Reduced documentation, such as stated
income, should be accepted only if there
are other mitigating factors such as
lower LTV and other more conservative
underwriting standards.
Simultaneous Second-Lien Loans—
Simultaneous second-lien loans result
in reduced owner equity and higher
credit risk. Historically, as combined

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loan-to-value ratios rise, defaults rise as
well. A delinquent borrower with
minimal or no equity in a property may
have little incentive to work with the
lender to bring the loan current to avoid
foreclosure. In addition, second-lien
home equity lines of credit (HELOCs)
typically increase borrower exposure to
increasing interest rates and monthly
payment burdens. Loans with minimal
owner equity should generally not have
a payment structure that allows for
delayed or negative amortization.
Introductory Interest Rates—Many
institutions offer introductory interest
rates that are set well below the fully
indexed rate as a marketing tool for
payment option ARM products. In
developing nontraditional mortgage
products, an institution should consider
the spread between the introductory rate
and the fully indexed rate. Since initial
monthly mortgage payments are based
on these low introductory rates, there is
a greater potential for a borrower to
experience negative amortization,
increased payment shock, and earlier
recasting of the borrower’s monthly
payments than originally scheduled. In
setting introductory rates, institutions
should consider ways to minimize the
probability of disruptive early recastings
and extraordinary payment shock.
Lending to Subprime Borrowers—
Mortgage programs that target subprime
borrowers through tailored marketing,
underwriting standards, and risk
selection should follow the applicable
interagency guidance on subprime
lending.6 Among other things, the
subprime guidance discusses the
circumstances under which subprime
lending can become predatory or
abusive. Additionally, an institution’s
practice of risk layering for loans to
subprime borrowers may significantly
increase the risk to both the institution
and the borrower. Institutions should
pay particular attention to these
circumstances, as they design
nontraditional mortgage loan products
for subprime borrowers.
Non Owner-Occupied Investor
Loans—Borrowers financing non owneroccupied investment properties should
be qualified on their ability to service
the debt over the life of the loan. Loan
terms should also reflect an appropriate
combined LTV ratio that considers the
potential for negative amortization and
maintains sufficient borrower equity
over the life of the loan. Further,
nontraditional mortgages to finance non
owner-occupied investor properties
6 Interagency Guidance on Subprime Lending,
March 1, 1999, and Expanded Guidance for
Subprime Lending Programs, January 31, 2001.
Federally Insured Credit Unions should refer to 04–
CU–12 ‘‘ Specialized Lending Activities (NCUA).

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should require evidence that the
borrower has sufficient cash reserves to
service the loan in the near term in the
event that the property becomes
vacant.7
Portfolio and Risk Management
Practices
Institutions should recognize that
nontraditional mortgage loans are
untested in a stressed environment and,
accordingly, should receive higher
levels of monitoring and loss mitigation.
Moreover, institutions should ensure
that portfolio and risk management
practices keep pace with the growth and
changing risk profile of their
nontraditional mortgage loan portfolios.
Active portfolio management is
especially important for institutions that
project or have already experienced
significant growth or concentrations of
nontraditional products. Institutions
that originate or invest in nontraditional
mortgage loans should adopt more
robust risk management practices and
manage these exposures in a thoughtful,
systematic manner by:
• Developing written policies that
specify acceptable product attributes,
production and portfolio limits, sales
and securitization practices, and risk
management expectations;
• Designing enhanced performance
measures and management reporting
that provide early warning for
increasing risk;
• Establishing appropriate ALLL
levels that consider the credit quality of
the portfolio and conditions that affect
collectibility; and
• Maintaining capital at levels that
reflect portfolio characteristics and the
effect of stressed economic conditions
on collectibility. Institutions should
hold capital commensurate with the risk
characteristics of their nontraditional
mortgage loan portfolios.
Policies—An institution’s policies for
nontraditional mortgage lending activity
should set forth acceptable levels of risk
through its operating practices,
accounting procedures, and policy
exception tolerances. Policies should
reflect appropriate limits on risk
layering and should include risk
management tools for risk mitigation
purposes. Further, an institution should
set growth and volume limits by loan
type, with special attention for products
and product combinations in need of
heightened attention due to easing terms
or rapid growth.
Concentrations—Concentration limits
should be set for loan types, third-party
7 Federally Insured Credit Unions must comply
with 12 CFR Part 723 for loans meeting the
definition of member business loans.

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originations, geographic area, and
property occupancy status, to maintain
portfolio diversification. Concentration
limits should also be set on key
portfolio characteristics such as loans
with high combined LTV and DTI ratios,
loans with the potential for negative
amortization, loans to borrowers with
credit scores below established
thresholds, and nontraditional mortgage
loans with layered risks. The
combination of nontraditional mortgage
loans with risk-layering features should
be regularly analyzed to determine if
excessive concentrations or risks exist.
Institutions with excessive
concentrations or deficient risk
management practices will be subject to
elevated supervisory attention and
potential examiner criticism to ensure
timely remedial action. Further,
institutions should consider the effect of
employee incentive programs that may
result in higher concentrations of
nontraditional mortgage loans.
Controls—An institution’s quality
control, compliance, and audit
procedures should specifically target
those mortgage lending activities
exhibiting higher risk. For
nontraditional mortgage loan products,
an institution should have appropriate
controls to monitor compliance and
exceptions to underwriting standards.
The institution’s quality control
function should regularly review a
sample of reduced documentation loans
from all origination channels and a
representative sample of underwriters to
confirm that policies are being followed.
When control systems or operating
practices are found deficient, business
line managers should be held
accountable for correcting deficiencies
in a timely manner.
Since many nontraditional mortgage
loans permit a borrower to defer
principal and, in some cases, interest
payments for extended periods,
institutions should have strong controls
over accruals, customer service and
collections. Policy exceptions made by
servicing and collections personnel
should be carefully monitored to
confirm that practices such as re-aging,
payment deferrals, and loan
modifications are not inadvertently
increasing risk. Since payment option
ARMs require higher levels of customer
support than other mortgage loans,
customer service and collections
personnel should receive productspecific training on the features and
potential customer issues.
Third-Party Originations—Institutions
often use third-party channels, such as
mortgage brokers or correspondents, to
originate nontraditional mortgage loans.
When doing so, an institution should

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have strong approval and control
systems to ensure the quality of thirdparty originations and compliance with
all applicable laws and regulations, with
particular emphasis on marketing and
borrower disclosure practices. Controls
over third parties should be designed to
ensure that loans made through these
channels reflect the standards and
practices used by an institution in its
direct lending activities.
Monitoring procedures should track
the quality of loans by both origination
source and key borrower characteristics
in order to identify problems, such as
early payment defaults, incomplete
documentation, and fraud. A strong
monitoring process should enable
management to determine whether
third-party originators are producing
quality loans. If appraisal, loan
documentation, or credit problems are
discovered, the institution should take
immediate action, which could include
terminating its relationship with the
third-party.8
Secondary Market Activity—The
sophistication of an institution’s
secondary market risk management
practices should be commensurate with
the nature and volume of activity.
Institutions with significant secondary
market reliance should have
comprehensive, formal approaches to
risk management.9 This should include
consideration of the risks to the
institution should demand in the
secondary markets dissipate.
While sale of loans to third parties
can transfer a portion of the portfolio’s
credit risk, an institution continues to
be exposed to reputation risk that arises
when the credit losses on sold loans or
securitization transactions exceed
expected losses. In order to protect its
reputation in the market, an institution
may determine that it is necessary to
repurchase defaulted mortgages. It
should be noted that the repurchase of
mortgage loans beyond the selling
institution’s contractual obligations is,
in the Agencies’ view, implicit recourse.
Under the Agencies’ risk-based capital
8 Refer to OCC Bulletin 2001–47—Third-Party
Relationships and AL 2000–9—Third-Party Risk
(OCC). Federally Insured Credit Unions should refer
to 01–CU–20 (NCUA), Due Diligence Over ThirdParty Service Providers.
9 Refer to ‘‘Interagency Questions and Answers on
Capital Treatment of Recourse, Direct Credit
Substitutes, and Residual Interests in Asset
Securitizations,’’ May 23, 2002; OCC Bulletin 2002–
22 (OCC); SR letter 02–16 (Board); Financial
Institution Letter (FIL–54–2002) (FDIC); and CEO
Letter 163 (OTS). See OCC’s Comptroller Handbook
for Asset Securitization, November 1997. The Board
also addressed risk management and capital
adequacy of exposures arising from secondary
market credit activities in SR letter 97–21. Federally
Insured Credit Unions should refer to 12 CFR Part
702 (NCUA).

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standards, repurchasing mortgage loans
from a sold portfolio or from a
securitization in this manner would
require that risk-based capital be
maintained against the entire portfolio
or securitization.10 Further, loans sold
to third parties typically carry
representations and warranties from the
institution that these loans were
underwritten properly and all legal
requirements were satisfied. Therefore,
institutions involved in securitization
transactions should consider the
potential origination-related risks
arising from nontraditional mortgage
loans, including the adequacy of
disclosures to investors.
Management Information and
Reporting—An institution should have
the reporting capability to detect
changes in the risk profile of its
nontraditional mortgage loan portfolio.
Reporting systems should allow
management to isolate key loan
products, risk-layering loan features,
and borrower characteristics to allow
early identification of performance
deterioration. At a minimum,
information should be available by loan
type (e.g., interest-only mortgage loans
and payment option ARMs); the
combination of these loans with risklayering features (e.g., payment option
ARM with stated income and interestonly mortgage loans with simultaneous
second-lien mortgages); underwriting
characteristics (e.g., LTV, DTI, and
credit score); and borrower performance
(e.g., payment patterns, delinquencies,
interest accruals, and negative
amortization).
Portfolio volume and performance
results should be tracked against
expectations, internal lending
standards, and policy limits. Volume
and performance expectations should be
established at the subportfolio and
aggregate portfolio levels. Variance
analyses should be performed regularly
to identify exceptions to policies and
prescribed thresholds. Qualitative
analysis should be undertaken when
actual performance deviates from
established policies and thresholds.
Variance analysis is critical to the
monitoring of the portfolio’s risk
characteristics and should be an integral
part of an institution’s forecasting
process to establish and adjust risk
tolerance levels.
Stress Testing—Institutions should
perform sensitivity analysis on key
portfolio segments to identify and
quantify events that may increase risks
in a segment or the entire portfolio. This
10 Federally Insured Credit Unions should refer to
12 CFR Part 702 for their risk based net worth
requirements.

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should generally include stress tests on
key performance drivers such as interest
rates, employment levels, economic
growth, housing value fluctuations, and
other factors beyond the institution’s
immediate control. Stress tests typically
assume rapid deterioration in one or
more factors and attempt to estimate the
potential influence on default rates and
loss severity. Through stress testing, an
institution should be able to identify,
monitor and manage risk, as well as
develop appropriate and cost-effective
loss mitigation strategies. The stress
testing results should provide direct
feedback in determining underwriting
standards, product terms, portfolio
concentration limits, and capital levels.
Capital and Allowance for Loan and
Lease Losses—Institutions should
establish appropriate allowances for the
estimated credit losses in their
nontraditional mortgage loan portfolios
and hold capital commensurate with the
risk characteristics of these portfolios.
Moreover, institutions should recognize
that the limited performance history of
these products, particularly in a stressed
environment, increases performance
uncertainty. As loan terms evolve and
underwriting practices ease, this lack of
seasoning may warrant higher capital
levels.
In establishing an appropriate ALLL
and considering the adequacy of capital,
institutions should segment their
nontraditional mortgage loan portfolios
into pools with similar credit risk
characteristics. The basic segments
typically include collateral and loan
characteristics, geographic
concentrations, and borrower qualifying
attributes. Credit risk segments should
also distinguish among loans with
differing payment and portfolio
characteristics, such as borrowers who
habitually make only minimum
payments, mortgages with existing
balances above original balances due to
negative amortization, and mortgages
subject to sizable payment shock. The
objective is to identify key credit quality
indicators that affect collectibility for
ALLL measurement purposes and
important risk characteristics that
influence expected performance so that
migration into or out of key segments
provides meaningful information about
future loss exposure for purposes of
determining the level of capital to be
maintained.
Further, those institutions with
material mortgage banking activities and
mortgage servicing assets should apply
sound practices in valuing the mortgage
servicing rights of nontraditional
mortgages in accordance with

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interagency guidance.11 This guidance
requires institutions to follow generally
accepted accounting principles and
conservatively treat assumptions used
in valuing mortgage-servicing rights.
Consumer Protection Issues
While nontraditional mortgage loans
provide flexibility for consumers, the
Agencies are concerned that consumers
may enter into these transactions
without fully understanding the product
terms. Nontraditional mortgage products
have been advertised and promoted
based on their near-term monthly
payment affordability, and consumers
have been encouraged to select
nontraditional mortgage products based
on the lower monthly payments that
such products permit compared with
traditional types of mortgages. In
addition to apprising consumers of the
benefits of nontraditional mortgage
products, institutions should ensure
that they also appropriately alert
consumers to the risks of these
products, including the likelihood of
increased future payment obligations.
Institutions should also ensure that
consumers have information that is
timely and sufficient for making a sound
product selection decision.12
Concerns and Objectives—More than
traditional ARMs, mortgage products
such as payment option ARMs and
interest-only mortgages can carry a
significant risk of payment shock and
negative amortization that may not be
fully understood by consumers. For
example, consumer payment obligations
may increase substantially at the end of
an interest-only period or upon the
‘‘recast’’ of a payment option ARM. The
magnitude of these payment increases
may be affected by factors such as the
expiration of promotional interest rates,
increases in the interest rate index, and
negative amortization. Negative
amortization also results in lower levels
of home equity as compared to a
traditional amortizing mortgage product.
As a result, it may be more difficult for
consumers to refinance these loans. In
addition, in the event of a refinancing or
11 Refer to the ‘‘Interagency Advisory on Mortgage
Banking,’’ February 25, 2003, issued by the bank
and thrift regulatory agencies. Federally Insured
Credit Unions with assets of $10 million or more
are reminded they must report and value
nontraditional mortgages and related mortgage
servicing rights, if any, consistent with generally
accepted accounting principles in the Call Reports
they file with the NCUA Board.
12 Institutions also should review the
recommendations relating to mortgage lending
practices set forth in other sections of this guidance
and any other supervisory guidance from their
respective primary regulators, including the
discussion in the Subprime Lending Guidance
referenced in footnote 6 about abusive lending
practices.

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a sale of the property, negative
amortization may result in the reduction
or elimination of home equity, even
when the property has appreciated. The
concern that consumers may not fully
understand these products would be
exacerbated by marketing and
promotional practices that emphasize
potential benefits without also
effectively providing complete
information about material risks.
In light of these considerations,
institutions should ensure that
communications with consumers,
including advertisements, oral
statements, promotional materials, and
monthly statements, are consistent with
product terms and payment structures.
These communications should also
provide clear and balanced information
about the relative benefits and risks of
these products, including the risk of
payment shock and the risk of negative
amortization. Clear, balanced, and
timely communication to consumers of
the risks of these products is important
to ensuring that consumers have
appropriate information at crucial
decision-making points, such as when
they are shopping for loans or deciding
which monthly payment amount to
make. Such communication should help
minimize potential consumer confusion
and complaints, foster good customer
relations, and reduce legal and other
risks to the institution.
Legal Risks—Institutions that offer
nontraditional mortgage products must
ensure that they do so in a manner that
complies with all applicable laws and
regulations. With respect to the
disclosures and other information
provided to consumers, applicable laws
and regulations include the following:
• Truth in Lending Act (TILA) and its
implementing regulation, Regulation Z.
• Section 5 of the Federal Trade
Commission Act (FTC Act).
TILA and Regulation Z contain rules
governing disclosures that institutions
must provide for closed-end mortgages
in advertisements, with an
application,13 before loan
consummation, and when interest rates
change. Section 5 of the FTC Act
prohibits unfair or deceptive acts or
practices.14
13 These program disclosures apply to ARM
products and must be provided at the time an
application is provided or before the consumer pays
a nonrefundable fee, whichever is earlier.
14 The OCC, the Board, and the FDIC enforce this
provision under the FTC Act and section 8 of the
FDI Act. Each of these agencies has also issued
supervisory guidance to the institutions under their
respective jurisdictions concerning unfair or
deceptive acts or practices. See OCC Advisory
Letter 2002–3—Guidance on Unfair or Deceptive
Acts or Practices, March 22, 2002; Joint Board and

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Institutions should also ensure that
they comply with fair lending laws and
the Real Estate Settlement Procedures
Act (RESPA). Other federal laws also
apply to these loan products. Moreover,
the Agencies note that the sale or
securitization of a loan may not affect an
institution’s potential liability for
violations of TILA, RESPA, the FTC Act,
or other laws in connection with its
origination of the loan. State laws,
including laws regarding unfair or
deceptive acts or practices, also may be
applicable. It is important that
institutions have their communications
and other acts and practices reviewed
by counsel for compliance with all
applicable laws. Institutions also should
monitor applicable laws and regulations
for revisions to ensure that
communications continue to be fully
compliant.

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Recommended Practices
Recommended practices for
addressing the risks raised by
nontraditional mortgage products
include the following:
Communications with Consumers—
As with all communications with
consumers, institutions should present
important information in a clear manner
and format such that consumers will
notice it, can understand it to be
material, and will be able to use it in
their decision-making processes.15
Furthermore, when promoting or
describing nontraditional mortgage
products, institutions should provide
consumers with information that will
enable them to make informed decisions
and to use these products responsibly.
Meeting this objective requires
appropriate attention to the timing,
content, and clarity of information
presented to consumers. Thus,
institutions should provide consumers
with information at a time that will help
FDIC Guidance on Unfair or Deceptive Acts or
Practices by State-Chartered Banks, March 11, 2004.
Federally insured credit unions are prohibited from
using any advertising or promotional material that
is inaccurate, misleading, or deceptive in any way
concerning its products, services, or financial
condition. 12 CFR 740.2. The OTS also has a
regulation that prohibits savings associations from
using advertisements or other representations that
are inaccurate or misrepresent the services or
contracts offered. 12 CFR 563.27. This regulation
supplements its authority under the FTC Act.
15 In this regard, institutions should strive to: (1)
Focus on information important to consumer
decision making; (2) highlight key information so
that it will be noticed; (3) employ a user-friendly
and readily navigable format for presenting the
information; and (4) use plain language, with
concrete and realistic examples. Comparative tables
and information describing key features of available
loan products, including reduced documentation
programs, also may be useful for consumers
considering these nontraditional mortgage products
and other loan features described in this guidance.

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consumers make product selection and
payment decisions. For example,
institutions should offer full and fair
product descriptions when a consumer
is shopping for a mortgage, not just
upon the submission of an application
or at consummation.
• Promotional materials and
descriptions of these products should
provide information that enables
consumers to prudently consider the
costs, terms, features, and risks of these
mortgages in their product selection
decisions, including information about:
—Payment Shock. Institutions should
apprise consumers of potential
increases in their payment obligations
(e.g., in both dollar and percentage
terms), including situations in which
interest rates or negative amortization
reach a contractual limit. For
example, product descriptions could
specifically state the maximum
monthly payment a consumer would
be required to pay under a
hypothetical loan example once
amortizing payments are required and
the interest rate and negative
amortization caps have been
reached.16 Information provided to
consumers also could clearly describe
when structural payment changes will
occur (e.g., when introductory rates
expire, or when amortizing payments
are required), and what the new
payment amount would be or how it
would be calculated. As applicable,
these descriptions could indicate that
the new payment amount may be
required sooner, and may be even
higher than the amount indicated, due
to factors such as negative
amortization or increases in the
interest rate index.
—Negative Amortization. When
negative amortization is possible
under the terms of the loan,
consumers should be apprised of the
potential consequences of increasing
principal balances and decreasing
home equity. For example, product
descriptions should include, with
sample payment schedules,
corresponding examples showing the
effect of those payments on the
consumer’s loan balance and home
equity.
—Prepayment Penalties. If the
institution may impose a penalty in
the event that the consumer prepays
the mortgage, consumers should be
alerted to this fact, and to the amount
of any such penalty.17
16 Consumers also should be apprised of other
material changes in payment obligations, such as
balloon payments.
17 Federal credit unions are prohibited from
imposing prepayment penalties. 12 CFR
701.21(c)(6).

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—Cost of Reduced Documentation
Loans. If an institution offers both
reduced and full documentation loan
programs and there is a pricing
premium attached to the reduced
documentation program, consumers
should be alerted to this fact.
• Monthly statements that are
provided to consumers on payment
option ARMs should provide
information that enables consumers to
make responsible payment choices,
including information about the
consequences of selecting various
payment options on the current
principal balance. Institutions should
present each payment option available,
explain each option, and note the
impact of each choice. For example, the
monthly payment statement should
contain an explanation, as applicable,
next to the minimum payment amount
that this payment would result in an
increase to the consumer’s outstanding
loan balance due to negative
amortization. Payment statements also
could provide the consumer’s current
loan balance, what portion of the
consumer’s previous payment was
allocated to principal and to interest,
and, if applicable, the amount by which
the principal balance increased.
Institutions should avoid leading
payment option ARM borrowers to
select the minimum payment (for
example, through the format or content
of monthly statements).
• Institutions also should avoid
practices that obscure significant risks
to the consumer. For example, if an
institution advertises or promotes a
nontraditional mortgage by emphasizing
the comparatively lower initial
payments permitted for these loans, the
institution also should provide clear
and comparably prominent information
alerting the consumer, as relevant, that
these payment amounts will increase,
that a balloon payment may be due, and
that the loan balance will not decrease
and may even increase due to the
deferral of interest and/or principal
payments. Similarly, institutions should
avoid such practices as promoting
payment patterns that are structurally
unlikely to occur.18 Such practices
could raise legal and other risks for
institutions, as described more fully
above.
• Institutions also should avoid such
practices as: Unwarranted assurances or
18 For example, marketing materials for payment
option ARMs may promote low predictable
payments until the recast date. At the same time,
the minimum payments may be so low that negative
amortization caps would be reached and higher
payment obligations would be triggered before the
scheduled recast, even if interest rates remain
constant.

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predictions about the future direction of
interest rates (and, consequently, the
borrower’s future obligations);
inappropriate representations about the
‘‘cash savings’’ to be realized from
nontraditional mortgage products in
comparison with amortizing mortgages;
statements suggesting that initial
minimum payments in a payment
option ARM will cover accrued interest
(or principal and interest) charges; and
misleading claims that interest rates or
payment obligations for these products
are ‘‘fixed.’’
Control Systems—Institutions also
should develop and use strong control
systems to ensure that actual practices
are consistent with their policies and
procedures, for loans that the institution
originates internally, those that it
originates through mortgage brokers and
other third parties, and those that it
purchases. Institutions should design
control systems to address compliance
and fair disclosure concerns as well as
the safety and soundness considerations
discussed above. Lending personnel
should be trained so that they are able
to convey information to consumers
about product terms and risks in a
timely, accurate, and balanced manner.
Lending personnel should be monitored
through, for example, call monitoring or
mystery shopping, to determine whether
they are conveying appropriate
information. Institutions should review
consumer complaints to identify
potential compliance, reputation, and
other risks. Attention also should be
paid to appropriate legal review and to
using compensation programs that do
not improperly encourage originators to
direct consumers to particular products.
Appendix: Terms Used in this
Document
Interest-only Mortgage Loan—A
nontraditional mortgage on which, for a
specified number of years (e.g., three or
five years), the borrower is required to
pay only the interest due on the loan
during which time the rate may
fluctuate or may be fixed. After the
interest-only period, the rate may be
fixed or fluctuate based on the
prescribed index and payments include
both principal and interest.
Payment Option ARM—A
nontraditional mortgage that allows the
borrower to choose from a number of
different payment options. For example,
each month, the borrower may choose a
minimum payment option based on a
‘‘start’’ or introductory interest rate, an
interest-only payment option based on
the fully indexed interest rate, or a fully
amortizing principal and interest
payment option based on either a 15year or 30-year loan term plus any
required escrow payments. The

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minimum payment option can be less
than the interest accruing on the loan,
resulting in negative amortization. The
interest-only option avoids negative
amortization but does not provide for
principal amortization. After a specified
number of years, or if the loan reaches
a certain negative amortization cap, the
required monthly payment amount is
recast to require payments that will
fully amortize the outstanding balance
over the remaining loan term.
Reduced Documentation—A loan
feature that is commonly referred to as
‘‘low doc/no doc,’’ ‘‘no income/no
asset,’’ ‘‘stated income’’ or ‘‘stated
assets.’’ For mortgage loans with this
feature, an institution sets reduced or
minimal documentation standards to
substantiate the borrower’s income and
assets.
Simultaneous Second-Lien Loan—A
lending arrangement where either a
closed-end second-lien or a home equity
line of credit (HELOC) is originated
simultaneously with the first lien
mortgage loan, typically in lieu of a
higher down payment.
This concludes the text of the
proposed Interagency Guidance on
Nontraditional Mortgage Products.
Dated: December 19, 2005.
John C. Dugan,
Comptroller of the Currency.
By order of the Board of Governors of the
Federal Reserve System, December 19, 2005.
Jennifer J. Johnson,
Secretary of the Board.
Dated at Washington, DC, the 19th day of
December, 2005.
By order of the Federal Deposit Insurance
Corporation.
Robert E. Feldman,
Executive Secretary.
Dated: December 19, 2005.
By the Office of Thrift Supervision.
John M. Reich,
Director.
By the National Credit Union
Administration on December 20, 2005.
Rodney E. Hood,
Vice Chairman.
[FR Doc. 05–24562 Filed 12–28–05; 8:45 am]
BILLING CODE 4810–33–P, 6210–01–P, 6714–01–P,
6720–01–P, 7535–01–P

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Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102