Regulators, Federal Reserve, Consumer Advocates Spar Over Nontraditional Florida Home Loans

Not every potential buyer can afford a large down payment, or even a typical mortgage. As prices in various housing markets level off, however, individuals still wish to apply for a Florida home loan. As a result, one important question is being debated between regulators and consumer advocates:

Whose job is it to decide that a particular Florida home mortgage loan is unsuitable for a specific customer?

Nontraditional Florida home loans surge

The argument centers around the growing popularity of what federal regulators call nontraditional Florida home loans - mortgages in which the borrower is required to pay only interest, and not principal, for the first few years. About one-quarter of new mortgages fall into this category, up from a negligible market share just five years ago.

This figures worries regulators because such loans are riskier. Some nontraditional loans, called payment-option adjustable-rate mortgages, don’t even require the borrower to pay the interest accrued: The amount owed can increase every month.

Regulators have proposed guidance, asking Florida home loan lenders to use caution when underwriting nontraditional loans. The proposed guidance says lenders should avoid loans “that may result in the borrower having to rely on the sale or refinancing of the property,” once the borrower has to start paying principal as well as interest. The idea is to avoid the defaults that have recently occurred on many Florida home mortgage loans.

In other words, don’t give a mortgage to someone who can’t afford to pay principal and interest, even if it’s an interest-only loan.

Added risk for Florida home loan applicants, lenders

Regulators worry about interest-only and payment-option mortgages because payments can rise abruptly after a few years. In unlikely worst-case scenarios, monthly payments can more than double in one traumatic leap. A lot of borrowers don’t make down payments or document their income - additional risk factors that increase the odds of eventual foreclosure.

Consumer advocates believe lenders should subject those trying to afford a Florida home loan in an expensive market to some suitability requirements - “some duty to the borrower to make sure they’re not put in a loan that’s not appropriate,” says Stella Adams, executive director of the North Carolina Fair Housing Center.

Adams imagines a trade group coming up “with a general script that explains the differences between the products and is uniformly applied, so that people can hear an explanation. I tell you, three-page disclosures with ‘wherefores’ and ‘therefores’ don’t cut it.” Thus far, these groups haven’t been pleased with proposed guidelines on exotic Florida home loans.

Screening Florida home loan candidates

A suitability standard “would put some obligation on some part of mortgage lenders and mortgage brokers to not squeeze people into loans where they have no reasonable prospect of being able to repay them,” says Allen Fishbein, director of housing and credit policy for the Consumer Federation of America.

Bankers counter that the lending industry has built-in suitability standards. Riskier borrowers pay higher interest rates and sometimes must buy mortgage insurance. Mortgages are bundled together and sold on the secondary market to investors, who have powerful analytical tools to gauge just how risky a particular pool of loans is.

“If loans are being underwritten that will inevitably fail, there will be no buyers for those loans on the secondary market,” says Robert McKew, general counsel for the American Financial Services Association. “The secondary market acts as a regulator in addition to government regulation.”

But consumer advocates argue that the secondary market allows the mortgage industry to view foreclosures as just another cost of doing business. One foreclosure in a package of hundreds of loans is a blip on an investor’s computer screen, but it’s long-lasting trauma to the family that loses a house.

Burden falls to consumers; Know your Florida home loan options

“Ultimately, suitability is about financial literacy,” Peter Macdonald, general counsel for LendingTree Loans, says. “That can’t be just within the industry. The American public can and will rise to the challenge of learning how these loans work.”

Michael Williams, vice president for legislative affairs for The Bond Market Association, agrees that “you have to put the burden on the consumer to be educated.” In other words: while debate rages on over the use of creative Florida mortgage loans, do your homework. Make sure you understand all aspects of any loan before signing on the dotted line.