Amla - Lesson 4 ' Unit 1

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U1 Summary of Subprime Lending

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Summary of Subprime Lending The Housing Agencies developed guidance on Subprime Mortgage Lending in order to address the emerging risks associated with certain subprime products and lending practices. This can be viewed in its entirety at the following websitehttp://www.federalreserve.gov/newsevents/press/bcreg/bcreg20070629a1.pdf The following are considered Subprime Lending risks:1. ARM products with low introductory rates, known as “teaser” rates.2. Qualifying borrowers on limited or no documentation of income3. Imposing substantial prepayment penalties4. Prepayment penalty periods that extend beyond initial fixed period5. No escrow accounts for payment of taxes and insurance6. Inadequate knowledge of product features and risks7. Payment shock and ability to repay8. Unfair or deceptive practices, predatory lending issues9. Shared Appreciation Mortgage Risk layering – is the practice of approving loans with multiple layers of risk, which may significantly increase the risks to both the lending institution and the borrower. Subprime borrowers are understood to be “at risk” borrowers because of past credit problems, layering on additional risk on the same loan would include such things as; reduced documentation, a simultaneous high LTV second mortgage, and not including escrows for taxes and insurance. With each layer of risk the chances for loan default increase substantially. Therefore, an institution should have clear policies governing the use of risk layering. When risk-layering features are combined with a loan, the lender should demonstrate or document effective mitigating factors that support both: Tight underwriting; andBorrowers’ ability to repay the loan (suitability) Q: What can FNMA utilize when there are additional layers of risks?A: Loan Level Pricing Adjustments

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U1 Summary of Subprime Lending QUESTION

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Subprime borrowers are understood to be “at risk” borrowers because of past credit problems( )True( )False ← Wrong answer Explanation:U1 Summary of Subprime LendingRisk layering – is the practice of approving loans with multiple layers of risk, which may significantly increase the risks to both the lending institution and the borrower. Subprime borrowers are understood to be “at risk” borrowers because of past credit problems, layering on additional risk on the same loan would include such things as; reduced documentation, a simultaneous high LTV second mortgage, and not including escrows for taxes and insurance. With each layer of risk the chances for loan default increase substantially. Therefore, an institution should have clear policies governing the use of risk layering. When risk-layering features are combined with a loan, the lender should demonstrate or document effective mitigating factors that support both: Tight underwriting; andBorrowers’ ability to repay the loan (suitability)

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1 Predatory Lending

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Predatory LendingThe Agencies guidance was clear to state; “Subprime lending is not synonymous with predatory lending…” (https://www.fdic.gov/regulations/laws/rules/5000-5160.html, FDIC Law, Regulations, Related Acts – Statement on Subprine Mortgage Lending - last updated 4/20/2014) the statement on subprime lending went on to define that predatory lending involved at least one of the following elements:Making loans based predominately on the foreclosure or liquidation value of the collateral rather than the borrower’s ability to repay the mortgage according to its terms.Inducing a borrower to repeatedly refinance a loan in order to charge high points and fees each time the loan is refinanced, known as “loan flipping” or;Engaging in fraud or deception to conceal the true nature of the loan obligation, or ancillary products, from an unsuspecting or unsophisticated borrower.

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2 Consumer Protection Principles

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Consumer Protection PrinciplesThe two most fundamental consumer protection principles relevant to the marketing, underwriting and funding of mortgage loans include:Sustainability; approving loans based on the borrower’s ability to repaySuitability; the transparent and open disclosure of information that enables a consumer to understand material terms, costs and the risks of loan products at a time that will help them to select a suitable loan product for their unique circumstances.All communications with consumers, including advertisements, oral statements and promotional materials should provide clear and balanced information regarding the benefits and risks of the loan products under consideration. Transparency: information provided consumers should clearly explain the risk of payment shock and the ramifications of prepayment penalties, balloon payments and the lack of escrows, as necessary. In this context, transparency means providing information regarding the risks of a subprime loan product in addition to the benefits in a clear and balanced manner. Prepayment Penalties: the applicability of prepayment penalties should not exceed the initial reset period. Borrowers should be provided a reasonable period of time (typically 60 days prior to reset) to refinance without penalty. Steering: originators should not use their expertise or position of trust to steer consumers to products favorable to the originator, at the exclusion of other products offered by the institution for which the borrower may qualify. Consumer Education: if borrowers do not understand that their monthly payments do not include taxes and insurance, and they have not budgeted for them, they may be faced with a crisis to raise funds on short notice. Cover these issues:Payment Shock and the potential for payment increases, including how the new payment will be calculated when the introductory rate expires.Prepayment Penalties, the existence of any and how it will be calculated as well as when it may be imposed.Balloon Payments, the existence of any balloon payment and the timing of such a feature.Cost of Reduced Documentation, an understanding of whether there is a pricing premium attached to a reduced doc or stated income loan program.Responsibility for Taxes and Insurance and the borrowers’ requirement to pay taxes and insurance in addition to the loan payment, if not escrowed, and that the cost of taxes and insurance can be substantial.

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2 Consumer Protection Principles QUESTION

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Providing information regarding the risks of a subprime loan product in addition to the benefits in a clear and balanced manner is which of the following?( )Suitability( )Sustainability( )Transparency( )SteeringExplanation:U1 Summary of Subprime Lending: 2 Consumer Protection PrinciplesTransparency: information provided consumers should clearly explain the risk of payment shock and the ramifications of prepayment penalties, balloon payments and the lack of escrows, as necessary. In this context, transparency means providing information regarding the risks of a subprime loan product in addition to the benefits in a clear and balanced manner.

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3 Control Systems

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Control SystemsMortgage lending institutions should develop strong control systems to monitor whether actual practices are consistent with their policies and procedures. The control systems should address compliance and consumer information concerns that include:Safety and soundness encompassing both the institution and third party service providersHiring and training of personnelOngoing quality control and due diligenceCompensation programs that avoid providing incentives that are inconsistent with sound underwriting and/or the steering of consumers to subprime loan products at the exclusion of other products for which the consumer may qualify. NOTE: All mortgage loan type/products are considered non-traditional mortgages (i.e. 15 year fixed, Adjustable Rate Mortgages (ARM). Home Equity Line of Credits (HELOC), close ended 2nd mortgages. Therefore there is ONLY one traditional loan product – 30 year fixed rate mortgage.

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4 Guidance on Non-Traditional Mortgage Product Risks

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GUIDANCE ON NONTRADITIONAL MORTGAGE PRODUCT RISKS 3 C’s to be addressed1) Credit – low credit scores2) Capacity – inability to verify income3) Collateral – not enough assets **Sub-prime credit scores below 620**Expanded ratios above 36% debt-to-income ratio The SAFE Act requires education pertaining to Non-traditional Mortgage Products: defined as any mortgage other than a 30-year fixed product. This will includeARMs,Interest Only,Negative Amortization,Will now include 25, 20, 15, and 10-year fixed rate mortgages***Only a 30-year fixed rate mortgage will NOT be considered Non-traditional.Sub-prime and/or exotic will be used when referencing the riskier categories of non-traditional mortgages, such as negative amortization, interest only, etc. Given the potential for heightened risk levels associated with some of the non-traditional sub-prime loan products, management should carefully consider and appropriately mitigate exposures created by these loans. To manage the risks associated with non-traditional mortgage loans, management should:Ensure that loan terms and underwriting standards are consistent with prudent lending practices, including consideration of a borrower’s repayment capacityEnsure that consumers have sufficient information to clearly understand loan terms and associated risks prior to making a product choice.

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4 QUESTION

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Which of the following is not one of the 3 Cs?( )Credit( )Character( )Capacity( )CollateralExplanation:U1 Summary of Subprime Lending: 4 Guidance on Non-Traditional Mortgage Product Risks3 C’s to be addressed1) Credit – low credit scores2) Capacity – inability to verify income3) Collateral – not enough assets