Nontraditional Mortgage Products Flashcards

1
Q

What mortgage products are considered nontraditional? (2)

A

-Interest only mortgages
-Payment option ARMs

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2
Q

What is an interest only mortgage?

A

Borrower pays no loan principal “only interest” for first few years of the loan after which the rate may fluctuate or become fixed.

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3
Q

What is a payment option ARM?

A

ARM with flexible payment options and potential for negative amortization. ex: borrower chooses payment based on initial interest rate, interest only option, or fully amortizing P&I payment.

Minimum payments are often less than interest accruing resulting in negative amortization. After a certain number of years the loan reaches a negative amort cap and the loan is recast to increase monthly payments to an amount that will fully amortized the remaining balance on the loan.

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4
Q

Why are nontraditional mortgages important to compliance risk?

A

Being offered by more lenders and to borrowers who may not qualify for traditional product and who may not fully understand the associated risks.

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5
Q

What specific risks are associated with nontraditional products? (5)

A

-Underwriting with less stringent income requirements (reduced documentation)
-often combined with second-lien loans, that may have less equity to ensure payment of loan.
-risk layering
-introductory interest rates set below fully indexed rates
-lending to subprime borrowers.

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6
Q

What controls can mitigate risks associated with NT mortgages? (6)

A

-Loan terms and Underwriting standards are prudent and consider the borrowers repayment capacity.

-strong risk management practices

-Policies and procedures that specify acceptable product attributes, portfolio limits, sales and securitization practices, and risk management

-Strong third party risk managment

-Enhanced reporting to management.

-Disclosures that allow borrowers to clearly understand loan terms and associated risks prior to making a product choice.

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7
Q

What should loan and underwriting standards include for NT mortgages? (4)

A

-address the effect of a substantial payment increase on the borrowers capacity to repay when loan amortization begins.
-comply with real estate lending standards and appraisal regulations/ guidelines.
-recognize potential impact of payment shock (especially for high DTI, low credit, high LTV borrowers)
-Analyze ability to repay at the fully indexed rate, with full amortization/neg amort.

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8
Q

What is payment shock?

A

Significant increase in payments once NT loans begin to amortize.

Particularly concerning for payment option ARM loans that may result in excessive negative amortization.

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9
Q

What types of loans are at higher risk under NT mortgages? (2)

A

Collateral dependent loans
Non-Owner Occupied Investor loans

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10
Q

When should creditors notify borrowers about the associated risks of NT mortgages?

A

Should notify them about the likelihood of increased payments before product selection and disclosures are provided under TILA.

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11
Q

What should advertisements and communications with customers include regarding NT mortgages? (2)

A

Clear balanced info about relative benefits and risks including:
-risk of payment shock
-risk of negative amortization

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12
Q

What laws govern NT mortgages? (4)

A

-TILA
-RESPA
-Fair Lending Laws
-UDAP (Federal Trade Commission Act)

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13
Q

What are the recommended practices for banks with NT mortgage practices? (5)

A

-Strong communication with customers (with disclosures and marketing)
-product descriptions and promotional materials that include information about costs, terms, features, risks
-Apprise customers of Payment Shock (ex: product description with example of maximum monthly payment)
-Disclose risk of negative amortization, prepayment penalties, reduced documentation.
-Monthly statements on loans that enables customer to make informed payment choices. (ex: statement details amount allocated to principal and interest, amount principal balance increased_

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14
Q

What are potential risks associated with negative amortization for a borrower? (3)

A

-increasing principal balances
-decreasing home equity.
-difficult to refinance home or obtain cash from equity

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15
Q

What practices should banks avoid with NT products? (5)

A

-Practices that obscure significant risks
-predicting direction of future interest rates
-discuss cash savings or expanded buying power from NT products vs. typical products
-suggesting minimal payments on payment option ARM will cover interest charges
-misleading claims that interest rates or payment obligations are “fixed”

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16
Q

What is a reduced documentation loan?

A

Loan feature that bank sets reduced or minimal documentation standards to substantiate borrowers income and assets.

17
Q

What is a Simultaneous Second-lien loan?

A

Lending arrangement where either a close end second lien or HELOC is originated simultaneously with a first lien mortgage product, typically in lieu of a higher down payment.