New Guidelines On Bad Credit Home Loans

It won’t mean the end to no-income verification or high-risk mortgages for bad credit home buyers, but new guidance from federal financial regulators almost certainly will cut their availability sharply.

Syndicated columnist Kenneth Harney writes that in a new statement on loans to borrowers with imperfect credit, federal financial regulators urged banks, credit unions and their mortgage subsidiaries to verify income, assets and employment.

That’s for borrowers of all home loans except in special cases where borrowers could demonstrate substantial financial reserves.

The guidelines, which took effect immediately nationwide, also instructed lenders to underwrite adjustable-rate bad credit home loan applicants at “fully indexed” interest rates - not deeply discounted teaser rates.

During the housing boom years, many lenders had lured credit-impaired buyers into “2/28″ and “3/27″ adjustable-rate loans featuring discounted mortgage rates - and fixed payments - for the first two or three years.

After the discount period, payments sometimes jumped by 50 percent or more, putting home buyers in serious financial jams.

Large numbers of those borrowers are now delinquent on their home mortgage loan payments and at risk of foreclosure problems.

The new guidelines target other once-popular lender practices, but do not ban them outright. For example, many subprime 2/28 and 3/27 adjustables also carried heavy prepayment penalties - up to six months of interest - designed to discourage borrowers from mortgage refinancing.

Under the new guidelines, lenders will be required to give borrowers a “reasonable period of time” - generally 60 days - before the rate reset date to refinance into more favorable loans without penalty.

The federal regulators also stressed that lenders should only approve subprime adjustable loans “based on the borrower’s ability to repay the loan according to its terms.”

That doesn’t amount to a formal “suitability” test, but it does require lenders to determine that the loan is appropriate to the applicant’s financial status and capacity to handle payments.

The guidelines also instruct lenders to make certain that every subprime applicant understands the risks built into the loan itself, including higher costs in connection with any reduced documentation, prepayment penalties and the responsibility to keep track of tax and insurance payments if the loan lacks an escrow account.

Consumer advocates generally welcomed the new guidelines but were quick to point out that they won’t make a dent in the ongoing bad credit mortgage crisis or prevent lenders from issuing new loans with toxic features.

Continue reading in the San Jose Mercury News …