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Lenders may soon be more careful about making home loans to people with tarnished credit. Federal regulators are proposing new guidelines that would discourage some of the riskiest loans to these so-called subprime borrowers. The crackdown comes as more and more borrowers are falling behind on their mortgage payments.
NPR's Scott Horsley reports.
SCOTT HORSLEY: Regulators' draft guidance for mortgage lenders is pretty simple. Before making a loan to someone with imperfect credit, make sure they can afford to pay it back in full - not just low teaser payments for the first couple of years, to which Deborah Goldstein of the Center for Responsible Lending says - in effect - duh.
Ms. DEBORAH GOLDSTEIN (Executive Vice President, Center for Responsible Lending): It sounds to us like a return to sound underwriting practices.
HORSLEY: But that's not the way some lenders have operated in recent years. Goldstein says many subprime lenders have been granting adjustable mortgages to borrowers who could barely afford the introductory payments. When their interest rates ratcheted up after a couple of years, their monthly bills spiked by up to 50 percent, a recipe for payment shock.
Ms. GOLDSTEIN: The consequence has been to put an enormous number of borrowers at risk of foreclosure. We recently did a study that projected that as many as 20 percent of subprime loans made in 2006 will end up in foreclosure, and we attribute a great deal of that to the loose underwriting practices.
HORSLEY: Top lawmakers applauded regulators for the proposed crackdown, but Steve O'Connor of the Mortgage Bankers Association says it's important not to overreact.
Mr. STEVE O'CONNOR (Mortgage Bankers Association): These products are designed to give consumers a choice. They can have the benefit of lower initial payments now with the potential - and I emphasize potential - for higher payments later. The fact is most consumers who have these hybrid arms (unintelligible) before their loan resets to a higher payment.
HORSLEY: Indeed, so long as home prices were rising, borrowers could refinance or sell their home at a profit. So lenders didn't have to worry much about loans going unpaid. But Deborah Goldstein says that's changed now that the escape hatch of rising prices has slammed shut.
Ms. GOLDSTEIN: With flattening of home prices, what that means is borrowers won't have that equity, and the refinance option will no longer be there. So many more of them are going to face foreclosure if they're not already in that situation.
HORSLEY: This past week, Countrywide Financial Corporation said nearly one out of five subprime borrowers services are behind on their mortgage payments, and there are millions of subprime borrowers out there, representing nearly a quarter of all home loans made last year. The rising number of subprime defaults has spooked some mortgage lenders and investors, who are already getting pickier about the loans they'll bankroll.
Steve O'Connor of the Mortgage Bankers Association says those market players can fix the problem if the government just leaves them alone.
Mr. O'CONNOR: What we're concerned about is the regulators potentially coming in and not allowing the market to correct.
HORSLEY: Regulators have given the industry 60 days to comment on the proposed guidance. Senate Banking Committee Chairman Christopher Dodd wants regulators to act quickly, saying a responsible standard would help to protect both borrowers and lenders.
Scott Horsley, NPR News.
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