By BOB KRETSCHMAN

The Daily Sentinel

Federal regulators are asking banks and other financial institutions to be more careful about signing up customers for “nontraditional mortgage products,” such as interest-only and payment-option adjustable-rate mortgages.

Many customers are finding that, when the attractive low payments at the front end of the loan expire, they’re hit with unexpected and burdensome payment increases.

“We’ve started to see some things in these new products that got into repayment ability of the customers,” said David Barr, spokesman for the Federal Deposit Insurance Corp.

The FDIC, along with the Federal Reserve’s board of governors, the National Credit Union Administration, and other regulators, have proposed “guidance” asking financial institutions to more carefully explain loan terms to consumers and to maintain adequate reserves to cover riskier loans. Barr said guidance is more flexible than formal regulations, but banks still are expected to follow it and can be subject to enforcement action if they don’t.

Grand Junction-area bankers say they’re already careful about the types of mortgage loans they offer to customers who want to buy a home.

“I think there’s a place for (nontraditional mortgage products), but it’s a very limited number of people who should use them,” said Dean Massey, regional president for Wells Fargo Bank in western Colorado.

Most of the people that Wells Fargo considers for nontraditional products have high income and “substantial” equity in an existing home.

“They’re usually a more sophisticated borrower as well. They have a reason they want that type of loan,” Massey said.

A wide variety of nontraditional mortgage products are available, and their appeal to many borrowers is the lower payments they offer during the early years of the loan. For example, interest-only loans let the borrower pay only the interest that accumulates on the loan each month, leaving the principal intact. But several years into the loan, the borrower must begin making principal payments in addition to interest, and monthly loan payments can sometimes jump hundreds of dollars.

Many borrowers sign up for such loans unaware of the payment cliff that awaits them. As a result, they either find it difficult to make the larger payments, or they become angry when they discover that even after several years of making payments, they haven’t accumulated any equity in their home.

Another seductive type of loan that can create problems for borrowers is the payment-option adjustable rate mortgage. With such a loan, the borrower can choose from among several payment options, ranging from a minimum payment based on a low introductory interest rate to a full payment that includes interest and principal.

According to the FDIC, the minimum-payment option can be less than the interest that accrues on the loan. Borrowers who consistently choose the lowest payment eventually see their loan balance grow to exceed the value of their home, a condition the banking industry refers to as “negative amortization.”

Mickie Fisher, president and owner of Colorado Credit Services, a company that helps debt-laden consumers repair their credit ratings, said negative-amortization loans are one of the most significant mortgage-related problems she sees with clients. In many cases, she said, borrowers who ended up in trouble didn’t understand how the financing worked when they signed their loan documents.

“People don’t ask questions. They just want to get it done and get into the home,” Fisher said. “We’re not educated enough as consumers.”

The FDIC and other regulators are proposing that lenders fully assess a borrower’s ability to repay a loan, including any balance added through negative amortization, at the interest rate that would apply after the introductory rate expires.

Tony Colaizzi, manager of First National Bank of the Rockies’ mortgage venture with Countrywide Financial, said loan originators at his bank are trained to analyze borrowers’ ability to repay nontraditional loans. For example, such borrowers need to have enough money in the bank to cover payments for three to six months, and loans are thoroughly explained to applicants.

Originators need to be ethical and not force borrowers into loans they won’t be able to afford later, Colaizzi said.

“You wouldn’t take somebody working on an hourly wage who is buying their first home and put them into one of these deals,” he said.

The FDIC’s proposed guidance also directs banks to recognize that some nontraditional mortgage loans haven’t been “tested” in an environment of stagnant or falling real-estate prices, and it directs institutions to adopt “strong risk-management standards as well as appropriate capital and loan loss reserves.”

Carol Skubic, president of Vectra Bank’s Grand Valley market, said her bank makes a “very limited” number of nontraditional loans locally. The fixed-rate, 25- or 30-year loan remains the most popular type of mortgage loan, she said.

“Vectra does recognize that some of these mortgage products are untested in a stressed environment,” she said.

Nontraditional mortgages are suitable in a small number of situations and only when borrowers fully understand the product they are offered, Skubic said.

“We make sure the borrowers have sufficient information to understand our recommendation,” she said. “A lot of customers do their research before they come into the bank.”

Vectra’s mortgage lenders assess every borrower’s credit status and analyze debt-to-income ratios.

“We always begin by assessing a buyer’s ability to repay the loan,” Skubic said.

Regulators recognize that nontraditional mortgage products have a place in the market, the FDIC’s Barr said.

“They are a good way for many people in high-cost areas to afford a home,” he said.

Regulators, however, want to ensure less-sophisticated borrowers aren’t unwittingly steered into loans that will get them into financial trouble.

“If somebody’s getting steered into them just so they can afford a home, there’s that cliff waiting for them when the loan resets (to a higher payment),” Barr said.

Bob Kretschman can be reached via e-mail at bkretschman@gjds.com.