New guidelines for nontraditional mortgage loans in Minnesota

Last October an interagency conference of federal and Minnesota banking executives and the Minnesota Department of Commerce arrived at a new set of guidelines for nontraditional mortgages in Minnesota. According to the Department of Commerce, “[t]he guidelines are intended to protect consumers from taking on high-risk mortgage loans without having a full understanding of the terms of those loans.” One hopes the Dept. of Commerce will soon go beyond postcards and sponsor legal enforcement of the new, more strict guidelines.

Follow the jump for more on nontraditional mortgages and the new guidelines.

A “nontraditional” mortgage includes interest-only mortgages, “payment option” mortgages, and reverse-amortization mortgages. Most have adjustable rate features. These can all be important mortgage options for the knowledgeable buyer, but in recent years, mortgage brokers have been pushing these mortgage products on regular home buyers without emphasizing the sometimes-severe downside risks.

The new guidelines address the following problem features of nontraditional mortgages, particularly as they apply to low-income, high-risk borrowers.

Essentially, nontraditional mortgages share a similar feature: they allow a home buyer to exchange lower initial payments for higher payments later on by allowing a buyer to defer principal payments, and sometimes interest as well.

The problem is that unsophisticated borrowers rarely understand or appreciate the risk to them of these options. The rise in nontraditional mortgage lending surely contributes to the rise in foreclosures (see our earlier post today; we still think having a lawyer is one of the best ways a borrower can look after their best interests). The risk is, of course, all the greater when a borrower is on shaky financial ground.

Because of the inability of many borrowers to make the later, increased payments, their ability to keep their home depends on refinancing their loan at least once, and sometimes multiple times. The guidelines assert that nontraditional mortgages should not be written for borrowers who cannot handle the loan as written, and that if there are to be any deviations from that standard, the reason for the justification should be justified.

The guidelines describe admirable aspirational goals, but do not provide legally-enforceable standards. Nor do they compensate for the inherent conflicts between mortgage brokers and borrowers. Brokers get paid at closing, while lenders and borrowers are locked in for the life of the loan, whether it ends with repayment or foreclosure. Lenders have the sophistication to protect themselves, but borrowers do not. Thus my post earlier today encouraging prospective homebuyers to hire an attorney to explain their options, risks, and dangers inherent in traditional and nontraditional mortgages.