State banking and financial regulators are responsible for overseeing  independent lenders and mortgage brokers and generally do so through  licensing that mandates certain experience, education, and operations  requirements to engage in mortgage activities. AMP Lending Rapidly Grew and Borrower Characteristics Changed as Consumers Sought Mortgage Products That Increased Affordability

From 2003 through 2005, AMP lending grew rapidly, with originations  increasing threefold from less than 10 percent of residential mortgages to  about 30 percent. Most of the originations during this period consisted of  interest-only ARMs and payment-option ARMs, and most of this lending  occurred in higher-priced regional markets concentrated on the East and  West Coasts. Historically, AMP borrowers consisted of wealthy and financially  sophisticated borrowers who used these specialized products as financial  management tools. However, today a wider range of borrowers use AMPs  as affordability products to purchase homes that might otherwise be  unaffordable using conventional fixed-rate mortgages. Borrowers Could Face Payment Shock; Lenders Face Credit Risk but Appear to Be Taking Steps to Manage the Risk

Although AMPs have increased affordability for some borrowers, they  could lead to increased payments or “payment shock” for borrowers and  corresponding credit risk for lenders. Regulators and consumer advocates have expressed concern that  some borrowers might not be able to afford these higher monthly  payments. In addition, with a wider range of AMP borrowers now than  in the past, those with fewer financial resources or limited equity in their  homes might find refinancing their mortgages or selling their homes  difficult, particularly if their loans have negatively amortized or their  homes have not appreciated in value. Federal and state  banking regulatory officials and lenders with whom we spoke said most  banks have diversified their assets to manage the credit risk of AMPs held  in their portfolios, or have reduced their risk through loan sales or  securitization. As such, in our report we agree with federal regulatory officials  and industry participants that it was too soon to tell the extent to which  AMP risks may result in delinquencies and foreclosures for borrowers and  losses for banks that hold AMPs in their portfolios. Borrowers May Not Be Well-informed of AMP Risks and Mortgage Disclosures May Not Effectively Describe These Risks to Consumers

Regulatory officials and consumer advocates expressed concern that some  AMP borrowers may not be well-informed about the terms and risks of  their complex AMP loans. These disclosures  were provided to borrowers between 2004 and 2006 by six federally  regulated lenders that collectively made over 25 percent of the interest- only and payment option ARMs produced in 2005.We found that these  disclosures addressed current Regulation Z requirements, but some did  not provide full and clear explanations of AMP risks such as negative   amortization or payment shock. Federal banking  regulators issued draft interagency guidance in December 2005 that  recommended prudent underwriting, portfolio and risk management, and  information disclosure practices related to AMP lending. During the public comment period for the guidance, lenders and others  suggested in their letters that the stricter underwriting recommendations  were overly prescriptive and might put federally and state-regulated banks  at a competitive disadvantage because the guidance would not apply to  independent mortgage lenders or brokers. Most States in Our Sample Responded to AMP-Lending Risks within Existing Regulatory Frameworks, While Others Have Taken Additional Actions

State banking and financial regulatory officials from the eight states in our  sample expressed concerns about AMP lending in their states; however,  most relied on their existing regulatory system of licensing and examining  mortgage lenders and brokers to stay abreast of and react to AMP issues. However, the  popularity, complexity, and widespread marketing of AMPs highlight the  importance of mortgage disclosures to help borrowers make informed  mortgage decisions.
Why GAO Did This Study

Alternative mortgage products (AMPs) can make homes more affordable by allowing borrowers to defer repayment of principal or part of the interest for the first few years of the mortgage. Recent growth in AMP lending has heightened the importance of borrowers' understanding and lenders' management of AMP risks. GAO's report discusses the (1) recent trends in the AMP market, (2) potential AMP risks for borrowers and lenders, (3) extent to which mortgage disclosures discuss AMP risks, and (4) federal and selected state regulatory response to AMP risks. GAO used regulatory and industry data to analyze changes in AMP monthly payments under various scenarios; reviewed available studies; and interviewed relevant federal and state regulators and mortgage industry groups, and consumer groups.

What GAO Found

From 2003 through 2005, AMP originations, comprising mostly interest-only and payment-option adjustable-rate mortgages, grew from less than 10 percent of residential mortgage originations to about 30 percent. They were highly concentrated on the East and West Coasts, especially in California. Federally and state-regulated banks and independent mortgage lenders and brokers market AMPs, which have been used for years as a financial management tool by wealthy and financially sophisticated borrowers. In recent years, however, AMPs have been marketed as an "affordability" product to allow borrowers to purchase homes they otherwise might not be able to afford with a conventional fixed-rate mortgage. Because AMP borrowers can defer repayment of principal, and sometimes part of the interest, for several years, some may eventually face payment increases large enough to be described as "payment shock." Mortgage statistics show that lenders offered AMPs to less creditworthy and less wealthy borrowers than in the past. Some of these recent borrowers may have more difficulty refinancing or selling their homes to avoid higher monthly payments, particularly in an interest-rate environment where interest rates have risen or if the equity in their homes fell because they were making only minimum monthly payments or home values did not increase. As a result, delinquencies and defaults could rise. Federal banking regulators stated that most banks appeared to be managing their credit risk well by diversifying their portfolios or through loan sales or securitizations. However, because the monthly payments for most AMPs originated between 2003 and 2005 have not reset to cover both interest and principal, it is too soon to tell to what extent payment shocks would result in increased delinquencies or foreclosures for borrowers and in losses for banks. Regulators and others are concerned that borrowers may not be well-informed about the risks of AMPs, due to their complexity and because promotional materials by some lenders and brokers do not provide balanced information on AMPs benefits and risks. Although lenders and certain brokers are required to provide borrowers with written disclosures at loan application and closing, federal standards on these disclosures do not currently require specific information on AMPs that could better help borrowers understand key terms and risks. In December 2005, federal banking regulators issued draft interagency guidance on AMP lending that discussed prudent underwriting, portfolio and risk management, and consumer disclosure practices. Some lenders commented that the recommendations were too prescriptive and could limit consumer choices of mortgages. Consumer advocates expressed concerns about the enforceability of these recommendations because they are presented in guidance and not in regulation. State regulators GAO contacted generally relied on existing regulatory structure of licensing and examining independent mortgage lenders and brokers to oversee AMP lending.