ILLUSTRATIONS OF CONSUMER INFORMATION FOR NONTRADITIONAL MORTGAGE PRODUCTS

I.         INTRODUCTION

The federal bank, thrift, and credit union regulatory agencies issued final illustrations of consumer information intended to help institutions implement the consumer protection portion of the Interagency Guidance on Nontraditional Mortgage Product Risks.

The illustrations consist of (1) a narrative explanation of nontraditional mortgage products, (2) a chart comparing interest-only and payment option adjustable rate mortgages (ARMs) to fixed-rate and traditional adjustable rate loans, and (3) a table that could be included with any monthly statement for a payment option ARM showing the impact of various payment options on the loan balance.

Institutions are not required to use the illustrations.  They may choose to use the illustrations, provide information based on the illustrations, or provide the consumer information described in the guidance in an alternate format.

II.        ILLUSTRATIONS

Institutions seeking to follow the recommendations set forth in the Interagency Nontraditional Mortgage Guidance may, at their option, elect to:

  • Use the illustrations;
  • Provide information based on the illustrations, but expand, abbreviate, or otherwise tailor any information in the illustrations as appropriate to reflect, for example:
  • The institution’s produce offerings, such as by deleting information about loan products and loan terms not offered by the institution and by revising the illustrations to reflect specific terms currently offered by the institution;
  • The consumer’s particular loan requirements;
  • Other information, consistent with the Interagency Nontraditional Mortgage Guidance, such as the payment and loan balance information for statements discussed in connection with Illustration 3 or information about when a prepayment penalty may be imposed; and
  • The results of consumer testing of such forms; or
  • Provide the information described in the Interagency Nontraditional Mortgage Guidance, as appropriate, in an alternate format.

To assist institutions that wish to use the illustrations, the agencies will be posting each of the illustrations on their respective websites in a form that can be downloaded and printed for easy reproduction.  In addition, in response to concerns that the interest rates used in Illustration No. 2 may become outdated with changes in market interest rates, the illustrations may be modified to reflect, among other things, current market conditions.  The agencies also will be posting on their respective websites a template that can be used by institutions that wish to modify the information presented in Illustration No. 2 to reflect more current interest rates (and corresponding payment amounts).  Illustration No. 2 itself reflects typical interest rates for prime borrowers in today’s environment, rounded to the nearest whole number to enhance simplicity.  Each of the three illustrations are set forth below.

A.        Illustration 1

Important Facts about Interest-Only and Payment Option Mortgages

Whether you are buying a house or refinancing your mortgage, this information can help you decide if an interest-only mortgage or a payment option mortgage is right for you.  These mortgages can be complicated.  If you do not understand how they work, you should not sign any loan contracts, and you might want to consider other types of loans. 

Interest-Only Mortgages allow you to pay only the interest on the money you borrowed for the first few years of the mortgage (the “interest-only period”).

If you pay only the amount due, then at the end of the interest-only period:

  • You will still owe the original amount you borrowed.

  • Your monthly payment will increase because you must pay back the principal as well as interest.

  • Your payment could increase even more if you have an adjustable rate mortgage (“ARM”) and interest rates increase.

Payment Option Mortgages allow you to choose among several payment options each month during the first few years of the loan (the “option period”).  The option period will end earlier than scheduled if the amount you owe grows beyond a set limit—for example, 110% or 125% of your original mortgage amount.

During the option period, the payment options usually include:

  • A payment of principal and interest, which reduces the amount you owe over time.
  • An interest-only payment, which does not reduce the amount you owe.
  • A minimum payment, which may be less than the interest due that month.  If you choose this option, any unpaid interest will increase the amount you owe.

At the end of the option period, depending on what payment options you chose:

  • You could owe substantially more than the original amount you borrowed.
  • Your monthly payment could increase significantly because:
  • You may have to start paying back principal, as well as interest.
  • Unpaid interest may have increased the amount you owe.
  • Interest rates may have increased (if you have an ARM).

Additional Information

•Home Equity - If you make interest-only payments, your payments are not building home equity and, if you make only the minimum payment on a payment option mortgage, you may be losing home equity.  This may make it harder to refinance your mortgage or to obtain funds from selling or refinancing your home.

•Prepayment Penalties - Some mortgages require you to pay a lump-sum prepayment penalty if you sell your home or refinance during the first few years of the loan.  You should find out if your mortgage has a prepayment penalty, how it works, and how much it could be. 

•No Doc/Low Doc Loans – “Reduced documentation” or “stated income” loans usually have higher interest rates or other costs compared to “full documentation” loans that require you to verify your income and assets.

B.        Illustration 2

Illustration 2:  Comparison of interest-only loans and payment-option ARMs to fixed-rate and traditional adjustable-rate loans

SAMPLE MORTGAGE COMPARISON

(Not actual loans available)

Sample Loan Amount $200,000 – 30-Year Term – Interest Rates For Example Purposes Only

 

Traditional Fixed

Rate Mortgage

(7%)

5-Year Interest-Only ARM

(initial rate 7%;

maximum rate 12%)

Payment Option ARM

(rate in 1st month 2%; variable rate after 1st month (starting at 7%); maximum rate 12%)

REQUIRED MONTHLY PAYMENTS

Years 1-5

$1,331

$1,167

$739–$987

(increasing annually)

Year 6 – if rates

don’t change

$1,331

$1,414

$1,565

Year 6 – if rates

rise 2%

$1,331

$1,678

$1,859

Year 8 – if rates

rise 5%

$1,331

$2,094

$2,319

EFFECT ON LOAN BALANCE AND HOME EQUITY

After 5 Years, How Much

Will You Owe?

$188,263

$200,000

$221,486

 

After 5 Years, How Much

Home Equity Have Your

Loan Payments Built?

$11,737

$0

NEGATIVE $21,486

C.         Illustration 3

Illustration 3:  Table for inclusion with monthly statement for a payment option ARM

Your Payment Options This

Month

Amount

Impact

Principal and Interest Payment

$_______
  • You will pay some of the principal on  your loan
  • You will reduce your loan balance

Interest-Only Payment

$_______
  • You will not pay any principal on your loan
  • You will not reduce your loan balance

Minimum Payment

$_______
  • You [will] [will not] cover the interest on your loan
  • You [will not] [will] increase your loan balance

 

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