There have been some changes recently to the ways you can pay back federal loans. On September 29, 2006, a "guidance" report was released that talked about the different ways people can pay their mortgages. The "Guidance" report was put together by the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp, the National Credit Union Administration, and the Office of Thrift Supervision.
Each of the above-mentioned regulators agreed that interest-only mortgages and the popular payment option, also known as "Pick and Pay," are both legal ways to finance a home. Pick and Pay, a popular payment option, lets the borrower choose how much they want to pay each month. Normally, this would give them the choice to pay, Interest Only this choice does not lower the amount that is owed on the mortgage's principal. This lets you avoid the principal reduction by making smaller payments for the first ten years instead of the first three. At the end of that time, the debt is still the same, but the borrower has to make higher payments to pay off the debt in a shorter amount of time. The fully amortising plan (P & I) includes both the interest and the principal.
The regulators said that either of these loans is fine as long as the people taking out the loans know what they are getting into. But lenders tend to market the loans to a large number of people with a lot of extras, which could be a bad idea. The government knows that lenders should try to avoid certain problems.
According to the report, the biggest thing lenders should try to avoid is giving loans to people who can't pay back the full amount. The report said that it is fine to give out a mortgage at a rate of 1% or 2% when the market rate is between 6.5% and 7%. But that only works if the borrower can pay the higher amount when it comes time to pay back the loan. If they can't, it becomes a big problem to extend the mortgage. The report said that just because the borrower can make the first few payments doesn't mean they can really afford the loan.
Lenders need proof of the income and assets of the people who want to borrow money. Those who work for themselves often find this hard to do. Stated income underwriting makes interest-only loans and loans with payment options very risky. If the bank doesn't check out what the borrower says is true, the bank should be wary of problems with the loan in the future.
Even though they sound good, piggyback plans are often very bad for the borrower. For example, a borrower can apply for a first mortgage with a payment option for 80% of the property's value and then open a line of interest-only credit for the other 20%. They won't put anything down and won't have a payment every month. But when those payments start, it can be and probably will be a big payment shock. Lenders should be aware of whether or not the borrower plans to live in the property. If the borrower didn't plan to live in the house, it's more likely that it will go into foreclosure or default.
