Newly released federal guidelines relating to “nontraditional” mortgages are receiving a mixed reaction in the Massachusetts banking community, although most local lenders are generally supportive of the measure.

“Final Guidance on Nontraditional Mortgage Product Risks” was issued Sept. 29, following an initial draft and comment period, by the Office of the Comptroller of the Currency, Federal Reserve, Federal Deposit Insurance Corp., Office of Thrift Supervision and National Credit Union Administration.

It covers mortgage loan products former Federal Reserve Chairman Alan Greenspan once referred to as “exotic,” including interest-only mortgages and payment option adjustable-rate mortgages, or option ARMs. It affects banks and credit unions – as well as their non-bank subsidiaries – regulated by one of the above agencies. The guidance, however, does not apply to some mortgage companies and brokers, which are regulated by individual states.

Some bankers worry the new guidelines will put them at a “competitive disadvantage” with institutions not subject to the regulations, said Stan Ragalevsky, a partner at Kirkpatrick & Lockhart Nicholson Graham in Boston.

In an October e-mail alert to its bank and mortgage company clients about the new federal guidance, Ragalevsky’s firm suggested that the agencies “have said they are committed to preparing a [comparable] model guidance document for state regulators of nondepository institutions,” but adds later that such an effort would be difficult to implement, in part because the authority of state regulators differs in every state.

Summarized by regulators in a statement announcing its release, the guidance includes directives aimed at “managing the potential heightened risk levels created by these loans.”

To that end, those overseeing mortgage loans should “ensure that loan terms and underwriting standards are consistent with prudent lending practices, including consideration of a borrower’s repayment capacity; recognize that many nontraditional mortgage loans Â… are untested in a stressed environment [and] warrant strong risk management standards, capital levels commensurate with risk, and an allowance for loan and lease losses that reflects the collectibility of the portfolio; and ensure that consumers have sufficient information to clearly understand loan terms and associated risks prior to making a product or payment choice.”

The message is simple, Kirkpatrick & Lockhart Nicholson Graham stated in its October e-mail: Mortgage lenders should not offer nontraditional products to the “higher-risk borrower” who wouldn’t qualify for a conventional loan.

In fact, the FDIC’s “Outlook – Summer 2006,” entitled “Breaking New Ground in U.S. Mortgage Lending,” notes that while “nontraditional loan products can be appropriate for financially savvy borrowers with low credit risk Â… what has changed Â… is how these loans have been marketed and used in recent years.”

“Lenders have targeted a wider spectrum of consumers who may not fully understand the embedded risks but use the loans to close the affordability gap,” the FDIC report suggests.

Many believe the new guidance is needed, especially now when the number of mortgages is waning and pressure is mounting to relax underwriting standards to keep volume up.

Lenders that stretch the rules make up about 10 percent to 20 percent of the industry, by the estimate of Brian Koss, a partner at Danvers-based Mortgage Network, and immediate past vice president for New England and New York at Countrywide Home Loans.

“There’s always a few Â… that ruin it for everyone else,” Koss remarked.

Koss said Mortgage Network is subject to certain aspects of the guidance because it engages in funding some of its loans, rather than simply brokering mortgages. Countrywide Home Loans, a non-bank subsidiary of Countrywide Bank, also must comply with the guidance (Countrywide, the nation’s top mortgage originator by dollar volume, declined comment for this article.)

“I think this crackdown is a great thing,” added Michael Sinclair, vice president at Hingham Institution for Savings. “Those of us who play by the rules are being painted with the same brush as the unscrupulous lenders out there. This benefits the borrower and those of us who have the borrower’s best interest in mind.”

Others, such as mega-lender Washington Mutual’s Jay Houllahan, the company’s home loan center manager for Boston and Quincy, said the guidance merely reiterates best practices already in place at the good companies.

“I don’t think [the new guidance] have any impact on us,” Houllahan said. “I think they come down to best practices. Washington Mutual does that to a huge degree, in terms of educating their staff” to educate borrowers before they take out a loan, he said.

Koss agreed that many of the new guidelines, in fact, “have been stated before,” by one or another of the multitude of agencies that regulate the mortgage industry.

“Now they’re saying, ‘We’re going to enforce it,'” he said.

However, Massachusetts Mortgage Bankers Association Director Kevin Cuff suggested the guidance creates some problems because it is “inconsistent to issue the same regulations for such different types of businesses” as small, local lenders and banking behemoths.

The answer to whether the number of nontraditional mortgage loans issued this year has gone up or down depends on whom you ask.

Regulator Concerns
Locally, brokers and lenders who offer such loans admit they’re less popular than conventional products this year – and some say they’re steering clients in other directions – in large part because interest rates are creeping up, making adjustable loans less attractive.

Currently, five- and seven-year interest-only ARMs are Washington Mutual’s most popular product, said Houllahan, although potential borrowers “love” the option ARM, he said, once it’s explained to them.

“I’ve had one since I bought my house in 1994. Sixty percent of my staff has one, too,” he said. “It’s a solid, good product.”

In fact, option ARMs have been around for at least 20 years, he and others estimated. The loan allows borrowers, each month, to choose one of four payment options: a minimum payment (similar to a credit card minimum payment) that pays off a portion of the interest, an interest-only payment, and interest-plus-principal payments based on 30- or 15-year terms. The problem is that the loans can “negative amortize” – in other words, borrowers can wind up owing more than the amount borrowed if they pay only the minimum amount each month. Coupled with a slumping real estate market that is driving home values down, that can be a recipe for disaster, some industry watchers say.

Minimum payments are generally adjusted every year or if the loan amount increases to 110 percent or more of the original amount borrowed – sometimes resulting in what the FDIC refers to as “payment shock.”

“I don’t know if there’s any empirical evidence that these type of loans result in foreclosures, but that’s certainly the fear among regulators,” Ragalevsky said.

Koss, who worked for Countrywide until Sept. 1, said that within the past couple of months, that company sent out letters to all its option ARM customers who were making only the minimum payment each month, asking them to consider why and reminding them of the risks.

The company originated $333 billion in mortgages nationwide (about half were refinancings) between January and September of this year, according to National Mortgage News, which also reported last month that, according to Countrywide CEO Angelo Mozilo, some 70 percent of Countrywide’s option ARM customers were choosing the lowest monthly payment.

Separately, the Consumer Federation of America found that more than one-third of interest-only borrowers earned below $70,000 a year, the Wall Street Journal reported in June.

An interest-only mortgage allows a borrower to pay back only interest on a loan, not principal, for a set period; the borrower then begins to pay back the principal when the original term is up.

Sushil Tuli, CEO of Arlington-based Leader Bank and 20-year-old Leader Mortgage, said the bank, which doesn’t offer option ARMs, also limits the volume of interest-only mortgages it issues.

“I personally don’t like them. I don’t think they should be sold to first-time homebuyers,” Tuli said.

“We will do it, but for the customers who [expect] a large sum in income at the end of the year.”

This year, the bank limited its interest-only loan volume to $5 million. Leader Mortgage offers option ARMs, but sells them to the secondary market, Tuli said.

‘Common Interest’
Eric Nelson, owner of United Funding Corp., a mortgage brokerage with offices in Milton and Boston, says his company tries to educate borrowers to “look at those option ARMs and see if they can find something more beneficial Â… We try to [make] them understand that if they are just making the minimum payment, their loan balance will go up.” Nationally, the Mortgage Bankers Association says that total first-mortgage origination volumes decreased 16 percent in the first half of 2006, according to its survey of 115 lenders, including most of the top 30 originators, nationwide.

But the results “continue to show strong demand for interest-only and payment option mortgages,” the trade group said.

Tough housing and employment markets in New England may have contributed to a demand for non-traditional mortgages, since, some say, some consumers may be attracted by initial low payments and see the loans as a means to get into a home they otherwise cannot afford.

“[Payment option loans] are a huge, huge product. They are a significant portion of originations from Washington Mutual and Countrywide,” said Charles Nilsen, regional vice president for Chase Home Finance, a division of J.P. Morgan Chase, which originated $1 billion in retail loans last year. Such loans have been “very aggressively sold in the last four to five years,” said Nilsen, whose company considers them too risky to offer “because lenders are looking at that very low [minimum] payment option to qualify [borrowers].”

Lately, there’s been pressure from the Federal Financial Institutions Examination Council (a division of the Office of the Comptroller of the Currency, which oversees large thrifts and banks) “to qualify people at what they actually would owe” rather than what their monthly payment will be, Nilsen said. Meanwhile, Federal Reserve Chairman Ben Bernanke told community development bankers at a Washington, D.C., conference this month that they and the bank “share a common interest in increasing economic opportunities for all Americans.”

One indicator of opportunity is access to credit, he said; another is the homeownership rate.

In the past decade, he said, U.S. households have experienced “notable gains” in those areas – although gaps between lower-income households and others “remain wide.”

Meanwhile, the National Association of Realtors says it supports the new federal mortgage guidance but “caution[s] federal regulators Â… not to restrict innovation in mortgage lending and, by extension, opportunities for homeownership. “When used correctly, nontraditional mortgages are viable options for many qualified homebuyers, and NAR supports lenders that make these loans responsibly,” said Association President Thomas M. Stevens in an Oct. 3 statement.

Koss predicted that, in the end, the market-driven American economic system will drive consumer behavior and industry practices faster than any regulation can.

The nonconventional loans with low initial payments and options to pay minimum amounts for long periods can make some hopeful homeowners believe they’ll be able to buy more home than they can afford, he said. And Americans today are “impatient.” “They want it all now,” Koss said.

“You can have all the regulations you want,” he added. “But as long as Wall Street is buying” a certain type of loan, somebody is probably going to offer it.