Unconventional Mortgages Attract Warning From Regulator
WASHINGTON—A type of unconventional mortgage that focuses on a borrower’s assets to vet repayment ability has drawn a warning from regulators for banks to maintain tight underwriting standards.
Asset-depletion loans, also known as asset-dissipation loans, are part of a small but growing subset of the mortgage market that includes subprime loans and other riskier products. They assume borrowers draw from assets to cover a mortgage, rather than just income.
They are designed for people who don’t have a conventional paycheck, including retirees or workers in the gig economy, and were traditionally aimed at high-net-worth individuals with portfolios that could be easily converted into cash for mortgage payments.
Now the loans are reaching a broader set of borrowers, raising concerns that lenders aren’t properly measuring their risk.
“As banks have expanded [asset-depletion underwriting] to qualify other applicants, examiners have noted weaknesses in policies and practices,” Richard Taft, the Office of the Comptroller of the Currency’s top credit-risk official, said in a written statement. He added that banks “should develop and implement policies, processes, and control systems in a manner consistent with safe and sound banking practices.”
The OCC, which regulates national banks, is asking lenders to tighten underwriting standards, ensuring they don’t overestimate borrowers’ ability to draw on their assets to pay down their mortgage.
Fannie Mae and Freddie Mac, two companies that support about half the nation’s mortgage market by buying mortgages from banks and other lenders, typically require such loans to be based on a borrower’s 401(k) or other employment-related asset.
In recent years Fannie and Freddie have eased standards for those loans, allowing lenders to ask for a smaller down payment from elderly borrowers or assume the assets would be tapped over a shorter period, increasing the estimated monthly payout.
The mortgage giants also have increasingly backed loans to borrowers who have heavy debt loads.
Lenders made $12 billion in unconventional loans in the second quarter, up 9% from the same time last year, according to Inside Mortgage Finance. That compares with $326 billion in conventional and conforming loans in the same period.
The OCC is advising lenders that make asset-focused loans to divide the borrower’s assets by the full term of the loan—or to follow timelines comparable to traditional mortgages—to estimate how much they could draw each month to cover the expense.
Prudent underwriting also would assume borrowers are making either no return on their assets or a rate supported by sound analysis, the regulator said.
“It’s a bit of a warning to banks,” said Kris Kully, a partner at Mayer Brown LLP who advises lenders on consumer financial issues. “‘We understand that this type of underwriting can be reasonable, but don’t forget that you need to dot your i’s and cross your t’s.’”
Banks have started to adjust their practices. TD Bank offers such mortgages for clients with more than $1 million in liquid assets and $5 million in net worth, said Rick Bechtel, head of U.S. residential lending at the bank.
“The primary borrower profile for this product is typically a wealthy retiree,” Mr. Bechtel said. “They don’t have a traditional job anymore. A lot of the ways in which mortgages typically work don’t apply to them.”
TD Bank recently made some tweaks to its asset-depletion program to comply with OCC requests, Mr. Bechtel said. Specifically, the bank now derives a hypothetical income figure by dividing the borrower’s assets by the full term of the loan, rather than a shorter term.
TD Bank has long offered the loans and they remain a niche product, according to Mr. Bechtel. But a number of factors have increased their popularity in recent years, including low borrowing costs, rising investment values and stricter rules around qualifying for more conventional loans.
Mr. Bechtel said the bank is conservative about making them, traditionally discounting the value of the assets to account for taxes and requiring a high credit score from the borrower.
“You want to make sure that every other element of their credit profile is strong, maybe even slightly stronger than normal,” Mr. Bechtel said.
—Ben Eisen contributed to this article.