Seal of the Board of Governors of the Federal Reserve System
WASHINGTON, D. C.  20551

SR 07-12 / CA 07-3
July 24, 2007

SUBJECT:  Statement on Subprime Mortgage Lending

On June 29, 2007, the Federal Reserve and the other federal financial institutions regulatory agencies (the agencies) issued the attached final Statement on Subprime Mortgage Lending (Subprime Statement) to address issues and questions related to certain adjustable-rate mortgage (ARM) products marketed to subprime borrowers. This statement applies to all banks and their subsidiaries and bank holding companies and their nonbank subsidiaries. The attachment provides the Subprime Statement.


The Subprime Statement emphasizes the need for prudent underwriting standards and clear and balanced consumer information so that institutions and consumers can assess the risks arising from certain ARM products with discounted or low introductory rates. The statement is focused on these types of ARMs and uses the interagency Expanded Guidance for Subprime Lending (Expanded Guidance)1 issued in 2001 to determine subprime borrower characteristics. While the Statement is focused on subprime borrowers, the principles in the statement are also relevant to ARM products offered to non-subprime borrowers.

Risk Management Practices

The risk management practices discussed in the Subprime Statement are generally consistent with existing interagency guidance regarding real estate lending, subprime lending, and nontraditional mortgage products.2 Like the nontraditional mortgage guidance issued in 2006, this Subprime Statement encourages institutions to evaluate the borrower’s repayment capacity and ability to repay the loan by final maturity at the fully indexed rate, assuming a fully amortizing repayment schedule.3 Further, the Subprime Statement emphasizes that an institution’s assessment of a borrower’s repayment capacity should include an evaluation of the borrower’s debt-to-income ratio and states that this assessment should include total monthly housing-related payments (i.e., principal, interest, taxes, and insurance).

The Subprime Statement also emphasizes the risks of stated income or reduced documentation loans in the subprime sector and indicates institutions should document any factors relied upon to mitigate the risk inherent in extending such loans. Such factors could include a borrower’s favorable payment performance or substantial liquid reserves. A higher interest rate is not considered an acceptable mitigating factor. The statement emphasizes the importance of an institution verifying and documenting a borrower’s income in order to adequately analyze repayment capacity, particularly for subprime borrowers. Typically, an institution should be able to readily document income using a borrower’s recent W-2 statements, pay stubs, or tax returns. In addition, institutions should develop strong control systems to monitor whether actual practices are consistent with internal policies and procedures, and to ensure appropriate corrective action in the event the institution fails to comply with applicable laws, regulations, internal policies, and third-party agreements.

Workout Arrangements

The Subprime Statement reiterates the principles in the interagency Statement on Working with Borrowers (April 2007) in which the agencies encouraged institutions to work constructively with residential borrowers who are in default or whose default is reasonably foreseeable. Both documents indicate that prudent workout arrangements that are consistent with safe and sound lending practices are generally in the long-term best interest of both the financial institution and the borrower. The Federal Reserve will not criticize institutions that pursue reasonable workout arrangements with borrowers.

Predatory Lending Considerations

The Subprime Statement outlines certain aspects of the covered lending practices that are considered predatory in nature and provides that institutions should not engage in these practices regardless of loan features. Further, the Subprime Statement clarifies that subprime lending is not synonymous with predatory lending and, therefore, there is no presumption that the ARM products discussed in the Subprime Statement are predatory in nature.

Consumer Disclosure Practices

The Subprime Statement states that institutions should ensure that communications with consumers, including advertisements, oral statements, and promotional materials provide clear and balanced information about the relative benefits and risks of the products offered. These communications should provide information about the costs, terms, features, and risks of the loan to the borrower, and should be provided in a timely manner, to assist consumers during the product selection process. Communications should include information on payment shock, prepayment penalties, balloon payments, cost of reduced documentation loans, and responsibility for taxes and insurance. With respect to prepayment penalties, borrowers should be provided a reasonable period of time (typically, at least 60 days prior to the reset date) to refinance without penalty.4

Supervisory Review

Federal Reserve examiners are expected to carefully review for the risk management and consumer compliance concerns contained in this guidance as a part of ongoing examination activities. Examiners will take action against institutions that exhibit predatory lending practices, violate consumer protection or fair lending laws, engage in unfair or deceptive acts or practices, or otherwise engage in unsafe or unsound lending practices.

Federal Reserve Banks are asked to distribute this letter and the interagency statement to banking organizations supervised by the Federal Reserve, as well as to their own supervisory and examination staff. For questions concerning the safety and soundness sections of this guidance, please contact in the Board’s Division of Banking Supervision and Regulation: Sabeth Siddique, Assistant Director, at (202) 452-3861; Virginia Gibbs, Senior Supervisory Financial Analyst, at (202) 452-2521; or Brian Valenti, Supervisory Financial Analyst, at (202) 452-3575. For questions related to consumer disclosure practices or predatory lending considerations, please contact Kathleen Ryan, Counsel, or Jamie Goodson, Attorney, at (202) 452-3667 in the Board’s Division of Consumer and Community Affairs.

signed by

Roger T. Cole
Division of Banking Supervision
and Regulation
signed by

Sandra F. Braunstein
Division of Consumer
and Community Affairs

Statement on Subprime Mortgage Lending (72 KB PDF)
Cross References:

  1. As discussed in the 2001 interagency Expanded Guidance for Subprime Lending Programs, the term “subprime” refers to the characteristics of individual borrowers. Subprime borrowers typically have weakened credit histories that include payment delinquencies and possibly more severe problems such as charge-offs, judgments, and bankruptcies. They also may display reduced repayment capacity as measured by credit scores, debt-to-income ratios, or other criteria that may encompass borrowers with incomplete credit histories.  Return to text
  2. The 1993 Interagency Guidelines for Real Estate Lending, the 1999 Interagency Guidance on Subprime Lending, the 2001 Expanded Guidance for Subprime Lending Programs, and the 2006 Interagency Guidance on Nontraditional Mortgage Product Risks.  Return to text
  3. The nontraditional mortgage (NTM) guidance covers mortgage products that allow borrowers to defer payment of principal and sometimes interest, including interest-only mortgages where a borrower pays no loan principal for the first few years of the loan and payment option ARMs where a borrower has flexible payment options with the potential for negative amortization. Because certain ARM products offered to subprime borrowers are fully amortizing, the NTM guidance does not cover such products.  Return to text
  4. There is no supervisory expectation for institutions to waive contractual terms with regard to prepayment penalties on existing loans.  Return to text

SR letters | 2007
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