Fed examining subprime ARMs

US banks may have sold subprime mortgages to borrowers unable ever to repay them, according to the US Federal Reserve.

The Fed, along with four other federal regulatory agencies, is to examine subprime adjustable-rate mortgages (ARMs). Specifically, the agencies are looking at whether the repayment terms of these loans are greater than the borrowers’ ability to payback the debt without forcing them to refinance or sell their property.

According to the proposal, a financial institution must analyse a borrower’s ability to repay the debt by its final maturity at a fully indexed rate, assuming a fully amortised repayment scheduled, when offering ARMs. A potential red flag could be whether the institution assesses the borrower’s total monthly housing-related payments – including principal, interest, taxes and insurance – as a percentage of gross monthly income.

Concerns surround whether borrowers fully understand the risks and consequences inherent in these mortgage products, and whether there is an increased credit risk to financial institutions because of the products.

The four other agencies involved in the study are the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision.