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Before the Subcommittees on Housing and Transportation and Economic 
Policy, Committee on Banking, Housing, and Urban Affairs, U.S. Senate: 

United States Government Accountability Office: 


For Release on Delivery Expected at 10:00 a.m. EDT: 

Wednesday, September 20, 2006: 

Alternative Mortgage Products: 

Impact on Defaults Remains Unclear, but Disclosure of Risks to 
Borrowers Could Be Improved: 

Statement of Orice M. Williams, Director Financial Markets and 
Community Investments: 


GAO Highlights: 

Highlights of GAO-06-1112T, a testimony to the Subcommittees on Housing 
and Transportation and Economic Policy, Committee on Banking, Housing, 
and Urban Affairs, U. S. Senate 

Why GAO Did This Study: 

Alternative mortgage products (AMPs) can make homes more affordable by 
allowing borrowers to defer repayment of principal or part of the 
interest for the first few years of the mortgage. Recent growth in AMP 
lending has heightened the importance of borrowers’ understanding and 
lenders’ management of AMP risks. GAO’s report discusses the (1) recent 
trends in the AMP market, (2) potential AMP risks for borrowers and 
lenders, (3) extent to which mortgage disclosures discuss AMP risks, 
and (4) federal and selected state regulatory response to AMP risks. 
GAO used regulatory and industry data to analyze changes in AMP monthly 
payments under various scenarios; reviewed available studies; and 
interviewed relevant federal and state regulators and mortgage industry 
groups, and consumer groups. 

What GAO Found: 

From 2003 through 2005, AMP originations, comprising mostly interest-
only and payment-option adjustable-rate mortgages, grew from less than 
10 percent of residential mortgage originations to about 30 percent. 
They were highly concentrated on the East and West Coasts, especially 
in California. Federally and state-regulated banks and independent 
mortgage lenders and brokers market AMPs, which have been used for 
years as a financial management tool by wealthy and financially 
sophisticated borrowers. In recent years, however, AMPs have been 
marketed as an “affordability” product to allow borrowers to purchase 
homes they otherwise might not be able to afford with a conventional 
fixed-rate mortgage. 

Because AMP borrowers can defer repayment of principal, and sometimes 
part of the interest, for several years, some may eventually face 
payment increases large enough to be described as “payment shock.” 
Mortgage statistics show that lenders offered AMPs to less creditworthy 
and less wealthy borrowers than in the past. Some of these recent 
borrowers may have more difficulty refinancing or selling their homes 
to avoid higher monthly payments, particularly in an interest-rate 
environment where interest rates have risen or if the equity in their 
homes fell because they were making only minimum monthly payments or 
home values did not increase. As a result, delinquencies and defaults 
could rise. Federal banking regulators stated that most banks appeared 
to be managing their credit risk well by diversifying their portfolios 
or through loan sales or securitizations. However, because the monthly 
payments for most AMPs originated between 2003 and 2005 have not reset 
to cover both interest and principal, it is too soon to tell to what 
extent payment shocks would result in increased delinquencies or 
foreclosures for borrowers and in losses for banks. 

Regulators and others are concerned that borrowers may not be well-
informed about the risks of AMPs, due to their complexity and because 
promotional materials by some lenders and brokers do not provide 
balanced information on AMPs benefits and risks. Although lenders and 
certain brokers are required to provide borrowers with written 
disclosures at loan application and closing, federal standards on these 
disclosures do not currently require specific information on AMPs that 
could better help borrowers understand key terms and risks. 

In December 2005, federal banking regulators issued draft interagency 
guidance on AMP lending that discussed prudent underwriting, portfolio 
and risk management, and consumer disclosure practices. Some lenders 
commented that the recommendations were too prescriptive and could 
limit consumer choices of mortgages. Consumer advocates expressed 
concerns about the enforceability of these recommendations because they 
are presented in guidance and not in regulation. State regulators GAO 
contacted generally relied on existing regulatory structure of 
licensing and examining independent mortgage lenders and brokers to 
oversee AMP lending. 

What GAO Recommends: 

GAO’s report includes a recommendation that as part of the Federal 
Reserve Board’s review of existing mortgage disclosure requirements, it 
should consider revising those requirements to improve the clarity and 
comprehensiveness of AMP disclosures. The Federal Reserve responded 
that it will conduct consumer testing to determine appropriate content 
and formats and use design consultants to develop model disclosure 
forms intended to better communicate information. 


To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Orice M. Williams at 
(202) 512-8678 or 

[End of Section] 

Chairmen and Members of the Subcommittees: 

I am pleased to be here today to discuss our work on alternative 
mortgage products (AMPs). As you know, an increasing number of 
borrowers have turned to AMPs, such as interest-only and payment-option 
adjustable rate mortgages (ARMs), to purchase homes they might not be 
able to afford with conventional fixed-rate mortgage payments. These 
products initially keep borrowers' payments low by allowing consumers 
in the short term to defer principal payments or make payments that do 
not cover principal or all accrued interest. However, unless the 
borrower refinances the mortgage or sells the property, the monthly 
payments eventually will increase when the interest-only and deferred 
payment periods end and higher, fully amortizing payments begin. 

My remarks will summarize the findings from the report being released 
today, which was prepared at the request of the Chairman of the 
Subcommittee on Housing and Transportation.[Footnote 1] Specifically, I 
will discuss: (1) recent trends in the AMP market, (2) the impact of 
AMPs on borrowers and on the safety and soundness of financial 
institutions, (3) the extent to which mortgage disclosures discuss the 
risks of AMPs, (4) the federal regulatory response to the risks of AMPs 
for lenders and borrowers, and (5) selected state regulatory responses 
to the risks of AMPs for lenders and borrowers. We gathered information 
from federal and state banking regulators, consumer groups, and the 
mortgage industry on AMP-lending trends and risks to borrowers and 
lenders, including laws and regulations on mortgage disclosures. We 
also reviewed a sample of disclosures to determine the extent to which 
they addressed AMP risks. 

In summary, we found the following: 

* AMP lending tripled over a 3-year period, and many borrowers were 
using interest-only or payment-option adjustable-rate products to 
purchase homes in high-priced markets. AMP lending has been 
concentrated in the higher-priced regional markets on the East and West 
Coasts in states such as California, Washington, Virginia, and 

* Lenders may have increased risks to themselves and their customers by 
relaxing underwriting standards and through "risk-layering", which 
includes combining AMPs with less stringent income and asset 
verification requirements or lending to borrowers with lower credit 
scores and higher debt-to-income ratios. However, it is too early to 
determine the extent to which high foreclosure rates will result or 
whether lenders will be affected. 

* A wider spectrum of borrowers that are now using AMPs may not fully 
understand their risks because (1) AMP loans often have complicated 
terms and features, (2) AMP advertising sometimes emphasizes the 
benefits of AMPs over their risks, and (3) mortgage disclosures can be 
unclearly written and may be hard to understand. Moreover, current 
federal disclosure requirements do not require lenders to address AMP- 
specific terms and risks. 

* Federal banking regulators collectively responded to AMP-lending 
concerns by issuing draft guidance that called for tightened 
underwriting, enhanced risk-management policies, and better information 
for consumers. Regulators also have individually responded by 
monitoring AMP lending, beginning to update the regulation governing 
mortgage disclosures, Regulation Z, and reinforcing the message about 
managing AMP risks to the mortgage industry. 

* State regulators included in our review generally addressed concerns 
about AMP lending through their licensing and examination processes, 
although a few states have started to collect more AMP-specific 
information as a prelude to other possible actions. 

Given the complexity of AMPs and their more widespread use, mortgage 
disclosures that can help borrowers make informed decisions are 
important. Although federal banking regulators have taken a range of 
proactive steps to address AMP lending, current federal standards for 
disclosures do not require information on AMP-specific risks. 
Therefore, we recommended in our report that as the Federal Reserve 
Board reviews Regulation Z, it consider improving the clarity and 
comprehensiveness of mortgage disclosures by requiring language that 
explains key features and potential risks specific to AMPs. 


Borrowers obtain residential mortgages through either mortgage lenders 
or brokers. Mortgage lenders can be federally or state-chartered banks 
or mortgage lending subsidiaries of these banks or of bank holding 
companies. Independent lenders, which are neither banks nor affiliates 
of banks, also may fund home loans to borrowers. Mortgage brokers act 
as intermediaries between lenders and borrowers, and for a fee, help 
connect borrowers with various lenders that may provide a wider 
selection of mortgage products. 

Federal banking regulators--Office of the Comptroller of the Currency 
(OCC), the Board of Governors of the Federal Reserve System (Federal 
Reserve), Federal Deposit Insurance Corporation (FDIC), National Credit 
Union Administration (NCUA), and Office of Thrift Supervision (OTS)-- 
have, among other things, responsibility for ensuring the safety and 
soundness of the institutions they oversee. To pursue this goal, 
regulators establish capital requirements for banks; conduct on-site 
examinations and off-site monitoring to assess their financial 
conditions; and monitor their compliance with applicable banking laws, 
regulations, and agency guidance. As part of their examinations, for 
example, regulators review mortgage lending practices, including 
underwriting, risk-management, and portfolio management practices, and 
try to determine the amount of risk lenders have assumed. From a safety 
and soundness perspective, risk involves the potential that either 
anticipated or unanticipated events may have an adverse impact on a 
bank's capital or earnings. In mortgage lending, regulators pay close 
attention to credit risk--that is the concerns that borrowers may 
become delinquent or default on their mortgages and that lenders may 
not be paid in full for the loans they have issued. 

Certain federal consumer protection laws, including the Truth in 
Lending Act and its implementing regulation, Regulation Z, apply to all 
mortgage lenders and brokers that close loans in their own names. Each 
lender's primary federal supervisory agency has responsibility for 
enforcing Regulation Z and generally uses examinations and consumer 
complaint investigations to check for compliance with both the act and 
its regulation. In addition, the Federal Trade Commission (FTC) is 
responsible for enforcing certain federal consumer protection laws for 
brokers and lenders that are not depository institutions, including 
state-chartered independent mortgage lenders and mortgage lending 
subsidiaries of financial holding companies. However, FTC is not a 
supervisory agency. FTC uses a variety of information sources in the 
enforcement process, including FTC investigations, consumer complaints, 
and state and federal agencies. 

State banking and financial regulators are responsible for overseeing 
independent lenders and mortgage brokers and generally do so through 
licensing that mandates certain experience, education, and operations 
requirements to engage in mortgage activities. States also may examine 
independent lenders and mortgage brokers to ensure compliance with 
licensing requirements, review their lending and brokerage functions, 
and look for unfair or unethical business practices. In the event such 
practices or consumer complaints occur, regulators and attorneys 
general may pursue actions that include license suspension or 
revocation, monetary fines, and lawsuits. 

AMP Lending Rapidly Grew and Borrower Characteristics Changed as 
Consumers Sought Mortgage Products That Increased Affordability: 

From 2003 through 2005, AMP lending grew rapidly, with originations 
increasing threefold from less than 10 percent of residential mortgages 
to about 30 percent. Most of the originations during this period 
consisted of interest-only ARMs and payment-option ARMs, and most of 
this lending occurred in higher-priced regional markets concentrated on 
the East and West Coasts. For example, based on data from mortgage 
securitizations in 2005, about 47 percent of interest-only ARMs and 58 
percent of payment-option ARMs were originated in California, which 
contained 7 of the 20 highest-priced metropolitan real estate markets 
in the country. On the East Coast, Virginia, Maryland, New Jersey, and 
Florida as well as Washington, D.C., exhibited a high concentration of 
AMP lending in 2005. Other examples of states with high concentrations 
of AMP lending include Washington, Nevada, and Arizona. These areas 
also experienced higher rates of home price appreciation during this 
period than the rest of the United States. 

In addition to this growth, the characteristics of AMP borrowers have 
changed. Historically, AMP borrowers consisted of wealthy and 
financially sophisticated borrowers who used these specialized products 
as financial management tools. However, today a wider range of 
borrowers use AMPs as affordability products to purchase homes that 
might otherwise be unaffordable using conventional fixed-rate 

Borrowers Could Face Payment Shock; Lenders Face Credit Risk but Appear 
to Be Taking Steps to Manage the Risk: 

Although AMPs have increased affordability for some borrowers, they 
could lead to increased payments or "payment shock" for borrowers and 
corresponding credit risk for lenders. Unless the mortgages are 
refinanced or the properties sold, AMPs eventually reach points when 
interest-only and deferred payment periods end and higher, fully 
amortizing payments begin. Regulators and consumer advocates have 
expressed concern that some borrowers might not be able to afford these 
higher monthly payments. To illustrate this point, we simulated what 
would happen to a borrower in 2004 that made minimum monthly payments 
on a $400,000 payment-option ARM. As figure 1 shows, the borrower could 
see payments rise from $1,287 to $2,931, or 128 percent, at the end of 
the 5-year payment-option period.[Footnote 2] In addition, with a wider 
range of AMP borrowers now than in the past, those with fewer financial 
resources or limited equity in their homes might find refinancing their 
mortgages or selling their homes difficult, particularly if their loans 
have negatively amortized or their homes have not appreciated in value. 

Figure 1: Increase in Minimum Monthly Payments and Outstanding Loan 
Balance with an April 2004 $400,000 Payment-Option ARM, Assuming Rising 
Interest Rates: 

[See PDF for image] 

Source: GAO. 

[End of figure] 

In addition, borrowers who cannot afford higher payments and may become 
delinquent or default on their mortgages may pose credit risks to 
lenders because these borrowers may not repay their loans in full. 
Lenders also may have increased risks to themselves and their customers 
by relaxing underwriting standards and through risk-layering. For 
example, some lenders combined AMPs with less stringent income and 
asset verification requirements than traditionally permitted for these 
products or lent to borrowers with lower credit scores and higher debt- 
to-income ratios. 

Although regulatory officials have expressed concerns about AMP risks 
and underwriting practices, they said that banks and lenders generally 
have taken steps to manage the resulting credit risk. Federal and state 
banking regulatory officials and lenders with whom we spoke said most 
banks have diversified their assets to manage the credit risk of AMPs 
held in their portfolios, or have reduced their risk through loan sales 
or securitization. In addition, federal regulatory officials told us 
that while underwriting trends may have loosened over time, lenders 
have generally attempted to mitigate their risk from AMP lending. For 
example, OCC and Federal Reserve officials told us that most lenders 
qualify payment-option ARM borrowers at fully indexed rates, not at 
introductory interest rates, to help ensure that borrowers have 
financial resources to manage future mortgage increases, or to pay more 
on their mortgages than the minimum monthly payment. OCC officials also 
said that some lenders may mitigate risk by having some stricter 
criteria for AMPs than for traditional mortgages for some elements of 
their underwriting standards. Although we are encouraged by these 
existing risk mitigation and management strategies, most AMPs issued 
between 2003 and 2005, however, have not reset to require fully 
amortizing payments, and it is too soon to tell how many borrowers will 
eventually experience payment shock or financial distress. As such, in 
our report we agree with federal regulatory officials and industry 
participants that it was too soon to tell the extent to which AMP risks 
may result in delinquencies and foreclosures for borrowers and losses 
for banks that hold AMPs in their portfolios. However, we noted that 
past experience with these products may not be a good indicator for 
future AMP performance because the characteristics of AMP borrowers 
have changed. 

Borrowers May Not Be Well-informed of AMP Risks and Mortgage 
Disclosures May Not Effectively Describe These Risks to Consumers: 

Regulatory officials and consumer advocates expressed concern that some 
AMP borrowers may not be well-informed about the terms and risks of 
their complex AMP loans. Obstacles to understanding these products 
include advertising that may not clearly or effectively convey AMP 
risks, and federal mortgage disclosure requirements that do not require 
lenders to tailor disclosures to the specific risks of AMPs to 

Mortgage Advertising May Not Clearly or Effectively Explain AMP Risks: 

Marketing materials that we reviewed indicated that advertising by 
lenders and brokers may not clearly provide information to inform 
consumers about the potential risks of AMPs. For example, one 
advertisement we reviewed promoted a low initial interest rate and low 
monthly mortgage payments without clarifying that the low interest rate 
would not last the full term of the loan. 

In other cases, promotional materials emphasized the benefits of AMPs 
without effectively explaining the associated risks. Some advertising, 
for example, emphasized loans with low monthly payment options without 
effectively disclosing the possibility of interest rate changes or 
mortgage payment increases. One print advertisement we reviewed for a 
payment-option ARM emphasized the benefit of a low initial interest 
rate but noted in small print on its second page that the low initial 
rate applied only to the first month of the loan and could increase or 
decrease thereafter. 

Federal Disclosures May Not Clearly and Completely Explain AMP Specific 

Regulatory officials noted that current Regulation Z requirements 
address traditional fixed-rate and adjustable-rate products, but not 
more complex products such as AMPs that feature risks such as negative 
amortization and payment shock. To better understand the quality of AMP 
disclosures, we reviewed eight interest-only and payment-option ARM 
disclosures provided to borrowers from federally regulated lenders. 
These disclosures were provided to borrowers between 2004 and 2006 by 
six federally regulated lenders that collectively made over 25 percent 
of the interest-only and payment option ARMs produced in 2005.We found 
that these disclosures addressed current Regulation Z requirements, but 
some did not provide full and clear explanations of AMP risks such as 
negative amortization or payment shock. For example, as shown in figure 
2, the disclosure simply states that monthly payments could increase or 
decrease on the basis of interest rate changes, which may be sufficient 
for a traditional ARM product, but does not inform borrowers about the 
potential magnitude of payment change, which may be more relevant for 
certain AMPs. In addition, most of the disclosures we reviewed did not 
explain that negative amortization, particularly in a rising interest 
rate environment, could cause AMP loans to reset more quickly than 
borrowers anticipated and require higher monthly mortgage payments 
sooner than expected. 

Figure 2: Example of 2005 Interest-only ARM Disclosure Explaining How 
Monthly Payments Can Change: 

[See PDF for image] 

Sources: Name withheld. Used with permission; GAO (boxed comments). 

[End of figure] 

In addition, the AMP disclosures generally did not conform to leading 
practices in the federal government, such as key "plain English" 
principles for readability or design. For example, the Securities and 
Exchange Commission's "A Plain English Handbook: How to Create Clear 
SEC Disclosure Documents (1998)" offered guidance for developing 
clearly written investment product disclosures and presenting 
information in visually effective and readable ways. The sample 
disclosures we reviewed, however, were generally written with language 
too complex for many adults to fully understand. Most of the 
disclosures also used small, hard-to-read typeface, which when combined 
with an ineffective use of white space and headings, made them even 
more difficult to read and buried key information. 

Federal Banking Regulators Issued Guidance, Sought Industry Comments, 
and Took Other Actions to Respond to Concerns about AMP Lending: 

Federal banking regulators have taken a range of actions--including 
issuing draft interagency guidance, seeking industry comments, 
reinforcing messages about AMP risks and guidance principles in many 
forums, and taking other individual regulatory actions--to respond to 
concerns about the growth and risks of AMP lending. Federal banking 
regulators issued draft interagency guidance in December 2005 that 
recommended prudent underwriting, portfolio and risk management, and 
information disclosure practices related to AMP lending. The draft 
guidance calls for lenders to consider the potential impact of payment 
shock on borrowers' capacity to repay their mortgages and to qualify 
borrowers on their ability to make fully amortizing payments on the 
basis of fully indexed interest rates. It also recommends that lenders 
develop written policies and procedures that describe portfolio limits, 
mortgage sales and securitization practices, and risk-management 
expectations. In addition, to improve consumer understanding of AMPs, 
the draft guidance suggests that lender communications with borrowers, 
including advertisements and promotional materials, be consistent with 
actual product terms, and that institutions avoid practices that might 
obscure the risks of AMPs to borrowers. When finalized, the guidance 
will apply to all federally regulated financial institutions.[Footnote 

During the public comment period for the guidance, lenders and others 
suggested in their letters that the stricter underwriting 
recommendations were overly prescriptive and might put federally and 
state-regulated banks at a competitive disadvantage because the 
guidance would not apply to independent mortgage lenders or brokers. 
Lenders said that this could result in fewer mortgage choices for 
consumers. Consumer advocates questioned whether the guidance would 
actually help protect consumers. They noted that guidance might be 
difficult to enforce because it does not carry the same force as law or 
regulation. Federal banking regulatory officials are using these 
comments as they finalize the guidance. 

Even before drafting the guidance, federal regulatory officials had 
publicly reinforced their concerns about AMPs in speeches, at 
conferences, and through the media. According to a Federal Reserve 
official, these actions have raised awareness of AMP issues and 
reinforced the message that financial institutions and the general 
public need to manage risks and understand these products. 

Some regulatory officials have also taken agency-specific steps to 
address AMP lending, including reviewing high-risk lending, which would 
include AMPs, and improving consumer education about AMP risks. For 
example, FDIC officials told us that they have developed a review 
program to identify high-risk lending areas and evaluate risk 
management and underwriting approaches. NCUA officials said that they 
have informally contacted their largest credit unions to assess the 
extent of AMP lending at these institutions. OTS officials said that 
they have performed a review of OTS's 68 most active AMP lenders to 
assess and respond to potential AMP lending risks and OCC have begun to 
conduct reviews of their lenders' AMP promotional and marketing 
materials to assess how well they inform consumers. In response to 
concerns about disclosures, the Federal Reserve officials told us that 
they initiated a review of Regulation Z that includes reviewing the 
disclosures required for all mortgage loans, including AMPs, and have 
begun taking steps to consider disclosure revisions. During the summer 
of 2006, the Federal Reserve held hearings across the country on home- 
equity lending, AMP issues, and the adequacy of consumer disclosures 
for mortgage products. According to Federal Reserve officials, the 
Federal Reserve is currently reviewing the hearing transcripts and 
public comment letters to help develop plans and recommendations for 
revising Regulation Z. In addition, they said that they are currently 
revising their consumer handbook on ARM loans, known as the CHARM 
booklet, to include information about AMPs. Finally, in May 2006, FTC 
officials said that they sponsored a public workshop that explored 
consumer protection issues as a result of AMP growth in the mortgage 
marketplace and worked with federal banking regulators and other 
federal departments to create a brochure to assist consumers with 
mortgage information. 

Most States in Our Sample Responded to AMP-Lending Risks within 
Existing Regulatory Frameworks, While Others Have Taken Additional 

State banking and financial regulatory officials from the eight states 
in our sample expressed concerns about AMP lending in their states; 
however, most relied on their existing regulatory system of licensing 
and examining mortgage lenders and brokers to stay abreast of and react 
to AMP issues. Most of the officials in our sample expressed concern 
about AMP lending and the negative effects it could have on consumers, 
including how well consumers understood complex AMP loans and the 
potential impact of payment shock, financial difficulties, or default 
and foreclosure. Other officials expressed concern about whether 
consumers received complete information about AMPs, saying that federal 
disclosures were complicated, difficult to comprehend, and often were 
not very useful to consumers. 

In addition to these general consumer protection concerns, some state 
officials spoke about state-specific issues. For example, Ohio 
officials expressed AMP concerns in the context of larger economic 
concerns, noting that AMP mortgages were part of wider economic 
challenges facing the state. Ohio already has high rates of mortgage 
foreclosures and unemployment that have hurt both Ohio's consumers and 
its overall economy. In Nevada, officials worried that lenders and 
brokers have engaged in practices that sometimes take advantage of 
senior citizens by offering them AMP loans that they either did not 
need or could not afford. 

Most of the state regulatory officials said that they have relied upon 
state law to license mortgage lenders and brokers and ensure they meet 
minimum experience and operations standards. Most said they also 
periodically examine these entities for compliance with state 
licensing, mortgage lending, and consumer protection laws, including 
applicable fair advertising requirements. As such, most of the 
regulatory officials relied on systems already in place to investigate 
AMP issues or complaints and, when needed, used applicable licensing 
and consumer protection laws to respond to problems such as unfair and 
deceptive trade practices. 

Some state regulatory officials with whom we spoke said they have taken 
other actions to better understand the issues associated with AMP 
lending and expand consumer protections. For example, some states such 
as New Jersey and Nevada have gathered data on AMPs to better 
understand AMP lending and risks. Others, such as New York, plan to use 
guidance developed by regulatory associations to help oversee AMP 
lending by independent mortgage lenders and brokers. 

In summary, it is too soon to tell the extent to which payment shock 
will produce financial distress for some borrowers and induce defaults 
that would affect banks that hold AMPs in their portfolios. However, 
the popularity, complexity, and widespread marketing of AMPs highlight 
the importance of mortgage disclosures to help borrowers make informed 
mortgage decisions. As a result, while we commend the Federal Reserve's 
efforts to review and revise Regulation Z, we recommended in our report 
that the Board of Governors of the Federal Reserve System consider 
amending federal mortgage disclosure requirements to improve the 
clarity and comprehensiveness of AMP disclosures. In response to our 
recommendation, the Federal Reserve said that it will conduct consumer 
testing to determine appropriate content and formats and use design 
consultants to develop model disclosure forms intended to better 
communicate information. 

Chairmen of the subcommittees, this completes my prepared statement. I 
would be pleased to respond to any questions you or other Members may 
have at this time. 

GAO Contact and Staff Acknowledgments: 

For additional information about this testimony, please contact Orice 
M. Williams on (202) 512-5837 or at Contact points 
for our Offices of Congressional Relations and Public Affairs may be 
found on the last page of this statement. Individuals making key 
contributions to this testimony include Karen Tremba, Assistant 
Director; Tania Calhoun; Bethany Claus Widick; Stefanie Jonkman; Marc 
Molino; Robert Pollard; Barbara Roesmann; and Steve Ruszczyk. 


[1] GAO, Alternative Mortgage Products: Impact on Defaults Remains 
Unclear, but Disclosure of Risks to Borrowers Could Be Improved, GAO-06-
1021 (Washington, D.C.: Sept. 19, 2006). 

[2] This example assumes a $400,000 payment-option ARM with a 1 percent 
initial interest rate, a 7.5 percent annual payment increase cap, and a 
10 percent negative amortization cap. The example reflects actual 
interest rates for 2004 to 2006 and rates are assumed to remain 
unchanged thereafter. With an initial interest rate of 1 percent the 
borrower's minimum payment would be $1,287. However, the lender likely 
would have qualified the borrower based on a fully indexed rate of 4.41 
percent, which corresponds to a first-year's fully amortizing monthly 
payment of $2,039. Federal Reserve and OCC officials told us that 
lenders generally qualify payment-option ARM borrowers at the fully 
indexed interest rate. Although the borrower is faced with a payment 
shock of 128 percent in year six as a result of making minimum 
payments, the increase is 44 percent more than the monthly payment that 
was originally used to qualify the borrower. 

[3] Federally regulated financial institutions include all banks and 
their subsidiaries, bank holding companies and their non bank 
subsidiaries, savings associations and their subsidiaries, savings and 
loan holding companies and their subsidiaries, and credit unions.  

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