Federal banking regulators that have supplied the markets with pioneering guidelines for credit-risk management for home-equity lending are now looking into sorting out risks for mortgages. The new guidelines dealing with first-time mortgages are likely to come out in 2006, serving to ward off concerns about the proliferation of new mortgage products that increase risks to lenders.

"Our next challenge is to look at what our expectations are for first mortgages," says Barbara Grunkemeyer, deputy comptroller for credit risk at the Office of the Comptroller of the Currency, which is taking the lead on this issue. "There’s a consensus among regulators that we need to be working on this."

According to the Mortgage Bankers Association’s survey, the interest-only and ARM share of mortgage originations rose to 17% for interest-only loans and 46% for loans with adjustable-rate but without an interest-only feature, based on the total number of loans originated in the second half of 2004. This stretch has generated fears that a string of defaults may be triggered by rising interest rates.

Innovative products are more likely to emerge in high-cost markets, such as California and Florida. Option ARMs that made up 6% of jumbo mortgages in the first quarter of 2004 have jumped in proportion to one-third in the fourth quarter, reports UBS. Jumbo loans are those that are made for amounts that exceed the limit set by Fannie Mae and Freddie Mac for loans they accept for reselling in the market.

Markets will be relieved to see guidelines for first-time mortgages put in place as these would better protect lenders and help spread their risks.