Federal regulators directed banks yesterday to properly explain the risks posed to borrowers by interest-only and other nontraditional mortgages.

The guidance was aimed at addressing the concern that consumers don't understand all the repayment risks involved in these mortgages - including rising interest rates, which could significantly increase the monthly payments.

The regulators said banks needed to make sure that the loans they made were "consistent with prudent lending practices, including consideration of a borrower's repayment capacity."

An explosion of nontraditional loans in recent years has raised concern about the risks to the financial system should there be a sizable number of defaults if borrowers were unable to meet rising mortgage payments.

Interest-only mortgages require the homeowner initially to pay only the interest on the loan for a set period. Thus, the principal, or original amount of the loan, is not reduced.

Option adjustable-rate mortgages give the homeowner flexibility to decide how much to pay each month. One of the options is a minimum payment that covers only a portion of the monthly interest.

These mortgages are appealing to people who need cash for other expenses or who have been struggling in recent years with rapidly rising home prices.

But these types of loans also expose borrowers to far greater risks. If housing prices drop, their loans could be worth more than their properties. If interest rates rise, their loans would become expensive to pay.

The Government Accountability Office told Congress last week that nontraditional mortgages rose from less than 10 percent of all mortgages in 2003 to about 30 percent in 2005.

Yesterday's guidance was issued jointly by the Office of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corp., the Office of Thrift Supervision, and the National Credit Union Administration.

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