Fed Proposes Crackdown on Lenders and Lending Practices

The Federal Reserve continued its flurry of activity this month by announcing on Tuesday a proposal for restrictive rules for mortgage lenders. The restrictions are aimed at limiting unfair and deceptive home-lending practices that contributed to this year's subprime meltdown.

Generally, the rules take aim at unscrupulous lenders that target subprime borrowers and others, those borrowers being persuaded that they can afford loans that should be out of reach.

"Our goal is to promote responsible mortgage lending, for the benefit of individual consumers and the economy," the Fed's chairman, Bend Bernanke, said in a statement. "We want consumers to make decisions about home mortgage options confidently, with assurances that unscrupulous home mortgage practices will not be tolerated."

The Fed's proposals, which would mean changes to Regulation Z (Truth in Lending) under the Home Ownership and Equity Protection Act, would affect subprime lenders and borrowers:

> Prohibit giving borrowers unaffordable loans. Some lenders use introductory interest rates on subprime adjustable-rate mortgages to determine a borrower's ability to repay the loan. However, this does not take into account the inevitable resetting to a higher interest rate, the bane of many subprime borrowers' current or future reality and the reason for spiking foreclosure rates. The Fed proposed that lenders base the determination of affordability on a borrower's ability to repay the loan at the reset rate.

> Restrict use of loans without income verification. Some lenders make loans without verifying the income of potential borrowers. Homebuyers then end up with homes they can't and could never afford. These are called "liar loans" or "stated income loans," and the Fed wants to eliminate them by requiring verification of income and assets.

> Prohibit or limit prepayment penalties. Many times prepayment penalties, like those incurred when homeowners want to refinance into more affordable loans, are overly punitive, adding up to six months of mortgage payments. The Fed wants to require lenders to waive prepayment penalties for 60 days prior to loan rate resetting.

> Encourage (or require) escrow for taxes and insurance. Some lenders do not disclose the entire cost of the home, including insurance and property taxes. The Fed wants lenders to collect taxes and insurance along with the mortgage payment and hold them in escrow for the borrower until they come due.

In addition to subprime loans and lenders, the Fed also made several proposals to improve all mortgage lending:

> Make broker incentives restricted and/or transparent. Some lenders will pay brokers to lock-in borrowers to higher rate loans than they would normally qualify for. This is called the "yield spread premium." The Fed wants to outlaw these payments unless they are clearly disclosed to borrowers.

> Prohibit appraiser coercion. Appraisers have often been pressured to overvalue homes by lenders. The Fed would end this practice.

> Prohibit unfair loan-servicing practices. The Fed wants to eliminate late fees that are charged more than once ("pyramided.") They would require that servicers credit consumer accounts on the day of receipt and provide records of payments.

> Require better disclosure overall. The proposed rules here include requiring complete and clear disclosure by lenders in ads and in person. This means all applicable rates advertised along with the "teaser" rates.

The Fed is inviting comment on these restrictions for 90 days.

Legislation Watch: House Passes Bill Restricting Mortgage Lenders

Desperate to show responsiveness and action on behalf of the growing number of families hit by the subprime crisis, the House passed a bill on Thursday restricting the activities of mortgage lenders.
The bill forces mortgage lenders to obtain licenses to operate, makes them responsible for determining a family's true ability to pay mortgage payments, and fines them for pushing borrowers toward subprime loans.
The bill sponsors say the restrictions are designed to prevent additional families from falling prey to the mortgage crisis. They recognize that the bill won't help families currently in trouble, but will go towards a better future.
"What we have today is a bill that cannot undo what happened, but makes it much less likely it will happen in the future," said Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, to the Federal News Radio.
More than 2 million adjustable rate mortgages are scheduled to reset by the end of 2008, and many American homeowners are expected to fall into debt. Supporters of this bill say that this situation could have been averted with stronger rules, and that past practices in the sub-prime market amounted to predatory lending, with confusing terms, high fees, and too much pressure by lenders.
Opponents to the bill, including Republicans and the White House administration, warn that measures such as these and other congressional intervention can make things worse. They worried that action by Congress can make it harder for current mortgage holders to refinance, and are concerned that lenders would be expected to forecast borrower's ability to pay.
Banking associations also oppose the bill. The Mortgage Bankers Association says the bill will limit credit availability and options for homeowners.

The bill:

> Prohibits lenders from making loans that borrowers can't repay

> Bans lenders from pushing homeowners into refinancing that provide minimal benefit and exorbitant fees

> Outlaws excessive fees for late payments

> Makes Wall Street banks that package mortgage securities into investments accountable for lending law violation

> Creates the Nationwide Mortgage Licensing System and Registry, a system for mortgage bankers and bank loan officers

The bill passed 291-127 and now goes to the Senate, where another bill attempting to regulate the mortgage industry has been stalled for weeks.