Getting tough on lenders

New Fed rules target abuses in sub-prime mortgage market

From wire reports

July 15, 2008

WASHINGTON - The nation's central bank clamped down hard yesterday on mortgage lenders, issuing new rules designed to curb the kind of shady practices that led to the subprime mortgage crisis.

Among the new rules is a restriction on the use of the word "fixed" to describe the terms of a loan whose rate will change over time, increased disclosure requirements for refinancings and home equity loans, and a prohibition on making subprime loans without verifying a borrower's income or ability to repay a mortgage even after a rate reset.

The new rules, which will take effect Oct. 1, will apply to all lenders, not just those regulated by the central bank.

"Rates of mortgage delinquencies and foreclosures have been increasing rapidly lately, imposing large costs on borrowers, their communities and the national economy," Federal Reserve Chairman Ben S. Bernanke said as he opened a meeting of the Fed board, which approved the new rules. "Although the high rate of delinquency has a number of causes, it seems clear that unfair or deceptive acts and practices by lenders resulted in the extension of many loans, particularly high-cost loans, that were inappropriate for or misled the borrower."

The new regulations particularly target abuses in the subprime mortgage market, which has been largely unregulated because the loans are secured and held by private investors. Subprime mortgages, designed to make loans available to borrowers with low incomes or poor credit, carry above-market interest rates to compensate investors for the added risk of default.

Critics - including some Democrats on Capitol Hill, consumer groups and others - contend that the Fed's failure to curb such lending practices years ago contributed to the mortgage meltdown.

"It was a race to the bottom in lending standards," said Susan Wachter, a professor of real estate and finance at the University of Pennsylvania's Wharton School of Business. Still, she believes the rules should protect people down the road - when the housing market gets back to health. "Memories are short," she warned.

For the more immediate term, the new lending rules might not get a test for some time because there are fewer home buyers these days, given all the problems in the housing and credit markets.

Also, some of the shady practices - along with some lenders - have not survived, felled by the mortgage meltdown. "The subprime market doesn't really exist right now," said Donald Kohn, the Fed's vice chairman.

Pava Leyrer, president of Heritage National Mortgage in Grand Rapids, Mich., said lenders already have tightened their standards. "I have people in my office every day. Their situation a year ago may have been completely different than it is now . I can't find loans for them, and they're good borrowers."

For subprime loans, the new rules will:

•Prohibit lenders from lending to borrowers who cannot repay the loan from income and assets other than a home's value.

•Require lenders to verify a borrower's income and assets.

•Ban prepayment penalties for the first four years of any adjustable-rate subprime mortgage; other subprime mortgages could have no prepayment penalties for two years.

•Require lenders to establish escrow accounts for property taxes and homeowner insurance for all first-lien mortgages.

For all mortgages, prime and subprime, the new rules will:

•Prohibit seven misleading advertising practices, including representing that a rate or payment is "fixed" if it will change over the course of the loan.

•Prohibit advertising in which different loans are compared unless all payments and rates are also disclosed.

•Prohibit foreign-language mortgage ads in which required disclosures are presented in English.

• Prohibit a lender from encouraging or coercing an appraiser to misrepresent a home's assessed value.

•Require lenders to credit borrowers' payments on the day of receipt.

•Prohibit so-called "pyramiding" of late fees.

•Require a lender to provide a payoff statement within a reasonable amount of time.

•Require a good-faith estimate of all loan costs and payments within three days of an application for any loan secured by a home's value, including home equity loans and refinancings of the original mortgage. (Currently, early disclosure is required only for home-purchase loans.) Borrowers cannot be charged any fees before receiving the estimates except for a fee to obtain the borrower's credit history.

One previously proposed regulation that has been withdrawn was disclosure of the bonuses, or "yield-spread premiums" that mortgage originators receive to underwrite subprime or other high-cost loans. The Fed said that consumer testing cast doubt on the effectiveness of the disclosure rule as proposed, and that the board is considering alternatives.

The rules "are intended to protect consumers from unfair or deceptive acts and practices in mortgage lending, while keeping credit available to qualified borrowers and supporting sustainable homeownership," Bernanke said.