Fed proposes mortgage rules to protect borrowers

Dec 19, 2007 - Lenders would have to confirm that a borrower can afford a mortgage before making the loan under protections proposed by the Federal Reserve on Tuesday following the havoc wrought by the US sub-prime loan crisis.

The proposals are intended to replace loose standards that have put many Americans at risk of losing their homes because they took out loans they could not afford and may not have fully understood.

The new rules will not assist today's struggling homeowners but would give consumers the right to sue mortgage lenders who act unfairly and deceptively in preparing loans. Millions of Americans who stretched to buy homes in recent years face the risk of foreclosure as mortgages with initial 'starter' rates reset sharply higher.

The Fed's board of governors unanimously approved the standards recommeded by its consumer rights staff and said they strike a balance by protecting consumers while preserving their access to credit.

'These new rules, once adopted, would apply to all mortgage lenders,' Fed Chairman Ben Bernanke said as the board met to consider the proposal. He said the rules would be 'consistently applied and vigorously enforced' by state and federal regulators.

The new rules would put the nation's 50,000 mortgage brokers under some federal supervision, according to Fed staff.

The proposal was criticised by several leading lawmakers and praised by an industry group.

The Fed has been faulted for failing to use all its consumer protection authority during the housing boom that ended in 2005, and lawmakers are threatening to take back some of those powers.

The proposed regulations would require that lenders confirm a borrower can afford a home loan by verifying his income and assets with tax records, payroll receipts and other documentation. That is aimed at ending the recent practice of so-called 'stated income' loans in which borrowers could state a particular income without anything to back the claim up.

The proposals would also limit the penalties imposed when a borrower pays off a home loan early. No 'prepayment penalty' would apply, for instance, if a loan is refinanced less than 60 days before its interest rate resets higher.

The proposed rules also would require that borrowers receive details on their brokers' compensation and be billed monthly for annual charges, such as property tax and insurance, that are placed in escrow.

The Fed plan also contains sweeping new standards for home appraisers and targets abusive practices by loan servicers.

The proposed regulations protect borrowers with interest rates of more than 3 percentage points above Treasury securities of similar duration. For example, a 30-year Treasury bond yields around 4.55 percent, and so a 'high-cost' 30-year mortgage loan today would have an interest rate of 7.55 per cent or higher.

Several leading lawmakers said the new rules were too little, too late and suggested Congress should assume some of the Fed's consumer protection role.

Senate Banking Committee Chairman Christopher Dodd faulted the Fed for limiting mandatory escrow to the mortgage's first year and opening only a two-month window of prepayment protection.

'It raises serious questions as to whether the Federal Reserve is the appropriate institution to house consumer protection functions,' the Connecticut Democrat said.

Mr Dodd, a Democratic presidential hopeful who has sponsored legislation aimed at reforming sub-prime mortgage lending, said legislative action was needed to help protect homeowners from 'abusive and predatory lending practices'. The Senate has yet to act on his legislation, but the House of Representatives has passed a bill aimed at curbing predatory lending practices.

The American Bankers Association praised the Fed for setting standards that could reach mortgage lenders who used Wall Street money to dive into the market and generally loosened standards more than depositor-backed institutions.

The proposed regulations will be open to public comment for 90 days before the Fed staff proposes final rules. At that point, there will be another public comment period, pushing final adoption well into next year.