Fed Prepares to Tighten Lending Rules

The U.S. Federal Reserve on Monday unveiled long-awaited final mortgage rules to ban misleading and deceptive practices, including prepayment penalties for many subprime loans.  
 
"The proposed final rules we will discuss today 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," said Fed Chairman Ben Bernanke. 
 
To better protect subprime borrowers from getting into loans they couldn't handle, the Fed proposed four new requirements. The rules would:  
 
* Require lenders to verify income and assets  
* Prohibit them from engaging in a "pattern or practice" of making loans borrowers can't afford  
* Limit prepayment penalties  
* Require lenders establish escrow accounts for taxes and insurance  
 
Also, for all loans regardless of rate, the regulator would ban the practice of allowing banks to pay brokers for steering homeowners into higher-priced loans, unless that compensation was disclosed in advance. And it would prohibit brokers from coercing appraisers into misstating a home's value.  
 
Consumer Advocates: More is Needed  
 
With the proposals, the Fed is attempting to answer critics who charged the agency could have flexed its muscles several years ago, clamping down on unscrupulous lenders during the real estate boom.  
 
"Had these rules been in place, many of these things wouldn't have happened," said Ken Wade, chief executive of NeighborWorks America, a national community revitalization group chartered by Congress whose board is made up of bank regulators. The late Edward Gramlich, a former Fed governor who served as chairman of NeighborWorks' board, pushed unsuccessfully to rein in the mortgage industry.  
 
Still, Wade and other consumer advocates say the proposed rules need to be tightened further to be effective.  
 
For instance, the Fed should outright prohibit lenders from originating loans without considering the borrower's ability to pay. It's very difficult to prove a "pattern or practice" of such behavior, said Jim Carr, chief operating officer of the National Community Reinvestment Coalition, an advocacy group.  
 
"We really need to just have firm rules that close the door on the potential and the incentive for misbehavior," Carr said. "Considering we're in the midst of the worst housing collapse in half-a-century, one would think the rules would be stern enough to make clear these practices are not acceptable."  
 
Advocates also want the Fed to ban all prepayment penalties, not just limit them. As proposed, the regulation would prevent lenders from imposing a penalty at least 60 days before a jump in monthly payments.  
 
Also, they say the agency should eliminate so-called "yield-spread premiums," which some call a kickback to mortgage brokers for signing up borrowers for higher-cost loans when they could afford traditional ones. All parties in the mortgage industry should clearly disclose their fees, advocates say.  
 
"No lender should be able to hide the additional fees they charge," Wade said. "It creates confusion for the consumer."  
 
Industry executives, meanwhile, say increased regulation would prompt lenders to originate fewer mortgages. The proposals would raise lenders' liability and workload.  
 
"If the rule passes, I'm afraid the Fed will have to back off on some of it because it will hurt homeownership," said Bill Howe, vice president of the National Association of Mortgage Brokers.  
 
Many brokers, bankers and trade associations submitted comments critiquing the Fed's proposals and warning of the consequences.  
 
High among their concerns is that the Fed's measure for what constitutes a subprime loan - one with a mortgage rate three percentage points above the yield on a comparable Treasury note - would capture some prime loans as well, subjecting borrowers to greater scrutiny.  
 
They are also asking for clear guidelines on how they should evaluate a borrower's ability to repay the loan. However, the final rules should allow the lenders some flexibility in assessing borrowers' capabilities, executives say.  
 
Also, the industry doesn't want the Fed to impose too many limitations on the penalties lenders assess borrowers who pay their mortgages early. Lenders are more willing to extend credit to subprime borrowers when they know the homeowners can't quickly refinance into a lower cost loan without a big penalty.  
 
"Prepayment fees allow borrowers access to lower rates and, for some borrowers, whose risk profiles are more challenged, their only opportunity for mortgage financing," wrote Kieran Quinn, chairman of the Mortgage Bankers Association.