New Federal Reserve rules, aimed at curbing abusive lending practices, will apply to all banks, financial institutions and mortgage brokers. Lenders who violate the rules are subject to consumer reports to federal regulators and potential lawsuits. The rules, which take effect on October 1, 2009, are not retroactive. So, borrowers who have previously entered into subprime loans or other loans that they cannot afford will not receive any relief under the new Federal Reserve rules. The rules apply to any loan secured by a borrower’s principal residence. State rules on lending practices, however, will trump the federal rules for state-regulated entities.
Subprime loans, which have affected populations with minimal resources or poor credit, are the primary target of the rules. Although the majority of lenders who specialized in subprime loans have ceased operations or modified their standards, consumer groups and federal regulators anticipate that history will repeat itself and that subprime loans will resurface at some point in the near future.
The Federal Reserve Board of Governors acted pursuant to its authority under the Home Ownership and Equity Protection Act, or "HOEPA,” and received over 4,500 comments and letters from consumer groups and other interested parties in response to its proposal for changes to lending practices. Governor Randall S. Kroszner has stated, “Abusive loans that strip borrowers' equity or cause them to lose their homes should not be tolerated . . . Our goal throughout this process has been to protect borrowers from practices that are unfair or deceptive and to preserve the availability of credit from responsible mortgage lenders.
The Federal Reserve is still considering proposed bans on abusive lending by consumer advocates. One proposal includes a prohibition on incentive-based pay or “yield spread premiums,” fees that mortgage brokers are paid for higher rate loans. The Department of Housing and Urban Development is working on its own version of a rule to govern “yield spread premiums.” Also of concern to consumer advocates are loans, such as adjustable-rate mortgages (ARMs), which are not covered by the new rules.
The following is a summary of some of the new rules, which are currently included in a 400-plus page document:
- Lenders can make subprime loans only to borrowers who can be reasonably expected to repay;
- Lenders must assess loan affordability, which includes an review of the borrower’s ability to pay the highest scheduled monthly payment in the first seven years of a loan;
- Lenders must verify a borrower’s income and assets;
- Beginning in 2010, lenders must put payments in escrow accounts for property taxes and homeowner’s insurance for all first-lien mortgage loans;
- The general use of prepayment penalties is limited, and permitted on fixed-rate loans only during the first two years of the loans;
- Prepayment penalties are barred with respect to subprime and adjustable-rate loans with rates that reset within the first five years of a loan;
- Lenders and mortgage brokers will be barred from coercing a real estate appraiser to misstate a home’s value;
- Companies that handle mortgages will be required to credit a consumer’s loan payments as of the date of receipt;
- New advertising standards, including a ban on lenders indicating that a mortgage rate is “fixed” when it can change, will apply to all mortgages; and
- Disclosure of Truth-in-Lending notices will be required early enough to help consumers shop for a mortgage.