On December 18, the Federal Reserve Board issued its long awaited proposed rules to curb lending abuses. The Federal Reserve has been roundly criticized for not previously taking action in this regard.

The proposed rule defines a new category of “higher-priced mortgages” as mortgages on a borrower’s principal residence with an annual percentage rate exceeding the yield on Treasury securities of comparable maturity by at least three percentage points for first-lien loans, or five percentage points for subordinate-lien loans. Under the proposal, lenders of “higher-priced mortgages” would be required to consider borrowers’ ability to repay, and to verify income or assets. The lenders would also be required initially to establish an escrow account for paying property taxes and homeowners’ insurance. Prepayment penalties on such loans would be significantly restricted.

For all mortgages secured by a principal dwelling, regardless of pricing, the proposal would prohibit lenders from paying mortgage brokers “yield spread premiums” without certain disclosures and agreements, and also prohibit certain servicing practices. Introductory rates in advertisements could be no more prominent than the fully-indexed rate. Terms such as “fixed” would be prohibited as deceptive if the rate is not fixed for the full loan term. Truth in Lending Act disclosures for closed-end mortgages would need to be provided earlier in the process.

Initial reaction from many legislators and community groups has focused criticism on the rule not being aggressive enough. As least one Federal Reserve Governor said, the Fed seeks to balance protecting borrowers from unfair or deceptive practices, while not choking off responsible lending or unduly limiting consumer choice.