On July 14, the Board of Governors of the Federal Reserve System (Federal Reserve) approved a final rule amending Regulation Z (Final Rule). The rule prohibits unfair, abusive or deceptive home mortgage lending practices and restricts certain other mortgage practices.

The Final Rule includes a definition of “higher-priced mortgage loans” which, according to the Federal Reserve, will “capture virtually all loans in the subprime market, but generally exclude loans in the prime market.” Specifically, a loan is “higher-priced” if it is a first-lien mortgage securing a consumer’s principal dwelling and has an annual percentage rate that is 1.5 percentage points or more above an index to be published by the Federal Reserve, or 3.5 percentage points or more if it is a subordinate-lien mortgage. To provide an index, the Federal Reserve Board will publish the "average prime offer rate," based on a survey currently published by Freddie Mac. With respect to “higher-priced mortgage loans” secured by a consumer’s principal dwelling, the Final Rule’s new protections include the following: (i) a lender is prohibited from making a loan without consideration of the borrowers’ ability to repay the loan from income and assets other than the home’s value; (ii) a creditor is required to verify the income and assets they rely upon to determine repayment ability; (iii) prepayment penalties are banned if the payment can change in the initial four years; and (iv) creditors are required to establish escrow accounts for property taxes and homeowner’s insurance for all first-lien mortgages.

For loans secured by a consumer’s principal dwelling, regardless of whether it is a higher-priced mortgage loan, the Final Rule also adopts the following protections: (i) neither a creditor nor a mortgage broker can coerce a real estate appraiser to misstate a home’s value; (ii) mortgage company servicers are prohibited from engaging in certain enumerated practices; and (iii) creditors must provide a good faith estimate of loan costs, including a schedule of payments, within three days after a consumer applies for any mortgage loan secured by a consumer’s principal dwelling, such as a home improvement loan or a loan to refinance an existing loan.

One element of the original proposal has been withdrawn. The Federal Reserve Board had proposed for public comment certain requirements pertaining to so-called "yield-spread premiums." During the intervening period, the Board engaged in consumer testing that cast significant doubt on the effectiveness of the proposed rule.

The new rules take effect October 1, 2009.