People taking out home mortgages may gain new protections soon against shady lending practices as the Federal Reserve seeks to back even the riskiest borrowers, already hit hardest by the housing and credit crunches.
Rules expected to be proposed Tuesday would apply to loans made by all types of lenders, including banks and brokers. The plan from the Fed, which has regulatory powers over the nation's financial system, could be finalized next year. The effective date would be know then.
The Fed is considering:
- Barring lenders from penalizing subprime borrowers — those with spotty credit or low incomes — who pay their loans off early.
- Forcing lenders to make sure that borrowers, especially subprime borrowers, set aside money to pay for taxes and insurance.
- Restricting loans that do not require proof of a borrower's income.
- Examining lenders' failure, in some cases, to consider a borrower's ability to repay a home loan.
- Improving financial disclosure so people better understand the terms and conditions of their mortgages and get this information when it is most useful.
- Curtailing abuses in mortgage advertising.
"We have an obligation to prevent fraud and abusive lending," the Fed chairman, Ben Bernanke, said earlier this year. "At the same time, we must tread carefully so as not to suppress responsible lending or eliminate refinancing opportunities for subprime borrowers.'
The issue has taken on heightened importance given the meltdown in the housing and credit markets that has led to record numbers of home foreclosures. The crisis has raised the odds that the economy might fall into a recession, roiled Wall Street and has given Democrats and Republicans much fodder to blame each other.
On prepayment penalties, consumer advocates say these deter homeowners from refinancing on more favorable terms. Those penalties can be hard on borrowers who want to get out of adjustable-rate mortgages that reset from a low introductory rate to a much higher one they have trouble paying off.
Mortgage industry representatives say prepayment penalties ensure that lenders receive a minimum return if loans are paid off early. They also say people with mortgages that include such penalties often get a benefit of lower upfront costs or lower interest rates.
Of the nearly 3 million subprime adjustable-rate loans surveyed by the Mortgage Bankers Association from July through September, a record 4.72 percent entered the foreclosure process during those months. At the same time, a record 18.81 percent of the subprime adjustable-rate loans were past due.
When home values weakened, borrowers were left with loans balances that eclipsed the value of their homes. They also were clobbered when their loans reset with much higher interest rates.
As for the idea of setting aside money to cover taxes and insurance, consumer groups worry that subprime borrowers do know about these expenses or might not be able to budget for them. These groups also have raised concerns about lenders quoting subprime borrowers monthly payments that do not include taxes and insurance costs.
The Mortgage Bankers Association has some problems with mandating escrow accounts — where those costs specifically are set aside each month — for borrowers. The association does support efforts to make sure borrowers have the appropriate information about their obligations to pay taxes and insurance.
The Fed says loans to subprime borrowers typically do not include such an account, while loans to people with better credit and lower risk to the lender usually do.
The central bank also says that lenders sometime will make a loan without documenting or verifying a borrower's income. Lenders may charge higher rates for such loans, the Fed says.
Mortgage lenders say these loans are appropriate for many borrowers, including those who are self-employed and cannot easily document their income. Consumer groups say many borrowers who could document their income are not aware they are getting a loan at a higher interest rate. These loans are sometimes called "liar's loans" because critics believe they can be used to perpetrate fraud.
Majority Democrats in Congress have been vocal in urging the Fed to act against abusive practices.
Massachusetts Rep. Barney Frank, chairman of the House Financial Services Committee, and other House Democrats said in a recent letter to the Fed that tougher rules are overdue and "needed to help eliminate the kinds of predatory lending practices that exacerbated the current subprime lending crisis."
The House has passed legislation that would put into law some of the same actions the Fed is considering. A similar bill is pending in the Senate. Supporters are heartened the Fed is moving ahead because they think the Fed might be able to finalize action before Congress does.