Federal Reserve Cracks Down on Lenders

Well, it’s about time. In an effort to regulate what has been seen by many as a lawless industry, the government has taken a step to clean up lenders’ practices. In the works for over 6 months, the new lending rule (an amendment to Regulation Z: Truth in Lending) has undergone multiple revisions prior to being approved. While many loopholes have been closed, thanks to the work of consumer advocacy groups, the disappointing fact is that these proposed rules will not go into effect until October 1st of 2009, which is more than a year away and leaves plenty of time for unscrupulous lenders to continue practicing.

The final rule prohibits unfair, abusive or deceptive home mortgage lending practices and restricts certain other mortgage practices. The final rule also establishes advertising standards and requires certain mortgage disclosures to be given to consumers earlier in the transaction. Fed Chairman Ben Bernanke says, “Besides offering broader protection for consumers, a uniform set of rules will level the playing field for lenders and increase competition in the mortgage market, to the ultimate benefit of borrowers.”

The rule covers two areas: general mortgages secured by a borrower’s primary dwelling and higher-priced mortgages secured by a borrower’s primary dwelling. The rules applicable to the first category are:

• Creditors and mortgage brokers are prohibited from coercing a real estate appraiser to misstate a home’s value.
• Companies that service mortgage loans are prohibited from engaging in certain practices, such as pyramiding late fees. In addition, servicers are required to credit consumers’ loan payments as of the date of receipt and provide a payoff statement within a reasonable time of request.
• Creditors must provide a good faith estimate of the 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. Currently, early cost estimates are only required for home-purchase loans. Consumers cannot be charged any fee until after they receive the early disclosures, except a reasonable fee for obtaining the consumer’s credit history.

The higher-priced loan rules are not for high-end or expensive properties, but for those loans that are 1.5 points or more above the average prime offer rate (which would be applicable to subprime mortgages). For the higher-price loans, the following rules also apply:

• Prohibit a lender from making a loan without regard to borrowers’ ability to repay the loan from income and assets other than the home’s value. A lender complies, in part, by assessing repayment ability based on the highest scheduled payment in the first seven years of the loan. To show that a lender violated this prohibition, a borrower does not need to demonstrate that it is part of a “pattern or practice.”

• Require creditors to verify the income and assets they rely upon to determine repayment ability.
• Ban any prepayment penalty if the payment can change in the initial four years. For other higher-priced loans, a prepayment penalty period cannot last for more than two years. This rule is substantially more restrictive than originally proposed.
• Require creditors to establish escrow accounts for property taxes and homeowner’s insurance for all first-lien mortgage loans.

Much of the terminology feels vague and open to interpretation, but overall this seems to be a step in the right direction. What do you think?