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Rule Against Shady Lending Practices Eyed in Wake of Mortgage Crisis

Dec 18, 2007 | Parker Waichman LLP

The mortgage crisis has prompted federal regulators to consider new consumer fraud rules to protect people from unscrupulous home loans.  The Federal Reserve—which maintains regulatory powers over the nation’s banking system—unveiled a proposal today that would allow those taking home mortgages new protections against shady lending practices.  According to Fed Chairman Ben Bernake, “Unfair and deceptive acts and practices hurt not just borrowers and their families, but entire communities, and indeed, the economy as a whole.  They have no place in our mortgage system.”  The proposed rules are expected to be endorsed by the Fed at its morning meeting and are geared to the riskiest sub-prime borrowers—those with tarnished credit or low incomes—already suffering from current housing and credit debacles.  The proposal is expected to apply to new or future loans made by all lenders, including banks and brokers and could be finalized next year.

The Fed is considering a variety of strategies such as to restrict lenders from penalizing certain sub-prime borrowers who pay off their loans early. The restriction would apply to loans that meet certain conditions, including that the penalty expire at least 60 days prior to any possible payment increase.  They would also force lenders to ensure sub-prime borrowers set aside money to pay for taxes and insurance, bar lenders from making loans when they don’t have proof or verification of a borrower’s income, and prohibit lenders from lending without considering a borrower’s ability to repay a home loan from sources other than the home’s value.

Fed policymakers are also considering requiring financial disclosures be given to borrowers early enough to use when mortgage shopping; lenders could not charge fees, except to obtain a credit report, until after the consumer receives disclosures.  The Fed may also prohibit certain types of misleading or deceptive advertising for certain loans and require all applicable rates or payments be disclosed in ads with equal prominence and as advertised, introductory rates.  The plan may also include barring lenders from paying mortgage brokers a broker fee exceeding the amount agreed to by the borrower in advance and banning certain practices, such as failing to credit a mortgage payment to a borrower’s account when the company servicing the mortgage receives it and prohibiting a broker or other company from encouraging appraisers to misrepresent a home’s value.  Before taking effect, the rules must be voted following a period of public comment.

The Fed’s response has taken on heightened importance given the serious issues in the housing and credit markets leading to record numbers of foreclosures and increasing the likelihood of a recession.

Critics have complained that Bernanke’s predecessor Alan Greenspan failed to act as a forceful regulator, especially during the 2001-2005 housing boom, where easy credit spurred many sub-prime home loans and exotic mortgages.  When the housing market went bust, sub-prime loans were hit hardest.  Of the nearly three million sub-prime adjustable-rate loans surveyed by the Mortgage Bankers Association, a record 4.72 % went into foreclosure and 18.81 % were past due.  When home values weakened, borrowers were left with loan balances exceeding home values and with much higher interest rates when loans reset.


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