The U.S. Federal Reserve Monday passed rules aimed at cracking down on misleading and deceptive practices in the mortgage lending industry, including a ban on prepayment penalties for many risky loans.
Fed Chairman Ben Bernanke said the rules will offer broad protection to consumers and will increase competition in the mortgage market by leveling the playing field for lenders.
The rules also prohibit lenders from making "higher-priced loans" unless the borrower has the ability to repay from income and assets other than the home's value.
This must be based on the highest payment in the loan's first seven years -- effectively ensuring that consumers can handle the higher payments after rates reset on adjustable-rate mortgages, the Fed said.
Bernanke vowed to vigorously enforce the new rules. In opening comments, he said rapidly increasing U.S. mortgage delinquencies and foreclosures were imposing "large costs" on borrowers, their communities and the national economy.
"The proposed final rules we will discuss today are intended to protect consumers from unfair or deceptive acts and practices in mortgage lending, while keeping credit available to qualified borrowers and supporting sustainable homeownership," Bernanke said.
"Virtually All" Subprime Loans Covered
The new rules mainly cover a new category of "higher-priced loans" that include virtually all subprime mortgages. They ban prepayment penalties on such loans if the monthly payment can rise during the initial four years. For other higher-priced loans, the period for pre-payment penalties cannot last for more than two years.
Such penalties have prevented some borrowers from refinancing or paying off loans early, locking them into unaffordable payments after interest rates reset.
Lenders must verify that borrowers have income and assets other than a home's value to make payments on higher-priced loans, the Fed said.
"The final rule establishes a lender's responsibility to assess a borrower's ability to repay on every loan originated, effectively giving wronged consumers a private right of action without demonstrating that their case was part of a broader pattern," Fed board member Randall Kroszner said in a statement.
The new rules also require lenders to establish, in the case of higher-priced loans, an escrow account for property taxes and insurance payments. Many subprime loans did not include these, leaving borrowers unable to pay these added costs.
In addition the rules ban certain lending and servicing practices for other mortgages, including failing to credit payments on the day they are received, and coercing or encouraging appraisers to misrepresent the value of a home.
Certain deceptive advertising practices also are banned, including the use of the term "fixed" associated with an interest rate or monthly payment when it can change.