Regulators tighten subprime lending rules

Borrowers should not be penalized for refinancing out of a mortgage before a low introductory rate resets to a higher level and lenders must have evidence a borrower can repay, according to a statement of principles issued by the regulators.

The guidelines, which lenders treat as binding, also call for lenders to warn borrowers when a reset is coming and grant them at least 60 days to refinance.

"This guidance ... underscores that the Federal Reserve and other banking regulators expect lenders to make sure subprime borrowers not only can afford their monthly payments while the introductory rate is in effect but also after the interest rate resets," Federal Reserve Board Governor Randall Kroszner said in a statement.

Many lenders relaxed underwriting standards for subprime borrowers with shaky credit during the recent housing boom. Among the most popular loans were those that offered low early payments that spiked within a few years.

As the housing market has soured, many of those borrowers fell behind in their payments and a record portion of borrowers faced losing their homes in the first three months of the year. Many of the biggest lenders to subprime borrowers have been pushed into bankruptcy.

Besides protecting borrowers from costly refinancing, the guidance discourages loans that have let borrowers inflate their income in order to qualify for a loan. So-called 'low doc' mortgages were offered to borrowers even if they could not document that they had the resources to make payments.

Lenders should only offer such loans to borrowers if there is other evidence that they can repay, according to the Friday statement.

A borrower who is refinancing a home or has a valuable asset that can be turned into cash might not need to prove all their income but low-doc loans should be the exception rather than the rule, said John Dugan, Comptroller of the Currency.

Dugan said he did not expect the standard to discourage home purchase among immigrants and others who work in a cash economy.