Lenders will have to confirm that a borrower can afford a mortgage before making a loan under protections proposed by the Federal Reserve on Tuesday, following defaults and losses on U.S. subprime mortgages this year.
The proposals are intended to replace loose lending standards that have put many Americans at risk of losing their homes because they took out mortgages they could not afford and may not have fully understood.
The new rules will not assist today's struggling homeowners but would give consumers the right to sue mortgage lenders who act unfairly and deceptively in preparing loans in future.
Millions of Americans who bought homes in recent years face the risk of foreclosure as mortgages with initial starter interest rates are reset with sharply higher rates in coming months.
The Fed's board of governors unanimously approved the standards recommended by its consumer rights staff and said they strike a balance by protecting consumers while preserving their access to credit.
These new rules, once adopted, would apply to all mortgage lenders, Fed Chairman Ben Bernanke said as the board met to consider the proposals. He said the rules would be consistently applied and vigorously enforced by state and federal regulators.
The new rules would put the nation's 50,000 mortgage brokers under some federal supervision, according to Fed staff.
The plan also states that lenders who are found to be engaging in a pattern or practice of offering unaffordable loans would run afoul of the rules.
The proposal was criticized by several leading lawmakers and praised by an industry group.
The Fed has been faulted for failing to use all its consumer protection authority during the housing boom that ended in 2005, and lawmakers are threatening to take back some of those powers.
The proposed regulations would require that lenders confirm a borrower can afford a home loan by verifying his income and assets with tax records, payroll receipts, and other documentation.
The new rules are aimed at ending the recent practice of so-called stated income loans in which borrowers state their income without any evidence.
The proposals would also limit the penalties imposed when a borrower pays off a home loan early. No prepayment penalty would apply, for instance, if a loan is refinanced less than 60 days before its interest rate resets higher.
The proposed rules also require that borrowers receive details of their brokers' compensation and be billed monthly for annual charges, such as property tax and insurance, that are placed in escrow.
The Fed plan also contains sweeping new standards for home appraisers and targets abusive practices by loan servicers.
The proposed regulations protect borrowers with interest rates of more than three percentage points above U.S. Treasury securities of similar maturity. For example, a 30-year Treasury bond yields around 4.55 percent, and so a high-cost 30-year mortgage loan today would have an interest rate of 7.55 percent or higher.
TOO LITTLE, TOO LATE?
Several leading lawmakers said the new rules were too little, too late and suggested Congress should assume some of the Fed's consumer protection role.
Senate Banking Committee Chairman Christopher Dodd faulted the Fed for limiting mandatory escrow to the mortgage's first year and opening only a two-month window of prepayment protection.
It raises serious questions as to whether the Federal Reserve is the appropriate institution to house consumer protection functions, the Connecticut Democrat said.
Dodd, a Democratic presidential hopeful who has sponsored legislation aimed at reforming subprime mortgage lending, said legislative action was needed to help protect homeowners from abusive and predatory lending practices.
The Senate has yet to act on Dodd's legislation, but the House of Representatives has passed a bill aimed at curbing predatory lending practices.
The American Bankers Association praised the Fed for setting standards that would apply to mortgage lenders who used Wall Street money to lend to home buyers and who had looser lending standards than depositor-backed institutions.
The real plus for customers will be knowing that uniform, national standards will apply to all lenders, and targeted especially to abuses by unregulated or lightly regulated non-bank lenders, the industry group said.
The proposed regulations will be open to public comment for 90 days before the Fed staff proposes final rules. At that point, there will be another public comment period, pushing final adoption well into next year.