New Fed Rules to Protect Mortgage Holders

Consumers taking out home mortgages are getting new protections against questionable lending practices under a plan introduced Tuesday by the Federal Reserve.

The Fed unanimously approved new rules that safeguard subprime borrowers — those with bad credit and low incomes. Subprime borrowers were hit hardest by the housing and credit debacles. The rules apply to new loans made by banks, mortgage brokers and other lenders.

In a 5-0 vote, the Fed agreed to set parameters that would halt seemingly carefree lending practices by requiring banks and other mortgage issuers to both lend only to those who prove their income and to make sure conditions of the loan are understood by borrowers.

The plan strengthening lending standards comes amid fresh news of ongoing turmoil in the housing industry. Housing construction fell in November and single-family activity dropped to the lowest level in more than 16 years.

The Commerce Department reported that construction of new homes and apartments dropped by 3.7 percent last month to a seasonally adjusted annual rate of 1.187 million units. Construction of single-family homes fell by 5.5 percent to an annual rate of 829,000 units, the lowest level since April 1991, while multifamily construction was up 4.4 percent to an annual rate of 332,000 units.

"Unfair and deceptive acts and practices hurt not just borrowers and their families but entire communities, and indeed, the economy as a whole," said Fed Chairman Ben Bernanke. "They have no place in our mortgage system."

The Bush administration recently laid out similar criteria for helping homeowners, including collaborating with the lending community to freeze the initial low interest on adjustable-rate mortgages for at least five years in a bid to stabilize the housing market.

But market watchers aren't so sure.

"The recovery keeps getting pushed back and back. The rebound is now forecast for 2009," said Brian Shappell, editor of Housing Market Report, a division of CD Publications, which reports on the residential homebuilding and mortgage markets.

"There was risky behavior in lending. There was overbuilding beyond the demand. So if all of those things were going on for a few years, is it realistic to expect it will be corrected in a few months?" he adds.

Critics say Alan Greenspan, Bernanke's predecessor who ran the Fed for 18 1/2 years, wasn't a forceful regulator, particularly during the 2001-2005 housing boom, where easy credit spurred lots of subprime home loans and many exotic types of mortgages.

The severity of the housing market's woes came to light around August when loan defaults and foreclosures were showing big jumps. Borrowers were unable to pay the "reset" amount on their adjustable-rate mortgages. The mortgages start at low, initial rate but tend to reset to double-digit amounts.

Those loans wreaked havoc in world financial markets where they were sold in bundles. But large lending institutions — such as Citigroup, Merrill Lynch and Countrywide Financial — took billion-dollar hits from the defaults, consequently squeezing the credit markets.

The Fed, which regulates the banking system, is expected to finalize the plan next year.

Among considerations:

Restricting lenders from penalizing subprime borrowers who pay their loans off early. Analysts are encouraged by the move, saying otherwise lenders are just piling on fees to those who are struggling the most. (The restriction would apply to loans with a penalty that expires at least 60 days before any possible payment increase.)

Forcing lenders to make sure that borrowers set aside money to pay for taxes and insurance. This permits consumers to see their full monthly mortgage amount. Otherwise the mortgage is underestimated; and, the borrower is not likely to be prepared for a huge assessment from a municipality. It's part of the disclosure and it needs to be clear. The plan will consider ways to crack down on misleading mortgage advertising.

Prohibiting loans without proof of income. "It's amazing that this was ever allowed to happen, and there will be some pain to correct this," Shappell said. Just how much pain won't be known for months though, he says, because December and January are typically slower when it comes to selling homes. "We won't know how much this helps or hurts or how much investors like the idea until around February."

Stopping lenders from making loans without considering a borrower's ability to repay a home loan from sources other than the home's value. The American dream of home ownership makes people take such risks. They hurt, however, when they go too far in this way or were led astray by the person originating the loan.

In addition, the Fed is expected to propose barring lenders from paying mortgage brokers a fee that exceeds the amount the would-be borrower had agreed to in advance.

And, the Fed would ban certain practices, such as failing to credit a mortgage payment to a borrower's account when the company servicing the mortgage receives it. The Fed also would prohibit a broker or other company from coercing or encouraging an appraiser to misrepresent the value of a home.

Before taking effect, the rules must be voted on again following a period of public comment and possible revisions.

If ultimately adopted, the plan offers Bernanke, who took over the helm in February 2006, an important opportunity to put his imprint on the Fed's regulatory powers.

With additional reporting by The Associated Press

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