WASHINGTON — The Federal Reserve Board approved a final rule Monday designed to curb abusive mortgage practices while loosening some provisions to avoid cutting off credit for future borrowers.
Changes made to the rule, issued under the Home Ownership and Equity Protection Act (HOEPA), included shortening the period in which prepayment penalties are allowed, broadening the definition of loans affected, removing a liability trigger for the ability to repay a loan, and removing proposed disclosure of mortgage broker compensation.
Fed Chairman Ben Bernanke said the agency tried to strike a balance between cracking down on abusive practices and ensuring the availability of credit.
"It seems clear that unfair or deceptive acts and practices by lenders resulted in the extension of many loans, particularly high-cost loans that were inappropriate for or misled the borrower," he said. "The proposed final rules … are intended to protect consumers from unfair or deceptive acts and practices in mortgage lending, while keeping credit available to qualified borrowers."
The central bank's changes would subject more loans to the homeownership law's protections for high-cost mortgages. "High-cost" will be tied to a survey-based estimate of interest rates rather than a Treasury index.
Fed Gov. Randall Kroszner said the law would apply more broadly to higher-priced mortgages, including all subprime loans, some alternative-A ones, and possibly some jumbo loans.
The final rule would ban prepayment penalties if the payment can change during the initial four years. For other high-priced loans, a prepayment penalty period could not last for more than two years, as opposed to the five-year period called for in the original proposal.
Also, the final rule excluded a "pattern or practice" provision, saying it could open the industry to lawsuits. The original proposal would have prohibited a pattern or practice of extending loans to consumers without regard to their repayment ability.
Lenders argued that the proposal would create a perceived lack of a safe harbor, and the Fed said the proposal created a presumption of a pattern of violation by the lender. The final rule removed the "pattern of practice" provision to clarify that lenders would be prohibited from offering high-cost loans on collateral without an ability to repay.
It would require a lender to consider repayment ability and verify the borrower's income, essentially banning no-documentation loans. However, the rule does provide lenders a safe harbor if they fail to verify income in cases where the borrower's income or assets were not materially higher than what the borrower would have verified at closing.
The rule also requires lenders to establish an escrow account for the payment of property taxes and insurance for first-lien loans. The borrower may cancel the account after one year.
The Fed withdrew its plan to require broker compensation disclosure, saying consumer testing showed that such disclosure would be confusing to borrowers. The rule would not apply to loans already made. Most of it would go into effect Oct. 1, 2009, with the escrow changes taking effect April 1, 2010.
