Legislation with broad support in the Senate Banking Committee to deal with "reverse redlining"--high-cost second mortgages--should be examined for potential unintended effects on the general mortgage market, home equity lending and the secondary market. the Federal Reserve Board says.
And despite claims from a chief sponsor--with support from Comptroller of the Currency Eugene L. Ludwig--that the Fed is being overly protective of lenders, it appears the panel's staff will be asked to revise the legislation to meet the Fed's concerns.
The legislation, S. 924, would amend the Fed-administered Truth In Lending Act to require additional disclosures to consumers who take out these types of mortgages on their homes and to restrict the terms of such mortgages. One of the tests for a high-cost second mortgage would be an annual percentage rate on the mortgage that exceeds the yield on comparable Treasury rates by 10 or more percentage points. Another test is that after the loan is made, the consumer's total monthly debt payment would exceed 60% of the consumer's gross income.
Lenders making these mortgage loans would have to disclose to the consumer additional information, including the fact that the consumer could lose his or her home. A three-day "cooling off" period between these disclosures and settlement would also be required.
Moreover, certain provisions could not be included in a high-cost mortgage: prepayment penalties, balloon payments, negative amortization and advance payment of principal and interest. And if the original lender fails to comply with the provisions of the bill. the holder in due course doctrine cannot be used to protect a purchaser of the mortgage.
But in a highly testy exchange with the usually combative Sen. Alfonse D'Amato, R-N.Y. during a hearing last Thursday, Fed Governor Lawrence B. Lindsay suggested that the legislation should be revised to eliminate home equity mortgages from its scope.
"In the cases of abusive lending which [we have] here, you and I have no disagreement." Lindsay told D'Amato. "I am concerned about how this bill might evolve. And if that were extended--say to more general types of mortgages--I am quite concerned about the impact of that on the secondary mortgage market, where frankly it is assumed that mortgages are legitimate, in part because a lot of these extra tests are not imposed. That would be my concern."
Lindsay also said the Fed wants open-ended lines of credit to be excluded from the scope of the legislation because these have some characteristics similar to the "high-cost mortgages" defined in the law.
"I'm afraid that if the bill in its current form were extended to these so-called open-ended lines [of credit] that we might see severe potential problems for almost every home equity loan out there, because it does, in fact, use a balloon--many of them, anyway."
Ludwig, however, supported D'Amato. "I think in this case, if you look at the bill as it stands, the fact that the bill only targets these abusive practices is part of really the sort of expandable nature of the bill."
"And as it stands, I don't think it's going to be restrictive on the secondary mortgage market." Ludwig added. "We're only talking here about second mortgages, talking about abusive practices. I don't think we're going to have that problem."