The Federal Reserve is in the midst of considering a plan that would curtail the types of subprime products lenders can offer, prohibit certain misleading disclosures, and limit the compensation of mortgage brokers. What makes this news somewhat significant? The Federal Reserve’s plan is forward thinking, and despite being reactive, is perhaps one of the only positive news stories to break in recent months surrounding the turmoil over subprime lending.
Rather than wasting time pointing fingers at who is to blame for the current situation the entire country is in, or gaze in shock at the billions of dollars that large financial institutions are writing down from their balance sheets, the Fed is attempting to impart positive and sound change on the lending market. These potential rules would only apply to loans going forward, not the subprime adjustable-rate loans that became extremely popular during the recent housing boom.
Some of the highlights of the Fed’s new proposal are:
- Mortgage Brokers or creditors would be banned from coercing or influencing home appraisers to misrepresent the value of a home and would prohibit certain practices from loan servicers, such as failing to promptly credit payments to customers’ accounts.
- The Fed staff proposal targets high-cost loans secured by a consumer’s principal dwelling. The proposal states these loans shouldn’t be made without regard to a borrower’s ability to repay, without verifying the income and assets of the borrowers, with a prepayment penalty in certain circumstances, and without establishing that borrowers pay insurance and taxes on the property.
- The Fed looks to “generally” ban lenders from “directly or indirectly paying mortgage brokers in connection with consumer credit transactions secured by a consumer’s principal dwelling, unless the mortgage broker enters into a written agreement with the consumer” and provides certain disclosures. Creditors wouldn’t be banned from paying brokers if the compensation isn’t determined by the borrower’s interest rate.
- Lenders would be banned from structuring traditionally “closed-end” mortgage products as “open-ended.” Fed staff believes this is necessary to prevent lenders from trying to evade the new protections.
- Prepayment penalties on high-cost loans would be changed so that they expire at least 60 days before an adjustable-rate loan resets from its starter rate into a higher rate. Many prepayment penalties on subprime adjustable-rate mortgages ran right up to or beyond the reset date.
- The plan would ban seven marketing practices, including marketing loans as having “fixed rates” when the fixed rate is for only a limited period of time. Lenders would also be banned from “advertising claims of debt elimination if the product would merely replace one debt obligation with another,” according to the proposal.
The Federal Reserve’s proposal is aimed at eliminating many of the lending practices that proliferated during the recent housing and credit boom.The Fed has never used this authority this broadly before, and it has been under constant criticism this year for not acting more aggressively as lending standards deteriorated in recent years.
Thank you to the Wall Street Journal for inspiring this blog post.
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Tim Ryan 
