July 23, 2008
House to Vote on Mortgage Lending Reforms on Wednesday, July 23
WASHINGTON, D.C. – New rules just issued by the Federal Reserve Board will help protect homebuyers from unfair mortgage lending practices, but more safeguards are needed, according to Consumers Union, the nonprofit publisher of Consumer Reports. The Federal Reserve Board regulations were issued as Congress and state lawmakers have been debating mortgage lending reforms. A vote on mortgage lending reform legislation is expected in the House on July 23.
“These regulations offer important new protections that will help address a number of the problems that brought about the current mortgage crisis,” said Pam Banks, spokesperson at Consumers Union. “But there is still much work to be done to protect borrowers from widespread mortgage lending abuses.”
The new rules amend the Truth in Lending Act and were issued in response to the staggering mortgage foreclosure crisis that has wreaked havoc on the economy over the past year. Among other things, the regulations require lenders to verify that borrowers have sufficient income and assets to repay subprime loans. Lenders will be required to establish escrow accounts for subprime borrowers to set aside payments for property taxes and insurance. The new rules prohibit lenders from imposing prepayment penalties for short-term adjusted rate mortgages (ARMs).
Unfortunately, the new regulations are insufficient to protect mortgage borrowers in some key areas. First, they apply only to subprime mortgage loans, not other risky loans that do not fall within the definition of “higher-priced” mortgage loans established by the regulations. The rules also fail to adequately address other key areas of abuse. For example, the ban on prepayment penalties applies only to subprime ARMS with payment adjustments within the first four years and not other subprime loans. Consumers Union believes the Fed should have followed the lead of states like New York and North Carolina that have banned all prepayment penalties. Prepayment penalties make it very difficult for borrowers in bad loans to refinance with more responsible lenders.
“At the very least, the Fed’s new rules should have restricted the dollar amount a lender can charge for a prepayment penalty,” said Banks. “Without a cap on the amount that can be charged, lenders are free to charge whatever they choose.”
Further, the new rules do not protect consumers from being steered into higher cost loans by brokers who receive kickbacks in the form of yield spread premiums for promoting more expensive loans. Consumers Union believes that the Fed should have banned the payment of yield spread premiums to brokers originating subprime mortgages.
The new rules also fall short by failing to impose a fiduciary duty on mortgage brokers to act in the best interest of their client, instead of in their own interest. Since many mortgage loans are originated by mortgage brokers, this requirement would go a long way towards ensuring that borrowers are getting the best loan they deserve, instead of the one that returns the greatest payout to the broker. In addition, the rules fail to regulate loan flipping (refinancing a mortgage loan within a short period of time), which generates new origination fees for the broker/lender without providing a benefit to the borrower. Finally, the rules do not require loan documents to be written in the language of loan negotiation.
Despite the urgent nature of the mortgage foreclosure crisis, the new regulations will not go into effect right away. The earliest protections become effective on October 1, 2009. The provisions dealing with mandatory escrow accounts do not become effective until April 1, 2010, and not until October 1, 2010 for mortgage loans secured by manufactured housing.
“Homebuyers are still vulnerable to many of the unfair lending practices that caused this unprecedented mortgage foreclosure crisis,” said Banks. “Now it’s up to lawmakers to fill in the gaps to ensure that the public and the economy are protected from an even greater mortgage meltdown.”
Pam Banks: 202-462-6262 or Norma Garcia: 415-431-6747