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So the Fed decides to regulate lending… questions aplenty.

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The New York Times reported today that the Fed Board of Governors has voted unanimously to implement lending regulations to avoid predatory lending practices (and a second sub-prime fiasco). I think this regulation is actually aimed at the banks (to eliminate the riskiest tranches of future mortgage securities) but just framed in the name of protecting the consumer. This proposed regulation has the potential to impact borrowers, lenders, and lead generators to a significant degree.

The proposal includes four key protections for “higher-priced mortgage loans” secured by a consumer’s principal dwelling:

  • Creditors would be prohibited from engaging in a pattern or practice of extending credit without considering borrowers’ ability to repay the loan.
  • Creditors would be required to verify the income and assets they rely upon in making a loan.
  • Prepayment penalties would only be permitted if certain conditions are met, including the condition that no penalty will apply for at least sixty days before any possible payment increase.
  • Creditors would have to establish escrow accounts for taxes and insurance.

The rule would define “higher-priced mortgage loan” to capture loans in the subprime market but generally exclude loans in the prime market. A loan would be covered if it is a first-lien mortgage and has an annual percentage rate (APR) that is three percentage points or more above the yield on comparable Treasury notes, or if it is a subordinate-lien mortgage with an APR exceeding the comparable Treasury rate by five points or more.

The following protections would apply to all loans secured by a consumer’s principal dwelling, regardless of the loan’s APR:

  • Lenders would be prohibited from compensating mortgage brokers by making payments known as “yield-spread premiums” unless the broker previously entered into a written agreement with the consumer disclosing the broker’s total compensation and other facts. A yield spread premium is the fee paid by a lender to a broker for higher-rate loans. The consumer’s written agreement with the broker must occur before the consumer applies for the loan or pays any fees.
  • Creditors and mortgage brokers would be prohibited from coercing a real estate appraiser to misstate a home’s value.
  • Companies that service mortgage loans would be prohibited from engaging in certain practices. For example, servicers would be required to credit consumers’ loan payments as of the date of receipt and would have to provide a schedule of fees to a consumer upon request.

The proposed revisions to TILA’s advertising rules require additional information about rates, monthly payments, and other loan features. The amendments also would ban seven deceptive or misleading advertising practices, including representing that a rate or payment is “fixed” when it can change.

Under the proposal, creditors would have to provide a good faith estimate of the loan costs, including a schedule of payments, within three days after a consumer applies for any mortgage loan secured by a consumer’s principal dwelling, such as a home improvement loan or a loan to refinance an existing loan. Currently, early cost estimates are only required for home-purchase loans. In addition, consumers could not be charged any fee until after they receive the early disclosures, except a reasonable fee for obtaining the consumer’s credit history.

The Federal Reserve has engaged in extensive outreach efforts with consumer groups, the financial services industry, lawmakers, and others to ensure that the proposed rules are likely to achieve the goal of protecting consumers from unfair practices without shutting off access to responsible credit. The proposal takes into consideration testimony given at four public hearings the Board held in the summer of 2006, and a hearing held in June 2007, as well as public comment letters received in connection with those hearings. The Board also consulted with other federal and state agencies and its own Consumer Advisory Council.

The Federal Register notice is attached. The comment period ends ninety days after publication of the proposal in the Federal Register, which is expected shortly. Read all of it here.

So what does this mean for you the borrower, lender, broker, or lead generator?

The devil is surely in the details.

- How will the standards be enforced?

- What will be considered “evidence” of ability to repay? Will qualified consumers be willing and able to meet these standards? Will unqualified consumers be able to meet these standards?

- What will be considered sufficient “verification of assets”? Who will do the verification? Who will be the first major lender to get caught looking the other way?

- Will reduction of prepayment penalties significantly change product offerings?

- Will the forced establishment of escrow accounts for taxes and insurance significantly change the product offerings? Is this even legal? What will the threshold be?

- If yield-spread premiums are eliminated who will benefit and who will be hurt under a flat compensation plan? Will this regulation be easily avoided by burying disclosure in the fine print?

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