Examining The Federal Reserve’s New Mortgage Loan Rules

Today the Federal Reserve approved new rules for home mortgage loans to protect consumers from questionable lending practices. While the Fed should be commended for creating these new rules, I doubt they would have acted if we were not in the current credit environment.

I think the new rules should apply to all mortgages. Most of the rules only apply to subprime loans, such as the lender must verify the borrower’s income and assets the borrower is relying on to pay the mortgage.

The new rules don’t take effect until October 1, 2009. The Fed doesn’t explain why such a long lead time is necessary. The rule requiring lenders to escrow property taxes and homeowner’s insurance on subprime loans “will be phased in during 2010 to allow lenders to establish new systems as needed.” Prior to the housing boom it was common practice for lenders to escrow property taxes and insurance.

Another subprime rule is that a borrower’s verified income and assets must be enough to be able to pay “the highest scheduled payment in the first seven years of the loan” in order to ensure the borrower is able to afford the home. This presents potential liabilities. The Fed has not specified whether the liability is borne solely by the mortgage originator or whether the liability will travel with the mortgage through packagers and investors.

The rules do not ban prepayment penalties, but implement different time spans where they are banned. I think the Fed should have a rule eliminating prepayment penalties if a borrower can prove extenuating circumstances such as a job change, divorce, or death.

One thing missing from the new regulations is a rule requiring lenders to provide borrowers final loan documentation prior to Closing. This would allow adequate time for the borrower as well as their attorney to ensure that the loan meets the borrower’s expectations. Ideally the documents should be delivered at least one week prior to the Closing date.

The new rules show that the Fed makes a clear distinction between owner-occupied homes and investor/second homes in that all of the rules only apply to owner-occupied homes. The implication is that purchasers of investment properties and/or second homes are smart enough to watch out for their own good. The Fed appears not to consider them consumers in need of protection. The housing boom and bust has shown us that speculators are really not that sophisticated.

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