(Revised July 23, 2008)

Today the Federal Reserve helped return the home lending industry to common-sense business practices by issuing new rules for mortgage lenders. We are pleased to see that the Fed has adopted key protections for borrowers who receive subprime loans, including:

  • Addressing the most substantial cause of current foreclosures, lenders must carefully evaluate a borrower's ability to repay a subprime loan, and verify the income used to do so;
  • Lenders cannot impose abusive prepayment penalties that trap borrowers in short-term subprime ARMs;
  • Lenders must escrow for taxes and insurance.

These rules represent significant progress, and the Fed should be congratulated for these protections. We also commend Federal Reserve Board Chairman Ben S. Bernanke for publicly acknowledging the new rules are needed because of the role that "unfair or deceptive acts and practices by lenders" played in the current mortgage crisis, which "resulted in the extension of many loans…that were inappropriate for or misled the borrower." However, more remains to be done, including addressing nontraditional loans and yield-spread premiums (YSPs).

The new rules do not cover nontraditional or exotic loans that had a major role in today's massive foreclosures, such as payment-option ARMs or interest only loans that don't meet the subprime definition.

Also, YSPs—kickbacks that reward mortgage brokers for steering borrowers into costlier loans—should be banned on subprime and nontraditional loans. The regulations do not address this, which means that incentives to charge borrowers more than they qualify for still exist. However, we are pleased the Fed recognized that its original disclosure-oriented broker rules were insufficient to curb abuses, and will continue to look for real solutions, not cosmetic ones.

In the meantime, states have continued to take the initiative. More than a dozen, including New York, Connecticut and North Carolina, have passed legislation in recent months to curb the abuses in the subprime market that have wrought record numbers of foreclosures and devastated the economy. Many of these laws go further than the Fed rules—for example, New York bans all subprime prepayment penalties, not just those on short-term subprime ARMs, and North Carolina bans subprime prepayment penalties and yield-spread premiums. California—the nation's largest market and arguably the epicenter of the foreclosure crisis—is considering legislation this session that would, among other provisions, ban or otherwise limit the use of YSPs.

Our country is in the midst of a massive crisis that could have been prevented with sensible rules. The recent turmoil of Fannie Mae and Freddie Mac, as well as the implosion of leading alt-A lender IndyMac, underscores the need for strong federal regulation and oversight. The Federal Reserve rules help substantially. We hope they will now take the next necessary steps to cover all dangerous loans and to stop the steering of borrowers into more expensive loans. It is also critical for the states to continue to play a leading role in cleaning up a market that has spun out of control.

Learn more about subprime mortgage lending.

Read CRL's past Comment Letters to the Fed.

For more information: Kathleen Day at (202) 349-1871 or kathleen.day@responsiblelending.org; Sharon Reuss at (919) 313-8527 or sharon.reuss@responsiblelending.org; or Ginna Green at (510) 379-5513 or ginna.green@responsiblelending.org.

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