Feds Tighten Sub-Prime Rules

Federal bank regulators recently issued tougher standards for high-risk mortgages that may stop some shaky lending practices but also limit the availability of loans to some borrowers with flawed or limited credit history.

"The Federal Reserve … expects lenders to make sure subprime borrowers not only can afford their monthly payments while the introductory rate is in effect, but also after the interest rate resets,” said Federal Reserve Governor Randal Kroszner.

Regulators decided that borrowers should have at least 60 days to refinance a loan, without penalty, before it resets to a higher rate.
Banks, credit unions and their mortgage subsidiaries will not be penalized for trying to restructure loans when a borrower has fallen behind.

To avoid problems that arose during the recent real estate boom, lenders now are asked to check income, assets and employment on all loans, unless the borrow can show large cash reserves.

Consumers need better information about when the interest rate on a loan will reset at a higher level, more details about possible large balloon payments and  borrowers, in addition to monthly loan repayments, must be aware they are responsible for property tax payments and insurance premiums.

During the boom years, lenders enticed buyers with sketchy credit histories to take out a loan that offered low initial payments. In some instances, payments would increase by 50 percent or more after the initial period, triggering a financial crisis for many borrowers.

While some lenders have been willing to work with borrowers to come up with a manageable repayment plan, a limited number of borrowers have fallen behind on monthly mortgage payments or let the foreclosure process begin.

Lawmakers praised the tougher regulations, which were issued on June 29, but said much more needs to be done to protect borrowers.
"Subprime borrowers, who are disproportionately black and Hispanic, deserve strong protections to attain and sustain home ownership," said Senate Banking Committee Chairman Chris Dodd, D-Conn.

Some lawmakers believe added rules are needed requiring subprime borrowers to establish escrow accounts for taxes and insurance.
Dodd and others suggested that the tougher federal regulations should be automatically extended not to just federally regulated banks, saving unions and thrifts, but to all lenders, such as firms that lend money from investors and Wall Street.

A high percentage of risky subprime loans were issued by non-banks that are regulated by states.

According to federal statistics, 70 percent of subprime loans made in 2006 carried a "pre-payment" penalty if the borrower refinanced or paid off the loan early.  Some 50 percent of loans were made on stated, not documented, income. And, too few loans required lenders to put taxes and insurance into escrow, thus leaving borrowers unprepared when the bill came due.

Regulators now would like lenders to make it harder to offer loans based on stated income only. Instead, borrowers should be able to verify income using W-2 statements, pay stubs or tax returns. Lawmakers are pressing lenders to offer leeway on pre-payment penalties for existing loans, while the new regulations state that pre-payment penalties should not extend beyond the initial interest rate reset on an adjustable loan.