New rules targeted primarily at mortgage lenders making higher-cost loans take effect Thursday, more than a year after they were finalized by the Federal Reserve. On Oct. 1, new rules adopted by the Federal Reserve will go into effect, requiring greater diligence on the part of mortgage lenders and brokers who make so-called high cost loans for borrowers with weak credit. The interest rates on these loans are at least 1.5 percentage points higher than the average prime mortgage rate.
The regulations - finalized in July 2008 but only now being put into effect - bar lenders from making a high-cost mortgage without verifying that a borrower could repay the loan in the conventional way, and not simply through a foreclosure sale. During the home lending boom from 2003 to 2006, subprime lenders would often offer loans without requiring borrowers to prove that they could make the monthly payments. With stated-income loans - or as some called them, "liar loans" - borrowers could easily fabricate annual income figures and even buy a home without a down payment.
The final rule adds four key protections for a newly defined category of "higher-priced mortgage loans" secured by a consumer's principal dwelling. For loans in this category, these protections will:
· Prohibit a lender from making a loan without regard to borrowers' ability to repay the loan from income and assets other than the home's value. A lender complies, in part, by assessing repayment ability based on the highest scheduled payment in the first seven years of the loan. To show that a lender violated this prohibition, a borrower does not need to demonstrate that it is part of a "pattern or practice."
· Require creditors to verify the income and assets they rely upon to determine repayment ability.
· Ban any prepayment penalty if the payment can change in the initial four years. For other higher-priced loans, a prepayment penalty period cannot last for more than two years. This rule is substantially more restrictive than originally proposed.• Require creditors to establish escrow accounts for property taxes and homeowner's insurance for all first-lien mortgage loans.