(The article featured below is a selection from Subprime, Mortgage and Securitization Law Update, which is available to subscribers of that publication.)

Fed Issues Final Home Mortgage Amendments

In order to better protect consumers and facilitate responsible lending, the Federal Reserve Board has issued a final rule for home mortgage loans that is intended to prohibit unfair, abusive or deceptive home mortgage lending practices and restrict certain other mortgage practices. The final rule also establishes advertising standards and requires certain mortgage disclosures to be given to consumers earlier in the transaction.

"These changes have made for better rules that will go far in protecting consumers from unfair practices and restoring confidence in our mortgage system," said Fed Governor Randall S. Kroszner.

The final rule, which amends Reg. Z --Truth in Lending (12 CFR 226), 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:

l prohibit a lender from making a loan without regard to a borrowers' ability to repay the loan from income and assets other than the home's value;

l require creditors to verify the income and assets they rely on to determine repayment ability;

l ban any prepayment penalty if the payment can change in the initial four years; and

l require creditors to establish escrow accounts for property taxes and homeowner's insurance for all first-lien mortgage loans.

"The proposed final rules are intended to protect consumers from unfair or deceptive acts and practices in mortgage lending, while keeping credit available to qualified borrowers and supporting sustainable homeownership," said Fed Chairman Ben S. Bernanke. "Importantly, the new rules will apply to all mortgage lenders, not just those supervised and examined by the Federal Reserve. Besides offering broader protection for consumers, a uniform set of rules will level the playing field for lenders and increase competition in the mortgage market, to the ultimate benefit of borrowers," the Chairman said.

Loans Secured by Principal Dwelling

In addition to governing higher-priced loans, the rule adopts the following protections for loans secured by a consumer's principal dwelling, regardless of whether the loan is higher-priced:

l Creditors and mortgage brokers are prohibited from coercing a real estate appraiser to misstate a home's value.

l Companies that service mortgage loans are prohibited from engaging in certain practices, such as pyramiding late fees. In addition, servicers are required to credit consumers' loan payments as of the date of receipt and provide a payoff statement within a reasonable time of a request.

l Creditors must 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. Consumers cannot be charged any fee until after they receive the early disclosures, except a reasonable fee for obtaining the consumer's credit history.

Advertising Standards

For all mortgages, the rule also sets additional advertising standards. Advertising rules now require information about rates, monthly payments and other loan features. The final rule bans seven deceptive or misleading advertising practices, including representing that a rate or payment is "fixed" when it can change.

The rule's definition of "higher-priced mortgage loans" will capture virtually all loans in the subprime market but generally exclude loans in the prime market. To provide an index, the Fed will publish the "average prime offer rate," based on a survey currently published by Freddie Mac. A loan is higher-priced if it is a first-lien mortgage and has an annual percentage rate that is 1.5 percentage points or more above this index, or 3.5 percentage points if it is a subordinate-lien mortgage.

Reaction to Rule

The American Bankers Association said it strongly supports the Fed rule's application of a uniform standard to all financial firms that make mortgage loans, including non-federally regulated lenders. The ABA added that it believes its members are already adhering to the loan origination, underwriting and servicing standards that protect mortgage customers and the bank.

Senate Banking Committee Chairman Christopher J. Dodd, D-Conn., stated that the regulation is expected to "put an end to certain abusive lending practices." According to Dodd, too many homeowners have been "put into loans that are unaffordable, and as a result, we are now seeing the devastating effects of the failure of millions of mortgage loans." Although expressing concerns that the rulemaking is not strong enough in all areas, Dodd opined that, if effectively followed and enforced, the new regulation, "will help to prevent similar abuses in the future."

Under the new rule, "lenders will only be permitted to make subprime mortgage loans that are sustainable," according to Dodd. He added, though, that the rule "does not cover non-traditional loans, such as hybrid and option-payment adjustable-rate mortgages (ARMs) and interest-only loans, which are also failing in large numbers." Additionally, Dodd does not feel the rule provides adequate protection against "a number of predatory practices that unscrupulous brokers and lenders are engaged in, including the predatory use of yield spread premiums to steer borrowers into higher cost loans."

The new rule takes effect on Oct. 1, 2009, with the exception of the escrow requirement, which will be phased in during 2010 to allow lenders to establish new systems as needed.