Fed Takes Aim at Deceptive Home Lending Practices

Michael Calhoun, president of the Center for Responsible Lending, said the Fed should have taken a page from Congress and banned lenders from giving loans to home buyers who cannot afford to pay after their adjustable rates increase. Instead, it merely proposed prohibiting them from "engaging in a pattern or practice" of selling such mortgages -- language Calhoun said is too vague and "riddled with loopholes."

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Industry associations expressed more support for the Fed's effort.

"It sets some tough standards, but it appears to take a reasonable and balanced approach that we hope will be workable," said Steve O'Connor, senior vice president of government affairs for the Mortgage Bankers Association.

Fed officials added that they are gaining a better understanding of the underlying causes of the mortgage mess.

Although a lot of attention was cast on the Bush administration's plan to offer a five-year rate freeze to some holders of subprime adjustable-rate mortgages, Fed researchers found that many homeowners are defaulting not because the rates on their mortgages are increasing but because they did not realize their payments would be so high when the cost of home insurance and property taxes is tacked on to the monthly cost. Many home buyers, especially the poor and immigrants, were confused by the massive stack of documents they had to sign at closing.

As a result, Fed officials crafted rules that would require lenders to establish an escrow account for insurance and taxes for holders of subprime loans and to provide better and clearer documentation on what home buyers would pay on a monthly basis.

Fed officials also noted that mortgage default rates were highest for homeowners who had provided little or no documentation. Under the new rules, borrowers would have to provide independent proof of their income, though some flexibility is given to the self-employed.

These regulations seek to "strive to protect borrowers from practices that are unfair or deceptive," said Randall S. Kroszner, a Fed governor who oversaw the drafting of the proposed rules. He added that the agency wanted "to do so without unintentionally causing responsible lending to shrink or unduly limiting consumer choice."

On Capitol Hill, the House yesterday voted to prevent forgiven mortgage debt from being taxed as income. The Senate has already passed the bill, which can spare homeowners from taxes as high as 35 percent on canceled mortgage debt. White House press secretary Dana Perino told Bloomberg News that President Bush would sign it.