Federal Reserve Proposes New Rules to Curb Abusive Practices in Consumer Lending
Friday, July 24, 2009
The Federal Reserve on Thursday unveiled a proposal to curb abusive lending practices by reining in compensation for mortgage brokers and by helping borrowers better understand the terms of loans available to them.
The plan, which builds on a similar effort adopted by the Fed last year, comes just as the central bank is trying to fend off a legislative initiative that would strip its consumer-protection role by creating an agency to oversee consumer financial products.
"It certainly doesn't hurt the Fed that they came out with mortgage lending rules that were tougher than most of the industry was expecting," said Jaret Seiberg, a policy analyst at Washington Research Group, a unit of Concept Capital.
The toughest part of the Fed's plan deals with compensation for mortgage brokers, who act as middlemen between borrowers and lenders. These brokers can be rewarded with extra fees for placing borrowers in higher-rate loans.
The proposal attempts to end this practice by barring lenders from offering extra compensation based on the terms of the loan, including the rate. Consumer advocates have long argued that incentive-based pay contributed to the subprime mortgage meltdown.
"This plan has got the potential to eliminate one of the worst practices in the mortgage market," said Michael Calhoun, president of the Center for Responsible Lending. "The devil will be in the details. Some of the worst actors in the industry have proven to be adept at exploiting weaknesses in rules. The final rule has to be tightly and carefully written."
The broker industry has managed to block similar efforts in the past. It has said brokers are not driven by these extra fees, but rather by what is best for the consumer.
Industry officials have also argued that higher-rate loans can be more suitable if the lender is willing to close on a loan more quickly than a competitor or if the lender accepts lower credit scores or higher debt loads.
But the industry and consumer groups hailed other aspects of Thursday's proposal, including its push to help people better understand and compare the mortgages available to them.
For starters, lenders would have to provide consumers a one-page list of key questions to ask when a loan is offered to them. After applying for the loan, people would get streamlined information about their mortgage highlighting any risky features.
The Fed has also proposed having lenders disclose the annual percentage rate of a loan in a way that reflects the fees and other settlement costs paid by the borrower. Lenders would also have to show how that rate compares to the average rate offered to borrowers with stellar credit.
The Fed's plan came out of testing with various consumer focus groups. Based on its findings, the Fed also wants lenders to provide disclosure forms at least three business days before a loan closes and to show borrowers with adjustable-rate loans how much their monthly payment might increase in the future.
The plan also addresses problems faced by a growing number of people with home-equity lines of credit. As home prices have dropped, lenders have worried about getting repaid, responding by freezing credit lines or lowering the credit amount. The Fed's proposal would provide those borrowers added protections.
"Creditors would have to provide additional information to consumers so that consumers will understand the reasons for the action and their right to request reinstatement," Fed Chairman Ben S. Bernanke said in a statement.
"The rules would also better define creditors' responsibilities in promptly investigating and responding to consumers who request reinstatement of their credit lines."