Federally regulated banks started the week with new rules governing how they write subprime loans.
Critics consider the rules too-little too-late because they don't apply to mortgage brokers and lenders that are not federally regulated. Also an estimated 2 million homeowners, many of them saddled with subprime loans they can't afford, are already in or destined for the foreclosure pipeline.
Effective immediately, the "Statement on Subprime Mortgage Lending" is the work of the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of Thrift Supervision and the National Credit Union Administration, federal monetary system regulators.
The new rules were spawned by waves of failing subprime mortgages.
Subprime loans are generally more expensive than prime loans, but they are intended for borrowers who pose a greater risk to lenders, typically because of the lack of credit or previous credit problems. Without the subprime segment, some borrowers would be locked out of the American Dream.
Unfortunately, in numerous documented class action suits, state-filed cases and other claims, too many subprime loans became predatory with exorbitantly high costs, penalties and other financially abusive features often directed at specific groups, including single women, minorities, older, low-income borrowers and others who can least afford the added cost.
Other studies revealed members of those same groups could qualify for prime loans but were steered toward subprime mortgages instead.
Many lenders have already tightened underwriting standards and not only for subprime loans, but also so-called nontraditional mortgages which were the target of previous regulatory tightening from the same group of regulators in "Interagency Guidance on Nontraditional Mortgage Products" and "Credit Risk Management Guidance For Home Equity Lending" .
Nevertheless, even as the Feds move to tighten regulations, subprime mortgages continue to flourish, according to the Center for Responsible Lending.
Last week, just days before the Feds released the new rules, the Center released a study of mortgage-backed securities consisting primarily of mortgages made in 2007 which contained high levels of subprime loans with risky terms.
The Center said on average, 77 percent of the loans included in the subprime securities came were adjustable rate mortgages (ARMs) and nearly half came with large scheduled interest rate increases. Many loans with prepayment penalties and others made without fully documenting borrowers' incomes also comprised a chunk of the loans.
HousingPredictor.com says in "Foreclosures Will Affect 2 Million Homeowners," new federal regulations won't be enough to stem the tide on subprime foreclosures.
The Feds' new group of subprime rules is, however, one of the fastest moves in recent regulatory history.
Lender mandates include:
- Curtailing predatory lending. Loans should be based on the borrower's ability to pay rather than the foreclosure or liquidation value of the home. Lenders should not induce borrowers to become serial refiancers for financial gain nor engage in fraud or deception to conceal the true nature of the borrower's obligation.
- Tightening underwriting controls. Loan approval should be based on the borrowers ability to pay the loan based on the fully indexed rate, rather than the starter rate.
- Offering workouts. Where warranted, lenders are encouraged to offer struggling borrowers loan modification or workout arrangements.
- Improving disclosures. Disclosures shouldn't be misleading, mystifying or unclear but spell out in understandable terms the costs, details and risks of loan products so that the borrower is better equipped to choose a loan that is best for him or her.
Consumers should be well informed of "payment shock," stemming from interest rate adjustments; prepayment penalties charged when a loan is paid off early in the term, even by a refinance; balloon payments' existence; the cost of reduced documentation loans; and the borrower's responsibility for other non-mortgage costs including taxes and insurance.
Consumer advocates hope states will follow suit and strengthen local level regulations as many did after the Feds released new rules for nontraditional mortgages and home equity loans.
Federal legislation aimed at such state level compliance from brokers and lenders not federally regulated are also making the rounds on Capital Hill.
