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New rules to curb abusive lending won't take effect till '09

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Associated Press / July 15, 2008

MIAMI - The Federal Reserve yesterday signed off on a long-anticipated plan to end the abusive lending practices that victimized many borrowers in the now-collapsed subprime market.

The rules, however, will cover only new loans, not existing ones, so they will have little effect on the rising tide of mortgage delinquencies and foreclosures. The rules don't go into effect until Oct. 1, 2009.

The rules bar lenders from making loans without proof of a borrower's income and require lenders to ensure risky borrowers have reserved money to pay for taxes and insurance. The plan prevents lenders from making a loan without considering a borrower's ability to repay a home loan from sources other than the home's value.

Lenders will also be restricted from penalizing subprime borrowers - those with tarnished credit - who repay their loans early. Such prepayment penalties are banned if the payment can change during the initial four years of the mortgage. In other cases, a penalty can't be imposed in the first two years of the mortgage.

Some consumer groups have complained that the Fed should just eliminate prepayment penalties altogether, arguing that they leave borrowers trapped in loans they don't want.

While mortgage brokers and consumer groups remain generally positive about the changes, some consumer advocates blasted the Fed for not acting years ago.

"If either Congress or the Fed had created strong origination rules years ago, things would not be as bad as they are now," said Alys Cohen, staff attorney at the National Consumer Law Center.

Advocates did get the Fed to change its original draft so that borrowers who get a loan they cannot repay can sue without having to prove the lender engaged in a similar "pattern or practice" of lending to others without regard to their repayment ability. A lender, however, can find a "safe harbor" against customer lawsuits by proving it followed certain steps in verifying if the borrower could indeed repay the loan.

The plan also establishes stricter advertising standards and requires certain mortgage disclosures to be given to consumers earlier in the transaction. Ads must include additional information about rates, monthly payments, and other loan features.

In another significant change from the draft, the Fed reversed its decision to change the way mortgage brokers disclose the commissions lenders pay them. Critics argued these payments give mortgage brokers an incentive to charge higher fees; supporters said it's a legitimate way for borrowers to spread out mortgage broker fees over the life of a loan.

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