Fed bans risky mortgage practices -  By Ruth Mantell, MarketWatch

WASHINGTON (MarketWatch) -- Looking to clean up the mortgage market while letting consumers still access credit, the Federal Reserve Board voted unanimously on Monday to bar some risky lending practices even as the economy continues to suffer from the housing downturn and fallout from troubled mortgages.

"I think the key issue is getting the right balance," said Fed governor Frederic Mishkin. "I think these rules will be helpful in that direction."

The new rules prohibit lenders from making higher-priced loans on a principal dwelling without regard to a consumers' ability to repay. A borrower does not need to demonstrate that a lender's violation of this ban is part of a "pattern or practice" - a provision that particularly pleases consumer advocates.

Also for higher-priced loans, the rules prohibit lenders from relying on income or assets that it does not verify to determine repayment ability, and from making a loan without establishing an escrow account for property taxes and homeowners' insurance for first-lien loans.

"Although the high rate of delinquency has a number of causes, it seems clear that unfair or deceptive acts and practices by lenders resulted in the extension of many loans, particularly high-cost loans, that were inappropriate for or misled the borrower," said Fed Chairman Ben Bernanke.

In addition, the rules for higher-priced loans would ban prepayment penalties if the payment can change during the initial four years. For other higher-priced loans a prepayment penalty period cannot last for more than two years.

"After two years, subprime borrowers who have made regular payments on their mortgages should have the opportunity to refinance into lower cost loans without penalty," said Sheila Bair, chairwoman of the Federal Deposit Insurance Corp., in a statement. "These final rules will assure their ability to do so, and will also assure that those with adjustable-rate mortgages will not be caught having to pay penalties to avoid steep resets through refinancing."
     

Fed governor Randall Kroszner said the key issue will be enforcement of the new rules, which will apply to all mortgage lenders, not just those supervised by the Fed. The rules go into effect Oct. 1, 2009, with the exception of the escrow rules, which go into effect in 2010.