Fed to Tighten Lending Standards, Will Seek to Limit Prepayment Penalties

Various sources reported Monday that the Federal Reserve will propose a new set of rules for the mortgage indstry under its HOEPA (Home Ownership and Equity Protection Act) authority at a meeting of the Fed’s Board of Governors, set for Tuesday morning.

Chief among the expected changes are new rules limiting the application of prepayment penalties in subprime lending, along with a few other changes that at this point should probably be considered par for the regulatory course: escrowing for taxes and insurance, qualifying at the fully-indexed rate, and limitations on the use of low-doc mortgages among subprime borrowers.

At least one state isn’t waiting for the Fed to step in and prohibit prepayment penalties, which have become the lightning rod for consumer criticism of subprime lending: Colorado Gov. Bill Ritter said Monday that the state has enacted an emergency rule limiting prepayment penalties. The rule went into effect on Friday.

From the press statement:

Acting on the concerns of Gov. Ritter as well as those of consumer groups and members of the legislature, [Division of Real Estate Director Erin Toll] has issued an emergency rule restricting prepayment penalties on mortgage loans. The new rule prohibits prepayment penalties that extend past the adjustment date of an interest rate, teaser rate or payment rate … The rule creates a presumption that a mortgage broker has violated their duty of good faith to the borrower if they recommend a loan product with a prepayment penalty that extends beyond the adjustment date.

Notice the language above, because it establishes a fiduciary standard for mortgage brokers. I suspect you’ll see similar language in the Fed proposal due on Tuesday.