business

When Americans buy a home, they almost always are buying a home loan as well. Most focus on the home-buying and give short shrift to the loan-buying.

Given the complexity of the mortgage loan transaction, there is a risk of the borrower misunderstanding the terms or even of being exploited.

Borrowers who failed to understand their loans or who got loans they could not afford have contributed to today's mortgage crisis.

The Federal Reserve Board published rules on July 10 that, when effective, will change aspects of the U.S. home mortgage industry to address problems that have come to light in the residential mortgage lending industry in recent years.

Criticisms of some mortgage lenders and others in the residential mortgage lending industry over the past five or so years have included claims of:

• Confusing and misleading advertising.

• Overaggressive marketing in which consumers are misled (for example, being falsely told that a prepayment penalty term in a loan will not be enforced).

• Encouraging people to take out loans they probably could not afford (notably, loans to borrowers who had fair-to-poor credit or who were lacking a credit history, went from 9 percent of all mortgage loans in 2001 to 20 percent of loans in 2005).

• "Bait and switch," in which a lender or broker is alleged to have offered a loan with good terms only to show up later at the closing offering a loan with worse terms.

• Exploitative loan servicing (that is, opportunistic behavior in the context of collecting mortgage loan payments, such as compounding penalty fees, delaying delivery of payoff statements or padding charges).

While there have been sharp business practices by some on the lending side of the table, borrowers also have played major roles in some flawed loan transactions. Mortgage fraud has been a serious industry problem for several years. Borrowers have been involved in "flipping" schemes, in which homes are sold and resold to defraud lenders. More than a few borrowers have made inflated claims of income to get a loan and later objected to having been given a loan they could not afford.

New rules proposed

To rein in these excesses, the Federal Reserve has proposed rules on advertising, high-priced loans and loan servicing.

Advertising. For decades, the federal Truth-in-Lending Act has required disclosure of "clear and conspicuous" loan terms. Now, those rules will be supplemented to make disclosure of certain loan terms (for sometimes complex loan products) clearer. The Fed is interested specifically in clearer disclosure of so-called "teaser," or promotional rates, so-called "balloon" payments and statements regarding the tax ramifications of certain loans.

Higher-priced loans. New rules will apply specifically to "higher-priced mortgage loans," because there have been more problems and abuses in the subprime market, in which such higher-priced loans are prevalent and, because regulations inherently impose constraints and expense, they therefore raise the cost of loans. The Fed concluded that the added cost of regulation was justified for higher-priced loans, but the added cost of certain new regulations would exceed the benefits for the "prime" mortgage market.

In addition to setting out a methodology to define higher-priced mortgage loans, new rules will apply to these loans. Most notably, lenders will have to verify the borrowers' ability to repay, and there will be significant restrictions on when prepayment penalties are allowed for these loans. Also, there will be mandatory escrow for tax and insurance for these loans.

In new rules for mortgage loans more broadly, the Federal Reserve Board addresses the problem of inflated appraisals and prohibits any coercion or undue influence of appraisers, whereby unscrupulous lenders or brokers have been known to pressure appraisers to inflate the value of collateral (i.e., the home) to obtain a larger loan.

Loan servicing. The new rules address loan servicing -- that is, the collection of borrowers' mortgage loan payments. They provide that no servicer shall fail to credit a consumer's periodic payment as of the date received; impose a late fee or delinquency charge where the charge is only because of a consumer's failure to include in a current payment a late fee or delinquency charge imposed on earlier payments, or fail to provide an accurate payoff statement within a reasonable time of request.

These rules will not take effect until 2009 (or later, for some of them). Some people will criticize the new rules as excessive and undue government interference. Others will criticize the changes as not having gone far enough. The Federal Reserve Board concluded that significant risks in the market for residential mortgage loans warranted these new adjustments to existing federal regulations.

Clearly, the new regulations will impose additional costs, and they could drive deserving borrowers out of the market. Time will tell. But hopefully, the costs will be offset by a better functioning market for residential mortgages.