Fed sets new rules for mortgages. Will subprime market come back?

The subprime market has disappeared, but just in case banks ever get the idea that they will like to return to making high rate mortgage loans, the Federal Reserve has some new rules they will have to follow. Some say these rules will eliminate the subprime market. I do not think so, but it will make it much harder to get a subprime loan.

First, what’s a subprime loan? The fed calls them “higher priced loans” and defines them as “…first-lien mortgages that are 1.5 percentage points above a new index the Fed plans to publish using a survey currently published by Freddie Mac. Subordinate-lien mortgages that are 3.5 percentage points above the Fed index would also be considered higher-priced.”

For these subprime loans the Fed will require creditors to verify borrowers’ income and assets, and to establish escrow accounts for all first-lien mortgages. (This excludes second mortgages or home equity loans.) Also, lenders will have to establish that the borrower has a reasonable chance to repay the loan even if the value of the house does not increase. Re-mortgaging for pay-up is not an allowable strategy. Also, prepayment penalties are limited.
“The rule also would require advertising to include new information about rates, monthly payments and other loan features and ban seven deceptive or misleading advertising practices, including representing that a rate or payment is “fixed” when it can change,” according to the Wall Street Journal.

The Fed has also issued rules for all mortgage loans, including prime loans. Mortgage lenders are forbidden from coercing real estate appraisers to mis-state home values, a big problem in the subprime bust. Also, the lender must provide a “good faith” estimate of loan cost, as well as a schedule of payments, within three days of the application filing.

Fed staff is recommending most changes go into effect by Oct. 1, 2009. However other regulations on escrow payments will not go into effect until April 1, 2010.

I find it disgusting that the Fed has to step in to protect lenders from their own excesses. Since there is no subprime market now, consumers in that market do not have much to lose. Maybe these new rules will open it up, just a bit.

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