Federal Reserve Suggests Mortgage Regulations

With all the hoopla surrounding IndyMac, Fannie Mae and Freddie Mac, not to mention other economic issues, one piece of news that is flying a little bit under the radar is the fact that the Federal Reserve has proposed some mortgage industry regulations. And while there are consumer advocates that complain that they don't go far enough, and mortgage industry insiders that complain that they go too far, they actually look a lot like common sense.

The proposed mortgage industry regulations by the Federal Reserve include the following:

Lenders must verify a borrower's income and assets

This is probably the mortgage industry regulation that makes the most sense to me. You would think that this is something that mortgage lenders would want to do anyway, right? Well, apparently not. See, the way that mortgage loans have been structured is that they are sold almost as soon as made in many cases. They are sold as investments, in bundled securities. So the broker or lender makes the loan, gets the commission, and then passes the loan (and the responsibility) to someone else. If a borrower's income and assets are fudged, it means more money for the lender, since a higher loan can be approved. That's irresponsible in my book, and it should be stopped.

Mortgage lenders have to avoid a "pattern or practice" of approving borrower's who can't afford loans

Another common lending practice that led to this mess was approving borrowers who couldn't actually afford loans. In some cases, subprime lenders were approving those with debt-to-income ratios in excess of 50%. (The commonly accepted cap is 36%.) Requiring mortgage lenders to reduce the amount of loans they make for "special circumstances" would go a long way toward cleaning things up.

Insurance and taxes would be put into an escrow account

Rather than wrapping these costs into the loan, boosting the total amount, these items would be placed in a separate account.

Prepayment penalties must have reasonable limits

Many subprime mortgages come with prepayment penalties. This means that if you pay off your loan early, you would have to pay a penalty, usually some percentage of the amount of money you saved by paying it off early. This is because the investors that buy the loans expect their return. I like the idea of reducing prepayment penalties. Of course, if you get a more conventional loan, you usually do not have to worry about prepayment penalties.

On a whole, these are reasonable regulations. And if the mortgage industry had been abiding by them voluntarily, we might not be in this mess right now.