Fed preparing to tighten mortgage lending rules

With a foreclosure rescue bill facing an uncertain fate in Congress, federal regulators said today they were preparing to adopt new rules designed to curb irresponsible mortgage lending and help some struggling homeowners refinance into more-affordable loans.

Among the measures expected to be approved next week by the Federal Reserve is a requirement that lenders document borrowers’ incomes and verify that they could make the mortgage payments, including the higher payments that come when adjustable rate loans reset.

The new Fed rules were first announced in December, but have been modified in recent months in response to public comment. Fed officials declined to describe the changes, but the regulations are expected to limit bonuses paid to brokers for making subprime loans and restrict prepayment penalties for borrowers who want to refinance.

Also Tuesday, the Federal Housing Administration announced an expansion of the qualifications for borrowers seeking low-cost FHA-insured mortgages, making them more available in cases where a homeowner is behind on payments or owes more than the home’s assessed value.

And in Oakland, Gov. Arnold Schwarzenegger signed into law a bill that represents the California Legislature’s first stab at trying to stem the tide of foreclosures.

The bill, which took effect immediately, requires lenders to give homeowners an early warning that their mortgages are heading toward default. The measure also gives renters an extra 30 days’ notice to find a new place to live if their landlord is losing the property.

“Foreclosures not only devastate families, they hurt neighborhoods and depress our economy and our budget,” Schwarzenegger said.

More than a year into the mortgage crisis sparks by defaulting subprime mortgages, policy makers are still debating what to do about it.

The Senate is expected to pass a version of a foreclosure prevention bill later this week, but it differs in critical ways from an earlier version adopted by the House. It remains to be seen whether lawmakers can reconcile their differences, and even if they do, it is uncertain whether President Bush would veto it.

For the most part, the Bush administration has said it prefers regulatory measures to assist a housing correction instead of a large-scale foreclosure prevention bill.

“Many of today’s unusually high number of foreclosures are not preventable,” Treasury Secretary Henry Paulson said in a speech Tuesday. “Due to the lax credit and underwriting standards of the past years, some people took out mortgages they can’t possibly afford and they will lose their homes. There is little public policymakers can, or should, do to compensate for untenable financial decisions.”

Still, Federal Reserve Chairman Benjamin S. Bernanke said the central bank would proceed with plans to tighten lending requirements for subprime loans, which carry higher interest rates because of the higher credit risk they pose to lenders.

“These new rules, which will apply to all lenders and not just banks, will address some of the problems that have surfaced in recent years in mortgage lending, especially high-cost mortgage lending,” Bernanke said.

Some of those new rules also may include restrictions on the use of the word “fixed” to describe the rate of a loan that may adjust in the future, and prohibit brokers from influencing the appraised value of homes.

Paul Leonard, director of the California office of the Center for Responsible Lending, said that many of the federal rules, as originally proposed, were too weak or poorly directed. For instance, he noted that many of the practices proposed by the Fed would apply only to subprime loans but not to other categories of non-traditional mortgages, including so-called “no doc” loans.

“The Fed has the power to regulate unfair and deceptive practices and their opportunity to use this power is long overdue,” Leonard said. “We would like them to be more aggressive in outlawing the reckless practices that got us into this mess in the first place.”

On the other hand, the Mortgage Bankers Assn. has expressed concerned that the new rules could impose burdensome requirement on lenders that would result in higher costs for consumers.

“We have not seen the final rule but the Board did demonstrate in the proposed rule an appreciation for the potential that overly broad regulation could stifle an already constrained mortgage market and deny worthy borrowers reasonable access to credit,” said MBA senior vice president Steve O’Connor. “However, we hope that they have made improvements to the rule that address our concerns about the broad new legal risk the proposed rule would impose on lenders. We also hope the Board will provide lenders a reasonable amount of time to implement the changes it imposes.”

 maura.reynolds@latimes.com

Times staff writer Marc Lifsher in Sacramento contributed to this report.