Fed looks to rein in 'liar loans'

NEW YORK (CNNMoney.com) -- The Federal Reserve opened a hearing in Washington today to solicit suggestions on how to curb abusive mortgage lending practices.

Representatives from a wide range of interest groups were scheduled to appear at the hearing, which was chaired by Randall S. Kroszner, a member of the Fed's Board of Governors.

In opening remarks Kroszner said, "The hearing will focus specifically on how the Board might use its rulemaking authority under HOEPA (Home Ownership and Equity Protection Act) to address concerns about abusive mortgage lending practices."

HOEPA, which Congress enacted in 1994, gives the Federal Reserve wide authority in regulating against abusive lending, but Kroszner pointed out that the states can pass their own prohibitions against predatory lending.

Bad loans are contributing to a crisis in home ownership with delinquencies and foreclosures rising steeply this year.

Kroszner also recognized that the mortgage lending transaction is already overburdened with often arcane, legalistic or incomprehensible paperwork that cover disclosures of various kinds.

Therefore, a main goal of the hearing was to gather information in order to craft rules that would curb abusive lending efficiently and effectively.

They would be aimed at four of the most troublesome practices he cited:

• Prepayment penalties: When borrowers seek to pay off expensive loans early they may be hit with a fee of as much as six months of mortgage payments.
• Failure to require escrows for taxes and insurance: These expenses add to the monthly costs of home ownership but mortgage servicers do not always require borrowers to bank the payments in escrow accounts with them. As a result, the payments may be put off, resulting in tax delinquencies or insurance coverage lapses.
• Stated income and low-documentation lending: "So-called "liar loans" that encourage borrowers to exaggerate income to qualify for larger mortgages than they can handle.
• Failure to give adequate consideration to a borrower's ability to repay a loan: Many loan originators have no monetary interest in loans after they the deal is done. That encourages them to approve borrowers they know, or should know, cannot afford to make the payments.

These practices are not, in themselves, abusive. Borrowers may, for example, rightly choose a loan with hefty prepayment penalties if that lowers the interest rates on their loans. The problems arise when loan originators apply these provisions indiscriminately or with predatory intent.

"Today, with your help," said Kroszner, "we intend to explore in detail when these types of practices can be beneficial and when they might be problematic."