A consumer watchdog for your wallet

WASHINGTON (CNNMoney.com) -- You've heard talk about a consumer financial protection regulator, the signature part of proposed legislation to prevent the next Wall Street crisis.

But amid the hundreds of pages of the House and Senate bills are some new powers the watchdog could wield that would directly impact your wallet.

The new regulator could ban penalty fees charged when high-interest mortgages are paid off early. It could let you take credit card disputes to court rather than be forced into mediation. And it could start a financial literacy drive to warn seniors about financial fraud and teach veterans to shop and compare auto loans.

"We need to make it easier for families to take better control of their financial lives," said Assistant Treasury Secretary Michael Barr.

The next step for the regulatory overhaul legislation is a final Senate vote in coming months, followed by a hashing out of differences with the House. Passage is by no means certain.

Generally, the bills leave a lot of leeway for the proposed consumer regulator to figure out what practices should be stopped or limited. However, Congress is more prescriptive in one case: Cracking down on penalty fees for paying off mortgages early.

The new consumer regulator must prohibit these penalty fees for subprime mortgages, and cap and phase out the fees for more traditional mortgages, according to the legislation.

More common in subprime markets, the fees are charged when a loan is repaid or refinanced in the first three to five years. The penalty can run 5% of the loan or several months of interest payments. Consumers often agree to risk the fee, because it allows them to lock in a comparatively lower subprime rate.

The banking industry says the penalties allow them to guarantee investors a return, while helping risky borrowers.

"If properly disclosed, the penalties allow consumers to make better choices," said Tom Koonce, chief lobbyist for the Mortgage Bankers Association. "It's a valuable tool for lowering rates. And if you take that away, you're going to risk rates going higher."

However, the penalties can trap some subprime borrowers into loans as their credit scores improve, preventing them from getting cheaper loans, said Mark Flannery, finance professor at the University of Florida Graduate School of Business.

"These penalties are going to make it unlikely that somebody repays the mortgage early," Flannery said. However, he agreed that doing away with penalties could result in higher mortgage rates.

The proposal goes beyond the Federal Reserve's 2008 effort to limit penalties on subprime mortgages and is being hailed by consumer advocates for nixing a "key ingredient to the subprime mortgage crisis," said Center for Responsible Lending spokeswoman Kathleen Day.

Many mortgages, credit cards, gift cards and auto loans force the buyer and seller to hash out disputes before a neutral party called an arbitration panel.

These arbitration contracts prevent disputes from going to court, with an eye toward forcing parties to work things out and cut down on lawsuits.

But consumer advocates and Treasury officials don't like the mandatory part of the contracts. They want consumers to be able to choose between arbitration and court.

The House bill directs the consumer regulator to consider banning forced arbitration for sales of financial products such as credit cards. The Senate says the watchdog needs to study the issue before banning or limiting them.

"If you can't go to court or join a class action lawsuit, that perpetuates unfair practices," said Ed Mierzwinski, national consumer program director at Public Interest Research Groups (PIRG). "Companies can ignore consumer complaints because they know they won't escalate to litigation."

Industry groups say the mandatory arbitration contracts lower the cost of providing products and services, by cutting back on lawsuits.

"These efforts are really a Trojan horse for more lawsuits," said Bryan Quigley, spokesman for the U.S. Chamber Institute for Legal Reform.

He said that many attorneys won't take smaller-dollar credit card cases. "Most people won't have access to justice at all. Instead of having an arbitration outlet, they're going to be forced to sue," Quigley said. "But if they can't find a lawyer, they can't sue."

A major role for the proposed consumer financial protection watchdog is to teach Americans to be more financially literate.

The Senate version creates an Office of Financial Literacy and the House creates an Office of Financial Protection for Older Americans. In both cases, the agencies create or embrace programs that teach Americans about savings, loans, liens and fees.

The agencies would set best practices standards for financial advice programs, preventing Americans, particularly seniors, from becoming victims of scams or from being steered to buying certain financial products.

"With everything that's happened with the economic crisis, you'd think there's so much economic education around. But there isn't," said Cindy Housell, president of the Women's Institute for a Secure Retirement.

The financial literacy agency would also streamline existing programs across agencies. For example, the Department of Defense has programs to train soldiers to watch out for abusive financial products. Under this proposal, the consumer agency and Defense Department would work together.

"We're worried about situations where consumer finance companies and auto lenders take advantage of young military families, which is bad for families, bad for the military and bad for military security," Barr said. "The financial literacy programs would continue, but with the help of the (consumer regulator) to convey best practices."

Banking lobbying groups, including the Financial Services Roundtable, support the general concept of financial literacy, said Scott Talbott, the group's chief lobbyist.

Yet, advocates worry that neither of the bills specify a funding source for new financial literacy programs. Existing financial literacy programs are already stumbling for lack of resources, Housell said.