Fed Bans Some Subprime ARM Prepay Penalties

The Federal Reserve Board has banned prepayment penalties on subprime adjustable-rate mortgages during the first four years of the loan, effectively discouraging a proliferation of 3/28 and 2/28 ARMs if there is a revival of subprime lending. The Fed took this action in finalizing its Home Ownership and Equity Protection Act rules to beef up consumer protections. The final rules are "intended to protect consumers from unfair and deceptive practices in mortgage lending, while keeping credit available to qualified borrowers and supporting sustainable homeownership," Fed chairman Ben Bernanke said. The final HOEPA rule requires subprime lenders to determine a borrower's ability to pay and allows borrowers to sue lenders that place them in unaffordable loans. This provision and the ban on prepayment penalties go into effect October 1, 2009. Starting April 1, 2010, all subprime loans must have an escrow account for the first 12 months. With the current turmoil in mortgage markets and little subprime lending, the Fed is giving lenders plenty of time to adjust to the new lending rules. The Fed also changed the benchmark for determining subprime loans. Instead of using a Treasury index, it is switching to the Freddie Mac primary mortgage market survey. Any first mortgage with an interest rate 150 basis points above the Freddie Mac PMMS is considered subprime. This change will exclude almost all prime loans except some higher-cost jumbo loans that might be considered subprime under the HOEPA rules.