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Tuesday, September 2, 2014

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Compliance Corner: Third Quarter 2007

FRS Alert: The Board's Rulemaking Hearing Under HOEPA to Address Unfair or Deceptive Practices in the Home Mortgage Market

The Board of Governors of the Federal Reserve System (Board) held a hearing on June 14, 2007, under the Home Ownership and Equity Protection Act of 1994 (HOEPA), a federal anti-predatory lending law, to explore how to exercise its rulemaking authority under HOEPA to address abusive practices in the mortgage market, particularly the subprime sector.1 This alert details the rulemaking hearing and the background of HOEPA.

HOEPA amended the Truth in Lending Act (TILA) by adding section 129, which imposes restrictions on non-purchase mortgage loans that meet the HOEPA definition of a high-rate or high-fee loan. In addition, section 129(l)(2) of TILA contains a rulemaking provision that provides the Board with broad authority to place restrictions on mortgage loan practices that are unfair or deceptive and on mortgage refinancing practices that are abusive:

The Board, by regulation or order, shall prohibit acts or practices in connection with-
(A) mortgage loans that the Board finds to be unfair, deceptive, or designed to evade the provisions of this section; and
(B) refinancing of mortgage loans that the Board finds to be associated with abusive lending practices, or that are otherwise not in the interest of the borrower.

It is important to note that while the existing HOEPA provisions only apply to high-rate or high-fee non-purchase loans, the Board's HOEPA rulemaking authority applies to all mortgage loans. HOEPA authorizes the Board to prohibit any mortgage act or practice if the Board finds it is unfair or deceptive and to prohibit any mortgage refinancing practice if the Board finds it is abusive or not in the interest of the borrower.

The broad scope of the Board's HOEPA authority is important because many regulated financial institutions have complained that the consumer mortgage market is not a level playing field. While banks, thrifts, and credit unions are accountable to the federal banking agencies, which regularly conduct consumer compliance examinations and issue supervisory guidance to the institutions they regulate, many nonbank lenders, like finance companies and mortgage brokers, are regulated lightly (if at all).2 A HOEPA rule would address this issue.

Section 158 of HOEPA directs the Board to hold public hearings periodically to determine the adequacy of the existing regulatory framework in protecting consumers. The Board scheduled the 2007 hearing to respond to the recent turmoil in the home mortgage market, where defaults and foreclosures have been rising precipitously, especially in the subprime sector. The hearing focused on the Board's use of its section 129 rulemaking authority to address questions related to the following four mortgage practices:

  1. Prepayment Penalties
    • Should prepayment penalties be restricted?
    • Would enhanced disclosures help address concerns about abuses?
  2. Escrow for taxes and insurance on subprime loans
    • Should escrow for taxes and insurance be required for subprime mortgage loans?
    • Should lenders be required to disclose the absence of escrows to consumers?
  3. "Stated income" or "low doc" loans
    • Should lenders be prohibited from using "stated income" or "low doc" loans in certain cases like subprime loans?
    • How would a restriction on "stated income" or "low doc" loans affect consumers and the type and terms of credit offered?
  4. Unaffordable Loans
    • Should lenders be required to underwrite all loans based on the fully indexed rate and fully amortizing payments?
    • Should there be a rebuttable presumption that a loan is unaffordable if the borrower's debt-to-income ratio exceeds 50 percent (at loan origination)?

These issues were debated for nearly eight hours by consumer groups, lenders, state regulators, community groups, and researchers. The Board will consider the testimony from this hearing in determining how to enact rules prohibiting abusive mortgage practices. The Board will also consider the following: the testimony at the four HOEPA hearings conducted in 2006;3 the comments received at the June 21, 2007, Consumer Advisory Council meeting, at which the HOEPA rulemaking was an agenda topic;4 as well as any public comments.5

During his recent appearance before Congress presenting the semiannual monetary policy report, Chairman Bernanke stated that he expected the Board to publish proposed HOEPA rules by the end of the year:

"We are certainly aware, however, that disclosure alone may not be sufficient to protect consumers. Accordingly, we plan to exercise our authority under the Home Ownership and Equity Protection Act (HOEPA) to address specific practices that are unfair or deceptive. We held a public hearing on June 14 to discuss industry practices, including those pertaining to pre-payment penalties, the use of escrow accounts for taxes and insurance, stated-income and low-documentation lending, and the evaluation of a borrower's ability to repay. The discussion and ideas we heard were extremely useful, and we look forward to receiving additional public comments in coming weeks. Based on the information we are gathering, I expect that the Board will propose additional rules under HOEPA later this year."

The Board is aware, however, as Governor Kroszner stated at the beginning of the hearing, of the need to "walk a fine line" between restricting unfair and deceptive acts while maintaining access to credit.

The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.