House Democrats proposed new legislation likely to stir up controversy in the financial services industry. The bill would allow homeowners to sue Wall Street firms for relief from mortgages they couldn’t afford.
Representative Barney Frank, a Massachusetts Democrat and chair of the House Financial Services Committee, introduced the bill. The legislation aims to restrict improper lending practices and largely targets for reform practices that grew out of mortgage-backed securities trading. Specifically, lawmakers continue their mission to stop lenders from offering subprime mortgages to low-income consumers or those with poor credit histories.
In the last two years, more than two million consumers obtained subprime loans with low start-up interest rates that drastically increase at the end of their introductory periods. An estimated one-fourth of these people may lose their homes.
The proposed legislation prohibits predatory lending practices. For example, the bill (1) prohibits financial incentives for steering borrowers to more expensive loans, (2) restricts prepayment penalties on loans, and (3) requires mortgage lenders to confirm that the borrowers have a “reasonable ability to repay” the loan.
Thus, the statute allows borrowers who can show they had no reasonable ability to repay their loans to demand better deals, better loans, or relief from Wall Street firms that purchased and resold the mortgage. How does a lender know if a borrower asks for more money than he can realistically expect to pay back? Frank gave an example of a loan with no reasonable likelihood of being repaid: one requiring monthly payments equal to half (or more) of the borrower’s income. Ultimately, the “unpayable loan” determination should be similar to the underwriting guidance issued by federal bank regulators. However, private lenders and brokers – not commercial or community banks – provided most of the subprime loans (and about half of all mortgages) in recent years. The new bill requires states to set standards for lenders and brokers. Failure to establish a standard leaves the private lenders subject to the strict federal standards, requiring action “solely in the best interest” of the borrower.
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