Truth in Lending, 1672-1735 [E7-25058]

Agencies

• FEDERAL RESERVE SYSTEM

[Federal Register Volume 73, Number 6 (Wednesday, January 9, 2008)]
[Proposed Rules]
[Pages 1672-1735]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-25058]



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Part II





Federal Reserve System





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12 CFR Part 226



Truth in Lending; Proposed Rule

Federal Register / Vol. 73 , No. 6 / Wednesday, January 9, 2008 / 
Proposed Rules

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FEDERAL RESERVE SYSTEM

12 CFR Part 226

[Regulation Z; Docket No. R-1305]


Truth in Lending

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Proposed rule; request for public comment.

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SUMMARY: The Board proposes to amend Regulation Z, which implements the 
Truth in Lending Act and Home Ownership and Equity Protection Act. The 
goals of the amendments are to protect consumers in the mortgage market 
from unfair, abusive, or deceptive lending and servicing practices 
while preserving responsible lending and sustainable homeownership; 
ensure that advertisements for mortgage loans provide accurate and 
balanced information and do not contain misleading or deceptive 
representations; and provide consumers transaction-specific disclosures 
early enough to use while shopping for a mortgage. The proposed 
revisions would apply four protections to a newly-defined category of 
higher-priced mortgage loans secured by a consumer's principal 
dwelling, including a prohibition on a pattern or practice of lending 
based on the collateral without regard to consumers' ability to repay 
their obligations from income, or from other sources besides the 
collateral. The proposed revisions would apply three new protections to 
mortgage loans secured by a consumer's principal dwelling regardless of 
loan price, including a prohibition on a creditor paying a mortgage 
broker more than the consumer had agreed the broker would receive. The 
Board also proposes to require that advertisements provide accurate and 
balanced information, in a clear and conspicuous manner, about rates, 
monthly payments, and other loan features; and to ban several deceptive 
or misleading advertising practices, including representations that a 
rate or payment is ``fixed'' when it can change. Finally, the proposal 
would require creditors to provide consumers with transaction-specific 
mortgage loan disclosures before they pay any fee except a reasonable 
fee for reviewing credit history.

DATES: Comments must be received on or before April 8, 2008.

ADDRESSES: You may submit comments, identified by Docket No. R-1305, by 
any of the following methods:
     Agency Web site: https://www.federalreserve.gov. Follow the 
instructions for submitting comments at https://www.federalreserve.gov/
generalinfo/foia/ProposedRegs.cfm.
     Federal eRulemaking Portal: https://www.regulations.gov. 
Follow the instructions for submitting comments.
     E-mail: regs.comments@federalreserve.gov. Include the 
docket number in the subject line of the message.
     Fax: (202) 452-3819 or (202) 452-3102.
     Mail: Address to Jennifer J. Johnson, Secretary, Board of 
Governors of the Federal Reserve System, 20th Street and Constitution 
Avenue, NW., Washington, DC 20551.
    All public comments will be made available on the Board's Web site 
at https://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as 
submitted, unless modified for technical reasons. Accordingly, comments 
will not be edited to remove any identifying or contact information. 
Public comments may also be viewed electronically or in paper in Room 
MP-500 of the Board's Martin Building (20th and C Streets, NW.) between 
9 a.m. and 5 p.m. on weekdays.

FOR FURTHER INFORMATION CONTACT: Kathleen C. Ryan, Dan S. Sokolov, or 
David Stein, Counsels; Jamie Z. Goodson, Brent Lattin, Jelena 
McWilliams, or Paul Mondor, Attorneys; Division of Consumer and 
Community Affairs, Board of Governors of the Federal Reserve System, 
Washington, DC 20551, at (202) 452-2412 or (202) 452-3667. For users of 
Telecommunications Device for the Deaf (TDD) only, contact (202) 263-
4869.

SUPPLEMENTARY INFORMATION: 

I. Summary of Proposal
    A. Proposals To Prevent Unfairness, Deception, and Abuse
    B. Proposals To Improve Mortgage Advertising
    C. Proposals To Give Consumers Disclosures Early
II. Consumer Protection Concerns in the Subprime Market
    A. Recent Problems in the Mortgage Market
    B. The Loosening of Underwriting Standards
    C. Market Imperfections That Can Facilitate Abusive and 
Unaffordable Loans
III. The Board's Hoepa Hearings
    A. Home Ownership and Equity Protection Act (HOEPA)
    B. Summary of 2006 Hearings
    C. Summary of June 2007 Hearing
    D. Congressional Hearings
IV. Inter-Agency Supervisory Guidance
V. Legal Authority
    A. The Board's Authority Under TILA Section 129(l)(2)
    B. The Board's Authority Under TILA Section 105(a)
VI. Proposed Definition of ``Higher-Priced Mortgage Loan''
    A. Overview
    B. Public Comment on the Scope of New HOEPA Rules
    C. General Principles Governing the Board's Determination of 
Coverage
    D. Types of Loans Proposed To Be Covered Under Sec.  226.35
    E. Proposed APR Trigger for Sec.  226.35
    F. Mechanics of the Proposed APR Trigger
VII. Proposed Rules for Higher-Priced Mortgage Loans--Sec.  226.35
    A. Overview
    B. Disregard of Consumers' Ability To Repay--Sec. Sec.  
226.34(a)(4) and 226.35(b)(1)
    C. Verification of Income and Assets Relied On--Sec.  
226.35(b)(2)
    D. Prepayment Penalties--Sec.  226.32(d)(6) and (7); Sec.  
226.35(b)(3)
    E. Requirement to Escrow--Sec.  226.35(b)(4)
    F. Evasion Through Spurious Open-end Credit--Sec.  226.35(b)(5)
VIII. Proposed Rules for Mortgage Loans--Sec.  226.36
    A. Creditor Payments to Mortgage Brokers--Sec.  226.36(a)
    B. Coercion of Appraisers--Sec.  226.36(b)
    C. Servicing Abuses--Sec.  226.36(c)
    D. Coverage--Sec.  226.36(d)
IX. Other Potential Concerns
    A. Other HOEPA Prohibitions
    B. Steering
X. Advertising
    A. Advertising Rules for Open-end Home-equity Plans--Sec.  
226.16
    B. Advertising Rules for Closed-end Credit--Sec.  226.24
XI. Mortgage Loan Disclosures
    A. Early Mortgage Loan Disclosures--Sec.  226.19
    B. Future Plans To Improve Disclosure
XII. Civil Liability and Remedies; Administrative Enforcement
XIII. Effective Date
XIV. Paperwork Reduction Act
XV. Initial Regulatory Flexibility Analysis

I. Summary of Proposal

    The Board is proposing to establish new regulatory protections for 
consumers in the residential mortgage market through amendments to 
Regulation Z, which implements the Truth in Lending Act (TILA) and the 
Home Ownership and Equity Protection Act (HOEPA). The goals of the 
amendments are to protect consumers in the mortgage market from unfair, 
abusive, or deceptive lending and servicing practices while preserving 
responsible lending and sustainable homeownership; ensure that 
advertisements for mortgage loans provide accurate and balanced 
information and do not contain misleading or deceptive representations; 
and provide consumers transaction-specific disclosures early enough to 
use while shopping.

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A. Proposals To Prevent Unfairness, Deception, and Abuse

    The Board is proposing seven new restrictions or requirements for 
mortgage lending and servicing intended to protect consumers against 
unfairness, deception, and abuse while preserving responsible lending 
and sustainable homeownership. The restrictions would be adopted under 
TILA Section 129(l)(2), which authorizes the Board to prohibit unfair 
or deceptive practices in connection with mortgage loans, as well as to 
prohibit abusive practices or practices not in the interest of the 
borrower in connection with refinancings. 15 U.S.C. 1639(l)(2). Some of 
the restrictions would apply only to higher-priced mortgage loans, 
while others would apply to all mortgage loans secured by a consumer's 
principal dwelling.
Protections Covering Higher-Priced Mortgage Loans
    The Board is proposing four protections for consumers receiving 
higher-priced mortgage loans. These loans would be defined as consumer-
purpose, closed-end loans secured by a consumer's principal dwelling 
and having an annual percentage rate (APR) that exceeds the comparable 
Treasury security by three or more percentage points for first-lien 
loans, or five or more percentage points for subordinate-lien loans. 
For higher-priced mortgage loans, the Board proposes to:
    [cir] Prohibit creditors from engaging in a pattern or practice of 
extending credit without regard to borrowers' ability to repay from 
sources other than the collateral itself;
    [cir] Require creditors to verify income and assets they rely upon 
in making loans;
    [cir] Prohibit prepayment penalties unless certain conditions are 
met; and
    [cir] Require creditors to establish escrow accounts for taxes and 
insurance, but permit creditors to allow borrowers to opt out of 
escrows 12 months after loan consummation.
    In addition, the proposal would prohibit creditors from structuring 
closed-end mortgage loans as open-end lines of credit for the purpose 
of evading these rules, which do not apply to lines of credit.
Protections Covering Closed-End Loans Secured by Consumer's Principal 
Dwelling
    In addition, in connection with all consumer-purpose, closed-end 
loans secured by a consumer's principal dwelling, the Board is 
proposing to:
    [cir] Prohibit creditors from paying a mortgage broker more than 
the consumer had agreed in advance that the broker would receive;
    [cir] Prohibit any creditor or mortgage broker from coercing, 
influencing, or otherwise encouraging an appraiser to provide a 
misstated appraisal in connection with a mortgage loan; and
    [cir] Prohibit mortgage servicers from ``pyramiding'' late fees, 
failing to credit payments as of the date of receipt, failing to 
provide loan payoff statements upon request within a reasonable time, 
or failing to deliver a fee schedule to a consumer upon request.

B. Proposals To Improve Mortgage Advertising

    Another goal of this proposal is to ensure that mortgage loan 
advertisements provide accurate and balanced information and do not 
contain misleading or deceptive representations. Thus the Board is 
proposing to require that advertisements for both open-end and closed-
end mortgage loans provide accurate and balanced information, in a 
clear and conspicuous manner, about rates, monthly payments, and other 
loan features. This proposal is made under the Board's general 
authority to adopt regulations to ensure consumers are informed about 
and can shop for credit. TILA Section 105(a), 15 U.S.C. 1604(a).
    The Board is also proposing, under TILA Section 129(l)(2), 15 
U.S.C. 1639(l)(2), to prohibit the following seven deceptive or 
misleading practices in advertisements for closed-end mortgage loans:
    [cir] Advertising ``fixed'' rates or payments for loans whose rates 
or payments can vary without adequately disclosing that the interest 
rate or payment amounts are ``fixed'' only for a limited period of 
time, rather than for the full term of the loan;
    [cir] Comparing an actual or hypothetical consumer's current rate 
or payment obligations and the rates or payments that would apply if 
the consumer obtains the advertised product unless the advertisement 
states the rates or payments that will apply over the full term of the 
loan;
    [cir] Advertisements that characterize the products offered as 
``government loan programs,'' ``government-supported loans,'' or 
otherwise endorsed or sponsored by a federal or state government entity 
even though the advertised products are not government-supported or -
sponsored loans;
    [cir] Advertisements, such as solicitation letters, that display 
the name of the consumer's current mortgage lender, unless the 
advertisement also prominently discloses that the advertisement is from 
a mortgage lender not affiliated with the consumer's current lender;
    [cir] Advertising claims of debt elimination if the product 
advertised would merely replace one debt obligation with another;
    [cir] Advertisements that create a false impression that the 
mortgage broker or lender has a fiduciary relationship with the 
consumer; and
    [cir] Foreign-language advertisements in which certain information, 
such as a low introductory ``teaser'' rate, is provided in a foreign 
language, while required disclosures are provided only in English.

C. Proposal To Give Consumers Disclosures Early

    A third goal of this proposal is to provide consumers transaction-
specific disclosures early enough to use while shopping for a mortgage 
loan. The Board proposes to require creditors to provide transaction-
specific mortgage loan disclosures such as the APR and payment schedule 
for all home-secured, closed-end loans no later than three days after 
application, and before the consumer pays any fee except a reasonable 
fee for the originator's review of the consumer's credit history.
    The Board recognizes that these disclosures need to be updated to 
reflect the increased complexity of mortgage products. In early 2008, 
the Board will begin testing current TILA mortgage disclosures and 
potential revisions to these disclosures through one-on-one interviews 
with consumers. The Board expects that this testing will identify 
potential improvements for the Board to propose for public comment in a 
separate rulemaking.

II. Consumer Protection Concerns in the Subprime Market

A. Recent Problems in the Mortgage Market

    Subprime mortgage loans are made to borrowers who are perceived to 
have high credit risk. These loans' share of total consumer 
originations, according to one estimate, reached about nine percent in 
2001 and doubled to 20 percent by 2005, where it stayed in 2006.\1\ The 
resulting increase in the supply of mortgage credit likely contributed 
to the rise in the homeownership rate from 64 percent in 1994 to a high 
of 69 percent in 2006--though about 68 percent now--and expanded 
consumers' access to the equity in their homes. Recently, however, some 
of this benefit has

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eroded. In the last two years, delinquencies and foreclosure starts 
among subprime mortgages have increased dramatically and reached 
exceptionally high levels as house price growth has slowed or prices 
have declined in some areas. The proportion of all subprime mortgages 
past-due ninety days or more (``serious delinquency'') was about 13 
percent in October 2007, more than double the mid-2005 level.\2\ 
Adjustable-rate subprime mortgages have performed the worst, reaching a 
serious delinquency rate of nearly 19 percent in October 2007, triple 
the mid-2005 level. These mortgages have seen unusually high levels of 
early payment default, or default after only one or two payments or 
even no payment at all.
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    \1\ Inside Mortgage Finance Publications, Inc., The 2007 
Mortgage Market Statistical Annual vol. I (IMF 2007 Mortgage 
Market), at 4.
    \2\ Delinquency rates calculated from data from First American 
LoanPerformance on mortgages in subprime securitized pools. Figures 
include loans on non-owner-occupied properties.
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    The serious delinquency rate has also risen for loans in alt-A 
(near prime) securitized pools. According to one source, originations 
of these loans were 13 percent of consumer mortgage originations in 
2006.\3\ Alt-A loans are made to borrowers who typically have higher 
credit scores than subprime borrowers, but the loans pose more risk 
than prime loans because they involve small down payments or reduced 
income documentation, or the terms of the loan are nontraditional and 
may increase risk. The rate of serious delinquency for these loans has 
risen to over 3 percent (as of September 2007) from 1 percent only a 
year ago. In contrast, 1 percent of loans in the prime-mortgage sector 
were seriously delinquent as of October.
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    \3\ IMF 2007 Mortgage Market, at 4.
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    The consequences of default are severe for homeowners, who face the 
possibility of foreclosure, the loss of accumulated home equity, higher 
rates for other credit transactions, and reduced access to credit. When 
foreclosures are clustered, they can injure entire communities by 
reducing property values in surrounding areas. Higher delinquencies are 
in fact showing through to foreclosures. Lenders initiated 430,000 
foreclosures in the third quarter of 2007, about half of them on 
subrpime mortgages. This was significantly higher than the quarterly 
average of 325,000 in the first half of the year, and nearly twice the 
quarterly average of 225,000 for the past six years.\4\
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    \4\ Estimates are based on data from Mortgage Bankers' 
Association's National Delinquency Survey (2007).
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B. The Loosening of Underwriting Standards

    Rising delinquencies have been caused largely by a combination of a 
decline in house price appreciation--and in some areas slower economic 
growth--and a loosening of underwriting standards. Underwriting 
standards loosened in large parts of the mortgage market in recent 
years as lenders--particularly nondepository institutions, many of 
which have since ceased to exist--competed more aggressively for market 
share. This loosening was particularly pronounced in the subprime 
sector, where the frequent combination of several riskier loan 
attributes--high loan-to-value ratio, payment shock on adjustable-rate 
mortgages, no verification of borrower income, and no escrow for taxes 
and insurance--increased the risk of serious delinquency and 
foreclosure for subprime loans originated in 2005 through early 2007.
    Payment shock from rate adjustments within two or three years of 
origination could make these loans unaffordable to many of the 
consumers who hold them. Approximately three-fourths of originations in 
securitized subprime ``pools'' from 2004 to 2006 were adjustable-rate 
mortgages (ARMs) with two-or three-year ``teaser'' rates followed by 
substantial increases in the rate and payment (so-called ``2-28'' and 
``3-27'' mortgages).\5\ The burden of these payment increases on the 
borrower would likely be heavier than expected if the borrower's stated 
income was inflated, as appears to have happened in some cases, and the 
inflated figure was used to determine repayment ability. In addition, 
affordability problems with subprime loans can be compounded by 
unexpected property tax and homeowners insurance obligations. In the 
prime market, lenders typically establish escrows for these 
obligations, but in the subprime market escrows have been the exception 
rather than the rule.
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    \5\ Figure calculated from First American Loan Performance data.
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    Delinquencies and foreclosure initiations in subprime ARMs are 
expected to rise further as more of these mortgages see their rates and 
payments reset at significantly higher levels. On average in 2008, 
374,000 subprime mortgages per quarter are scheduled to undergo their 
first interest rate and payment reset. Relative to past years, avoiding 
the payment shock of an interest rate reset by refinancing the mortgage 
will be much more difficult. Not only have home prices flattened out or 
declined, thereby reducing homeowners' equity, but borrowers often had 
little equity to start with because of very high initial cumulative 
loan-to-value ratios. Moreover, prepayment penalty clauses, which are 
found in a substantial majority of subprime loans, place an added 
demand on the limited equity or other resources available to many 
borrowers and make it harder still for them to refinance. Borrowers who 
cannot refinance will have to make sacrifices to stay in their homes or 
could lose their homes altogether.\6\
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    \6\ These effects may be mitigated for some borrowers by a 
recently-announced agreement among major loan servicers and 
investors to ``freeze'' many subprime ARMs at their initial interest 
rates for five years.
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    Relaxed underwriting was not limited to the subprime market. 
According to one estimate, interest-only mortgages (most of them with 
adjustable rates) and ``option ARMs''--which permit borrowers to defer 
both principal and interest for a time in exchange for higher payments 
later--rose from 7 percent of total consumer mortgage originations in 
2004 to 26 percent in 2006.\7\ By one estimate these mortgages reached 
78 percent of alt-A originations in 2006.\8\ These types of mortgages 
hold the potential for payment shock and increasingly contained 
additional layers of risk such as loan amounts near the full appraised 
value of the home, and partial or no documentation of income. For 
example, the share of interest-only mortgages with low or no 
documentation in alt-A securitized pools increased from around 60 
percent in 2003 to nearly 80 percent in 2006.\9\ Most of these 
mortgages have not yet reset so their full implications are not yet 
apparent. The risks to consumers and to creditors were serious enough, 
however, to cause the federal banking agencies to issue supervisory 
guidance, which many state agencies later adopted.\10\
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    \7\ IMF 2007 Mortgage Market, at 6.
    \8\ David Liu & Shumin Li, Alt-A Credit--The Other Shoe Drops?, 
The MarketPulse (First American LoanPerformance, Inc., San 
Francisco, Cal.), Dec. 2006.
    \9\ Figures calculated from First American LoanPerformance data.
    \10\ Interagency Guidance on Nontraditional Mortgage Product 
Risks, 71 FR 58609, Oct. 4, 2006.
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    A decline in underwriting standards does not just increase the risk 
that consumers will be provided loans they cannot repay. It also 
increases the risk that originators will engage in an abusive strategy 
of ``flipping'' borrowers in a succession of refinancings, ostensibly 
to lower borrowers' burdensome payments, that strip borrowers' equity 
and provide them no

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benefit. Moreover, an atmosphere of relaxed standards may increase the 
incidence of abusive lending practices by attracting less scrupulous 
originators into the market, while at the same time bringing more 
vulnerable borrowers into the market. These abuses can lead consumers 
to pay more for their loans than their risk profiles warrant.
    The market has responded to the current problems with increasing 
attention to loan quality. Structural factors, or market imperfections, 
however, make it necessary to consider regulations to help prevent a 
recurrence of these problems. New regulation can also provide the 
market clear ``rules of the road'' at a time of uncertainty, so that 
responsible higher-priced lending, which serves a critical need, may 
continue.

C. Market Imperfections That Can Facilitate Abusive and Unaffordable 
Loans

    The recent sharp increase in serious delinquencies has highlighted 
the roles that structural elements of the subprime mortgage market may 
play in increasing the likelihood of injury to consumers who find 
themselves in that market. Limitations on price and product 
transparency in the subprime market--often compounded by misleading or 
inaccurate advertising--may make it harder for consumers to protect 
themselves from abusive or unaffordable loans, even with the best 
disclosures. The injuries consumers in the subprime market may suffer 
as a result are magnified when originators' incentives to carefully 
assess consumers' repayment ability grow weaker, as can happen when 
originators sell off their loans to be securitized. The fragmentation 
of the originator market can further exacerbate the problem by making 
it more difficult for investors to monitor originators and for lenders 
to monitor brokers. The multiplicity of originators and their 
regulators can also inhibit the ability of regulators to protect 
consumers from abusive and unaffordable loans.
Limited Transparency and Limits of Disclosure
    Limited transparency in the subprime market increases the risk that 
borrowers in that market will receive unaffordable or abusive loans. 
The transparency of the subprime market to consumers is limited in 
several respects. First, price information for the subprime market is 
not widely and readily available to consumers. A consumer searching in 
the prime market can buy a newspaper or access the Internet and easily 
find current interest rates from a wide variety of lenders without 
paying a fee. In contrast, subprime rates, which can vary significantly 
based on the individual borrower's risk profile, are not broadly 
advertised. Advertising in the subprime market focuses on easy approval 
and low payments. Moreover, a borrower shopping in the subprime market 
generally cannot obtain a useful rate quote from a particular lender 
without submitting an application and paying a fee. The quote may not 
even be reliable, as loan originators sometimes use ``bait and switch'' 
strategies.
    Second, products in the subprime market tend to be complex, both 
relative to the prime market and in absolute terms, as well as less 
standardized than in the prime market.\11\ As discussed earlier, 
subprime originations have much more often had adjustable rates than 
more easily understood fixed rates. Adjustable-rate mortgages require 
consumers to make judgments about the future direction of interest 
rates and translate expected rate changes into changes in their payment 
amounts. Subprime loans are also far more likely to have prepayment 
penalties. The price of the penalty is not reflected in the annual 
percentage rate (APR); to calculate that price, the consumer must both 
calculate the size of the penalty according to a formula such as six 
months of interest, and assess the likelihood the consumer will move or 
refinance during the penalty period. In these and other ways subprime 
products tend to be complex for consumers.
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    \11\ U.S. Dep't of Hous. & Urban Dev. & U.S. Dep't of Treasury, 
Recommendations to Curb Predatory Home Mortgage Lending 17 (2000) 
(``While predatory lending can occur in the prime market, such 
practices are for the most part effectively deterred by competition 
among lenders, greater homogeneity in loan terms and the prime 
borrowers' greater familiarity with complex financial 
transactions.''); Howard Lax, Michael Manti, Paul Raca & Peter Zorn, 
Subprime Lending: An Investigation of Economic Efficiency (Subprime 
Lending Investigation), 15 Housing Policy Debate 3, 570 (2004) 
(stating that the subprime market lacks the ``overall 
standardization of products, underwriting, and delivery systems'' 
that is found in the prime market).
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    Third, the roles and incentives of originators are not transparent. 
One source estimates that 60 percent or more of mortgages originated in 
the last several years were originated through a mortgage broker, often 
an independent entity, who takes loan applications from consumers and 
shops them to depository institutions or other lenders.\12\ Anecdotal 
evidence indicates that consumers in both the prime and subprime 
markets often believe, in error, that a mortgage broker is obligated to 
find the consumer the best and most suitable loan terms available. For 
example, in a 2003 survey of older borrowers who had obtained prime or 
subprime refinancings, seventy percent of respondents with broker-
originated refinance loans reported that they had relied ``a lot'' on 
their brokers to find the best mortgage for them.\13\ Consumers who 
rely on brokers often are unaware, however, that a broker's interests 
may diverge from, and conflict with, their own interests. In 
particular, consumers are often unaware that a creditor pays a broker 
more to originate a loan with a rate higher than the rate the consumer 
qualifies for based on the creditor's underwriting criteria.
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    \12\ Data reported by Wholesale Access Mortgage Research and 
Consulting, Inc., available at https://www.wholesaleaccess.com/8-17-
07-prs.shtml; https://www.wholesaleaccess.com/7_28_mbkr.shtml.
    \13\ Kellie K. Kim-Sung & Sharon Hermanson, Experiences of Older 
Refinance Mortgage Loan Borrowers: Broker- and Lender-Originated 
Loans, Data Digest No. 83 (AARP Public Policy Inst., Washington, 
DC), Jan. 2003, at 3, available at https://www.aarp.org/research/
credit-debt/mortgages/experiences_of_older_refinance_mortgage_
loan_borro.html.
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    Limited shopping. In this environment of limited transparency, 
consumers--particularly those in the subprime market--who have been 
told by an originator that they will receive a loan from that 
originator may reasonably decide not to shop further among originators 
or among loan options. The costs of further shopping may be 
significant, including completing another application form and paying 
yet another application fee. Delaying receipt of funds is another cost 
of continuing to shop, a potentially significant one for the many 
borrowers in the subprime market who are seeking to refinance their 
obligations to lower their debt payments at least temporarily, to 
extract equity in the form of cash, or both.\14\ Nearly 90 percent of 
subprime ARMs used for refinancing in recent years were ``cash out.'' 
\15\
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    \14\ See Anthony Pennington-Cross & Souphala Chomsisengphet, 
Subprime Refinancing: Equity Extraction and Mortgage Termination, 35 
Real Estate Economics 2, 233 (2007) (reporting that 49% of subprime 
refinance loans involve equity extraction, compared with 26% of 
prime refinance loans); Marsha J. Courchane, Brian J. Surette, and 
Peter M. Zorn, Subprime Borrowers: Mortgage Transitions and Outcomes 
(Subprime Outcomes), 29 J. of Real Estate Economics 4, 368-371 
(2004) (discussing survey evidence that borrowers with subprime 
loans are more likely to have experienced major adverse life events 
(marital disruption; major medical problem; major spell of 
unemployment; major decrease of income) and often use refinancing 
for debt consolidation or home equity extraction); Subprime Lending 
Investigation, at 551-552 (citing survey evidence that borrowers 
with subprime loans have increased incidence of major medical 
expenses, major unemployment spells, and major drops in income).
    \15\ Figure calculated from First American LoanPerformance data.
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    While the cost of continuing to shop is likely obvious, the benefit 
may not be

[[Page 1676]]

clear or may appear quite small. Without easy access to subprime 
product prices, a consumer who has been offered a loan by one 
originator may have only a limited idea whether further shopping is 
likely to produce a better deal. Moreover, consumers in the subprime 
market have reported in studies that they were turned down by several 
lenders before being approved.\16\ Once approved, these consumers may 
see little advantage to continuing to shop if they expect, based on 
their experience, that many of their applications to other originators 
would be turned down. Furthermore, if a consumer uses a broker and 
believes that the broker is shopping for the consumer, the consumer may 
believe the chance of finding a better deal than the broker is small. 
An unscrupulous originator may also seek to discourage a consumer from 
shopping by intentionally understating the cost of an offered loan. For 
all of these reasons, borrowers in the subprime market may not shop 
beyond the first approval and may be willing to accept unfavorable 
terms.\17\
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    \16\ James M. Lacko & Janis K. Pappalardo, Fed. Trade Comm'n, 
Improving Consumer Mortgage Disclosures: An Empirical Assessment of 
Current and Prototype Disclosure Forms (Improving Mortgage 
Disclosures), 24-26 (2007) (reporting evidence based on qualitative 
consumer interviews); Subprime Lending Investigation, at 550 
(finding based on survey data that ``[p]robably the most significant 
hurdle overcome by subprime borrowers * * * is just getting approved 
for a loan for the first time. This impact might well make subprime 
borrowers more willing to accept less favorable terms as they become 
uncertain about the possibility of qualifying for a loan at all.'').
    \17\ Subprime Outcomes, at 371-372 (reporting survey evidence 
that relative to prime borrowers, subprime borrowers are less 
knowledgeable about the mortgage process, search less for the best 
rates, and feel they have less choice about mortgage terms and 
conditions); Subprime Mortgage Investigation, at 554 (``Our focus 
groups suggested that prime and subprime borrowers use quite 
different search criteria in looking for a loan. Subprime borrowers 
search primarily for loan approval and low monthly payments, while 
prime borrowers focus on getting the lowest available interest rate. 
These distinctions are quantitatively confirmed by our survey.'').
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    Limited focus. Consumers considering obtaining a typically complex 
subprime mortgage loan may simplify their decision by focusing on a few 
attributes of the product or service that seem most important.\18\ A 
consumer may focus on loan attributes that have the most obvious and 
immediate consequence such as loan amount, down payment, initial 
monthly payment, initial interest rate, and up-front fees (though up-
front fees may be more obscure when added to the loan amount, and 
``discount points'' in particular may be difficult for consumers to 
understand). These consumers, therefore, may not focus on terms that 
may seem less immediately important to them such as future increases in 
payment amounts or interest rates, prepayment penalties, and negative 
amortization. They are also not likely to focus on underwriting 
practices such as income verification, and on features such as escrows 
for future tax and insurance obligations.\19\ Consumers who do not 
fully understand such terms and features, however, are less able to 
appreciate their risks, which can be significant. For example, the 
payment may increase sharply and a prepayment penalty may hinder the 
consumer from refinancing to avoid the payment increase. Thus, 
consumers may unwittingly accept loans that they will have difficulty 
repaying.
---------------------------------------------------------------------------

    \18\ Jinkook Lee & Jeanne M. Hogarth, Consumer Information 
Search for Home Mortgages: Who, What, How Much, and What Else? 
(Consumer Information Search), Financial Services Review 291 (2000) 
(``In all, there are dozens of features and costs disclosed per 
loan, far in excess of the combination of terms, lenders, and 
information sources consumers report using when shopping.'').
    \19\ Consumer Information Search, at 285 (reporting survey 
evidence that most consumers compared interest rate or APR, loan 
type (fixed-rate or ARM), and mandatory up-front fees, but only a 
quarter considered the costs of optional products such as credit 
insurance and back-end costs such as late fees). There is evidence 
that borrowers are not aware of, or do not understand, terms of this 
nature even after they have obtained a loan. See Improving Mortgage 
Disclosures, at 27-30 (discussing anecdotal evidence based on 
consumer interviews that borrowers were not aware of, did not 
understand, or misunderstood an important cost or feature of their 
loans that had substantial impact on the overall cost, the future 
payments, or the ability to refinance with other lenders); Brian 
Bucks & Karen Pence, Do Homeowners Know Their House Values and 
Mortgage Terms? 18-22 (Fed. Reserve Bd. of Governors Fin. and Econ. 
Discussion Series Working Paper No. 2006-3, 2006) (discussing 
statistical evidence that borrowers with ARMs underestimate annual 
as well as life-time caps on the interest rate; the rate of 
underestimation increases for lower-income and less-educated 
borrowers), available at https://www.federalreserve.gov/pubs/feds/
2006/200603/200603pap.pdf.
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    Limits of disclosure. Disclosures describing the multiplicity of 
features of a complex loan could help some consumers in the subprime 
market, but disclosures may not be sufficient to protect them against 
unfair loan terms or lending practices. Obtaining widespread consumer 
understanding of the many potentially significant features of a typical 
subprime product is a major challenge.\20\ Moreover, even if all of a 
loan's features are disclosed clearly to consumers, they may continue 
to focus on a few features that appear most significant. Alternatively, 
disclosing all features may ``overload'' consumers and make it more 
difficult for them to discern which features are most important.
---------------------------------------------------------------------------

    \20\ Improving Mortgage Disclosures, at 74-76 (finding that 
borrowers in the subprime market may have more difficulty 
understanding their loan terms because their loans are more complex 
than loans in the prime market).
---------------------------------------------------------------------------

    Furthermore, a consumer cannot make effective use of disclosures 
without having a certain minimum level of understanding of the market 
and products. Disclosures themselves, likely cannot provide this 
minimum understanding for transactions that are complex and that 
consumers engage in infrequently. Moreover, consumers may rely more on 
their originators to explain the disclosures when the transaction is 
complex; some originators may have incentives to misrepresent the 
disclosures so as to obscure the transaction's risks to the consumer; 
and such misrepresentations may be particularly effective if the 
originator is face-to-face with the consumer.\21\ Therefore, while the 
Board anticipates proposing changes to Regulation Z to improve mortgage 
loan disclosures, it appears unlikely that better disclosures, alone, 
will address adequately the risk of abusive or unaffordable loans in 
the subprime market.
---------------------------------------------------------------------------

    \21\ U.S. Gen. Accounting Office, GAO 04-280, Consumer 
Protection: Federal and State Agencies Face Challenges in Combating 
Predatory Lending 97-98 (2004) (stating that the inherent complexity 
of mortgage loans, some borrowers' lack of financial sophistication, 
education, or infirmities, and misleading statements and actions by 
lenders and brokers limit the effectiveness of even clear and 
transparent disclosures).
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Misaligned Incentives and Obstacles to Monitoring
    Not only are consumers in the subprime market often unable to 
protect themselves from abusive or unaffordable loans, originators may 
at certain times be more likely to extend unaffordable loans. The 
recent sharp rise in serious delinquencies on subprime mortgages has 
made clear that originators may not give adequate attention to 
repayment ability if they sell the mortgages they originate and bear 
little loss if the mortgages default. The growth of the secondary 
market gave lenders--and, thus, mortgage borrowers--greater access to 
capital markets, lowered transaction costs, and allowed risk to be 
shared more widely. This ``originate-to-distribute'' model, however, 
may also tend to contribute to the loosening of underwriting standards, 
particularly during periods of rapid house price appreciation, which 
may mask problems by keeping default and delinquency rates low until 
price appreciation slows or reverses.
    This potential tendency has several related causes. First, when an 
originator sells a mortgage and its servicing rights, depending on the 
terms of the sale, most or all of the risks typically are passed on

[[Page 1677]]

to the loan purchaser. Thus, originators who sell loans may have less 
of an incentive to undertake careful underwriting than if they kept the 
loans. Second, warranties by sellers to purchasers and other 
``repurchase'' contractual provisions have little meaningful benefit if 
originators have limited assets. Third, fees for some loan originators 
have been tied to loan volume, making loan sales--sometimes 
accomplished through aggressive ``push marketing''--a higher priority 
than loan quality for some originators. Fourth, investors may not 
exercise adequate due diligence on mortgages in the pools in which they 
are invested, and may instead rely heavily on credit-ratings firms to 
determine the quality of the investment.
    The fragmentation of the originator market can further exacerbate 
the problem. Data reported under HMDA show that independent mortgage 
companies--those not related to depository institutions or their 
subsidiaries or affiliates--made nearly one-half of higher-priced 
first-lien mortgages in 2005 and 2006 but only one-fourth of loans that 
were not higher-priced. Nor was lending by independent mortgage 
companies particularly concentrated: In each of 2005 and 2006 around 
150 independent mortgage companies made 500 or more higher-priced 
first-lien mortgage loans on owner-occupied dwellings. In addition, one 
source suggests that 60 percent or more of mortgages originated in the 
last several years were originated through a mortgage broker.\22\ This 
same source estimates the number of brokerage companies at over 50,000 
in recent years.
---------------------------------------------------------------------------

    \22\ Data reported by Wholesale Access Mortgage Research and 
Consulting, Inc. Available at https://www.wholesaleaccess.com/8-17-
07-prs.shtml; https://www.wholesaleaccess.com/7_28_mbkr.shtml.
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    Thus, a securitized pool of mortgages may have been sourced by tens 
of lenders and thousands of brokers. Investors have limited ability to 
directly monitor these originators' activities. Similarly, a lender may 
receive a handful of loans from each of hundreds or thousands of small 
brokers every year. A lender has limited ability or incentive to 
monitor every small brokerage's operations and performance.
    Government oversight of such a fragmented originator market faces 
significant challenges. The various lending institutions and brokers 
operate in fifty different states and the District of Columbia with 
different regulatory and supervisory regimes, varying resources for 
supervision and enforcement, and different practices in sharing 
information among regulators. State regulatory regimes come under 
particular pressure when a booming market brings new lenders and 
brokers into the marketplace more rapidly than regulators can increase 
their oversight resources. These circumstances may inhibit the ability 
of regulators to protect consumers from abusive and unaffordable loans.
A Role for New HOEPA Rules
    As explained above, consumers in the subprime market face serious 
constraints on their ability to protect themselves from abusive or 
unaffordable loans, even with the best disclosures; originators 
themselves may at times lack sufficient market incentives to ensure 
loans they sell are affordable; and regulators face limits on their 
ability to oversee a fragmented subprime origination market. These 
circumstances appear to warrant imposing a new national legal standard 
on subprime lenders to help ensure that consumers receive mortgage 
loans they can afford to repay, and help prevent the equity-stripping 
abuses that unaffordable loans facilitate. Adopting this standard under 
authority of HOEPA would ensure that it applied uniformly to all 
originators and provide consumers an opportunity to redress wrongs 
through civil actions to the extent authorized by TILA. As explained in 
the next part, substantial information supplied to the Board through 
several public hearings confirms the need for new HOEPA rules.

III. The Board's HOEPA Hearings

A. Home Ownership and Equity Protection Act (HOEPA)

    The Board has recently held extensive public hearings on consumer 
protection issues in the mortgage market, including the subprime 
sector. These hearings were held pursuant to the Home Ownership and 
Equity Protection Act (HOEPA), which directs the Board to hold public 
hearings periodically on the home equity lending market and the 
adequacy of existing law for protecting the interests of consumers, 
particularly low income consumers. HOEPA imposes substantive 
restrictions, and special pre-closing disclosures, on particularly 
high-cost refinancings and home equity loans (``HOEPA loans'').\23\ 
These restrictions include limitations on prepayment penalties and 
``balloon payment'' loans, and prohibitions of negative amortization 
and of engaging in a pattern or practice of lending based on the 
collateral without regard to repayment ability.
---------------------------------------------------------------------------

    \23\ HOEPA loans are closed-end, non-purchase money mortgages 
secured by a consumer's principal dwelling (other than a reverse 
mortgage) where either: (a) The APR at consummation will exceed the 
yield on Treasury securities of comparable maturity by more than 8 
percentage points for first-lien loans, or 10 percentage points for 
subordinate-lien loans; or (b) the total points and fees payable by 
the consumer at or before closing exceed the greater of 8 percent of 
the total loan amount, or $547 for 2007 (adjusted annually).
---------------------------------------------------------------------------

    When it enacted HOEPA, Congress granted the Board authority, 
codified in TILA Section 129(l), to create exemptions to HOEPA's 
restrictions and to expand its protections. 15 U.S.C. 1639(l). Under 
TILA Section 129(l)(1), the Board may create exemptions to HOEPA's 
restrictions as needed to keep responsible credit available; and under 
TILA Section 129(l)(2), the Board may adopt new or expanded 
restrictions as needed to protect consumers from unfairness, deception, 
or evasion of HOEPA. In HOEPA Section 158, Congress directed the Board 
to monitor changes in the home equity market through regular public 
hearings.
    Hearings the Board held in 2000 led the Board to expand HOEPA's 
protections in December 2001.\24\ Those rules, which took effect in 
2002, lowered HOEPA's rate trigger, expanded its fee trigger to include 
single-premium credit insurance, added an anti-``flipping'' 
restriction, and improved the special pre-closing disclosure.
---------------------------------------------------------------------------

    \24\ Truth in Lending, 66 FR 65604, 65608, Dec. 20, 2001.
---------------------------------------------------------------------------

B. Summary of 2006 Hearings

    In the summer of 2006, the Board held four hearings in four cities 
on three broad topics: (1) The impact of the 2002 HOEPA rule changes on 
predatory lending practices, as well as the effects on consumers of 
state and local predatory lending laws; (2) nontraditional mortgage 
products and reverse mortgages; and (3) informed consumer choice in the 
subprime market. Hearing panelists included mortgage lenders and 
brokers, credit ratings agencies, real estate agents, consumer 
advocates, community development groups, housing counselors, 
academicians, researchers, and state and federal government officials. 
In addition, consumers, housing counselors, brokers, and other 
individuals made brief statements at the hearings during an ``open 
mike'' period. In all, 67 individuals testified on panels and 54 
comment letters were submitted to the Board.
    Consumer advocates and some state officials stated that HOEPA is 
generally effective in preventing abusive terms in loans subject to the 
HOEPA price triggers. They noted, however, that very

[[Page 1678]]

few loans are made with rates or fees at or above the HOEPA triggers, 
and some advocated that Congress lower them. Consumer advocates and 
state officials also urged regulators and Congress to curb abusive 
practices in the origination of loans that do not meet HOEPA's price 
triggers.
    Consumer advocates identified several particular areas of concern. 
They urged the Board to prohibit or restrict certain loan features or 
terms, such as prepayment penalties, and underwriting practices such as 
``stated income'' or ``low documentation'' (``low doc'') loans for 
which the borrower's income is not documented or verified. They also 
expressed concern about aggressive marketing practices such as steering 
borrowers to higher-cost loans by emphasizing initial low monthly 
payments based on an introductory rate without adequately explaining 
that the consumer will owe considerably higher monthly payments after 
the introductory rate expires.
    Some consumer advocates stated that brokers and lenders should be 
held to a higher duty such as a duty of good faith and fair dealing or 
a duty to make only loans suitable for the borrower. These advocates 
also urged the Board to ban ``yield spread premiums,'' payments that 
brokers receive from the lender at closing for delivering a loan with 
an interest rate that is higher than the lender's ``buy rate,'' because 
they provide brokers an incentive to increase consumers' interest 
rates. They argued that such steps would align reality with consumers' 
perceptions that brokers serve their best interests. Consumer advocates 
also expressed concerns that brokers, lenders, and others may coerce 
appraisers to misrepresent the value of a dwelling; and that servicers 
may charge consumers unwarranted fees and in some cases make it 
difficult for consumers who are in default to avoid foreclosure.
    Industry panelists and commenters, on the other hand, expressed 
concern that state predatory lending laws may reduce the availability 
of credit for some subprime borrowers. Most industry commenters opposed 
prohibiting stated income loans, prepayment penalties, or other loan 
terms, asserting that this approach would harm borrowers more than help 
them. They urged the Board and other regulators to focus instead on 
enforcing existing laws to remove ``bad actors'' from the market. Some 
lenders indicated, however, that restrictions on certain features or 
practices might be appropriate if the restrictions were clear and 
narrow. Industry commenters also stated that subjective suitability 
standards would create uncertainties for brokers and lenders and 
subject them to excessive litigation risk.

C. Summary of June 2007 Hearing

    In light of the information received at the 2006 hearings and the 
rise in defaults that began soon after, the Board held an additional 
hearing in June 2007 to explore how it could use its authority under 
HOEPA to prevent abusive lending practices in the subprime market while 
still preserving responsible subprime lending. The Board focused the 
hearing on four specific areas: Lenders' determination of borrowers' 
repayment ability; ``stated income'' and ``low doc'' lending; the lack 
of escrows in the subprime market relative to the prime market; and the 
high frequency of prepayment penalties in the subprime market.
    At the hearing, the Board heard from 16 panelists representing 
consumers, mortgage lenders, mortgage brokers, and state government 
officials, as well as from academicians. The Board also received almost 
100 written comments after the hearing from an equally diverse group.
    Industry representatives acknowledged concerns with recent lending 
practices but urged the Board to address most of these concerns through 
supervisory guidance rather than regulations under HOEPA. They 
maintained that supervisory guidance, unlike regulation, is flexible 
enough to preserve access to responsible credit. They also suggested 
that supervisory guidance issued recently regarding nontraditional 
mortgages and subprime lending, as well as market self-correction, have 
reduced the need for new regulations. Industry representatives support 
improving mortgage disclosures to help consumers avoid abusive loans. 
They urged that any substantive rules adopted by the Board be clearly 
drawn to limit uncertainty and narrowly drawn to avoid unduly 
restricting credit.
    In contrast, consumer advocates, state and local officials, and 
Members of Congress urged the Board to adopt regulations under HOEPA. 
They acknowledged a proper place for guidance but contended that recent 
problems indicate the need for requirements enforceable by borrowers 
through civil actions, which HOEPA enables and guidance does not. They 
also expressed concern that less responsible, less closely supervised 
lenders are not subject to the guidance and that there is limited 
enforcement of existing laws for these entities. Consumer advocates and 
others welcomed improved disclosures but insisted they would not 
prevent abusive lending. More detailed accounts of the testimony and 
letters are provided below in the context of specific issues the Board 
is proposing to address.

D. Congressional Hearings

    Congress has also held a number of hearings in the past year about 
consumer protection concerns in the mortgage market.\25\ In these 
hearings, Congress has heard testimony from individual consumers, 
representatives of consumer and community groups, representatives of 
financial and mortgage industry groups and federal and state officials. 
These hearings have focused on rising subprime foreclosure rates and 
the extent to which lending practices have contributed to them.
---------------------------------------------------------------------------

    \25\ E.g., Progress in Administration and Other Efforts to 
Coordinate and Enhance Mortgage Foreclosure Prevention: Hearing 
before the H. Comm. on Fin. Servs., 110th Cong. (2007); Legislative 
Proposals on Reforming Mortgage Practices: Hearing before the H. 
Comm. on Fin. Servs., 110th Cong. (2007); Legislative and Regulatory 
Options for Minimizing and Mitigating Mortgage Foreclosures: Hearing 
before the H. Comm. on Fin. Servs., 110th Cong. (2007); Ending 
Mortgage Abuse: Safeguarding Homebuyers: Hearing before the S. 
Subcomm. on Hous., Transp., and Cmty. Dev. of the S. Comm. on 
Banking, Hous., and Urban Affairs, 110th Cong. (2007); Improving 
Federal Consumer Protection in Financial Services: Hearing before 
the H. Comm. on Fin. Servs., 110th Cong. (2007); The Role of the 
Secondary Market in Subprime Mortgage Lending: Hearing before the 
Subcomm. on Fin. Insts. and Consumer Credit of the H. Comm. on Fin. 
Servs., 110th Cong. (2007); Possible Responses to Rising Mortgage 
Foreclosures: Hearing before the H. Comm. on Fin. Servs., 110th 
Cong. (2007); Subprime Mortgage Market Turmoil: Examining the Role 
of Securitization: Hearing before the Subcomm. on Secs., Ins., and 
Inv. of the S. Comm. on Banking, Hous., and Urban Affairs, 110th 
Cong. (2007); Subprime and Predatory Lending: New Regulatory 
Guidance, Current Market Conditions, and Effects on Regulated 
Financial Institutions: Hearing before the Subcomm. on Fin. Insts. 
and Consumer Credit of the H. Comm. on Fin. Servs., 110th Cong. 
(2007); Mortgage Market Turmoil: Causes and Consequences, Hearing 
before the S. Comm. on Banking, Hous., and Urban Affairs, 110th 
Cong. (2007); Preserving the American Dream: Predatory Lending 
Practices and Home Foreclosures, Hearing before the S. Comm. on 
Banking, Hous., and Urban Affairs, 110th Cong. (2007).
---------------------------------------------------------------------------

    Consumer and community group representatives testified that certain 
lending terms or practices, such as hybrid adjustable-rate mortgages, 
prepayment penalties, low or no documentation loans, lack of escrows 
for taxes and insurance, and failure to consider the consumer's ability 
to repay have contributed to foreclosures. In addition, these witnesses 
testified that consumers often believe that mortgage brokers represent 
their interests and shop on their behalf for the best loan terms. As a 
result, they argue that consumers do not shop independently to ensure 
that they are getting the best terms for which they qualify. They also

[[Page 1679]]

testified that, because originators sell most loans into the secondary 
market and do not share the risk of default, brokers and lenders have 
less incentive to ensure consumers can afford their loans.
    Financial services and mortgage industry representatives testified 
that consumers need better disclosures of their loan terms, but that 
substantive restrictions on subprime loan terms would risk reducing 
access to credit for some borrowers. In addition, these witnesses 
testified that applying a fiduciary duty to the subprime market, such 
as requiring that a loan be in the borrower's best interest, would 
introduce subjective standards that would significantly increase 
compliance and litigation risk. According to these witnesses, some 
lenders would be less willing to offer loans in the subprime market, 
making it harder for some consumers to get loans.

IV. Inter-Agency Supervisory Guidance

    In December 2005, the Board and the other federal banking agencies 
responded to concerns about the rapid growth of nontraditional 
mortgages in the previous two years by proposing supervisory guidance. 
Nontraditional mortgages are mortgages that allow the borrower to defer 
repayment of principal and sometimes interest. The guidance advised 
institutions of the need to reduce ``risk layering'' practices with 
respect to these products, such as failing to document income or 
lending nearly the full appraised value of the home. The proposal, and 
the final guidance issued in September 2006, specifically advised 
lenders that layering risks in nontraditional mortgage loans to 
subprime borrowers may significantly increase risks to borrowers as 
well as institutions.\26\
---------------------------------------------------------------------------

    \26\ Interagency Guidance on Nontraditional Mortgage Product 
Risks, 71 FR 58609, Oct. 4, 2006.
---------------------------------------------------------------------------

    The Board and the other federal banking agencies addressed concerns 
about the subprime market more broadly in March 2007 with a proposal 
addressing the heightened risks to consumers and institutions of ARMs 
with two or three-year ``teaser'' rates followed by substantial 
increases in the rate and payment. The guidance, finalized in June, 
sets out the standards institutions should follow to ensure borrowers 
in the subprime market obtain loans they can afford to repay.\27\ Among 
other steps, the guidance advises lenders to (1) use the fully-indexed 
rate and fully-amortizing payment when qualifying borrowers for loans 
with adjustable rates and potentially non-amortizing payments; (2) 
limit stated income and reduced documentation loans to cases where 
mitigating factors clearly minimize the need for full documentation of 
income; (3) provide that prepayment penalty clauses expire a reasonable 
period before reset, typically at least 60 days.
---------------------------------------------------------------------------

    \27\ Statement on Subprime Mortgage Lending, 72 FR 37569, Jul. 
10, 2007.
---------------------------------------------------------------------------

    The Conference of State Bank Supervisors (CSBS) and American 
Association of Residential Mortgage Regulators (AARMR) issued parallel 
statements for state supervisors to use with state-supervised entities, 
and many states have adopted the statements.
    The guidance issued by the federal banking agencies has helped to 
promote safety and soundness and protect consumers in the subprime 
market. Guidance, however, is not necessarily implemented uniformly by 
all originators. Originators who are not subject to routine examination 
and supervision may not adhere to guidance as closely as originators 
who are. Guidance also does not provide individual consumers who have 
suffered harm because of abusive lending practices an opportunity for 
redress. The new and expanded consumer protections that the Board is 
proposing would apply uniformly to all creditors and be enforceable by 
federal and state supervisory and enforcement agencies and in many 
cases by borrowers.

V. Legal Authority

A. The Board's Authority Under TILA Section 129(l)(2)

    The substantive limitations in new proposed Sec. Sec.  226.35 and 
226.36 and corresponding revisions proposed for existing Sec.  226.32, 
as well as proposed restrictions on misleading and deceptive 
advertisements, would be based on the Board's authority under TILA 
Section 129(l)(2), 15 U.S.C. 1639(l)(2). That provision gives the Board 
authority to prohibit acts or practices in connection with:
     Mortgage loans that the Board finds to be unfair, 
deceptive, or designed to evade the provisions of HOEPA; and
     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.
    The authority granted to the Board under Section 129(l)(2), 15 
U.S.C. 1639(l)(2), is broad both in absolute terms and relative to 
HOEPA's statutory prohibitions. For example, this authority reaches 
mortgage loans with rates and fees that do not meet HOEPA's rate or fee 
trigger in TILA Section 103(aa), 15 U.S.C. 1602(aa), as well as types 
of mortgage loans not covered under that section, such as home purchase 
loans. Nor is the Board's authority limited to regulating specific 
contractual terms of mortgage loan agreements; it extends to regulating 
loan-related practices generally, within the standards set forth in the 
statute. Moreover, while HOEPA's current restrictions apply only to 
creditors and only to loan terms or lending practices, TILA Section 
129(l)(2) is not limited to creditors, nor is it limited to loan terms 
or lending practices. See 15 U.S.C. 1639(l)(2). It authorizes 
protections against unfair or deceptive practices when such practices 
are ``in connection with mortgage loans,'' and it authorizes 
protections against abusive practices ``in connection with refinancing 
of mortgage loans.''
    HOEPA does not set forth a standard for what is unfair or 
deceptive, but the Conference Report for HOEPA indicates that, in 
determining whether a practice in connection with mortgage loans is 
unfair or deceptive, the Board should look to the standards employed 
for interpreting state unfair and deceptive trade practices acts and 
the Federal Trade Commission Act, Section 5(a), 15 U.S.C. 45(a).\28\
---------------------------------------------------------------------------

    \28\ H.R. Rep. 103-652, at 162 (1994) (Conf. Rep.).
---------------------------------------------------------------------------

    Congr