Fed proposes mortgage rules to protect borrowers

By Patrick Rucker and John Poirier

WASHINGTON (Reuters) - Lenders will have to confirm that a borrower can afford a mortgage before making a loan under protections proposed by the Federal Reserve on Tuesday, following defaults and losses on U.S. subprime mortgages this year.

The proposals are intended to replace loose lending standards that have put many Americans at risk of losing their homes because they took out mortgages they could not afford and may not have fully understood.

The new rules will not assist today's struggling homeowners but would give consumers the right to sue mortgage lenders who act unfairly and deceptively in preparing loans in future.

Millions of Americans who bought homes in recent years face the risk of foreclosure as mortgages with initial "starter" interest rates are reset with sharply higher rates in coming months.

The Fed's board of governors unanimously approved the standards recommended by its consumer rights staff and said they strike a balance by protecting consumers while preserving their access to credit.

"These new rules, once adopted, would apply to all mortgage lenders," Fed Chairman Ben Bernanke said as the board met to consider the proposals. He said the rules would be "consistently applied and vigorously enforced" by state and federal regulators.

The new rules would put the nation's 50,000 mortgage brokers under some federal supervision, according to Fed staff.

The plan also states that lenders who are found to be "engaging in a pattern or practice" of offering unaffordable loans would run afoul of the rules.

The proposal was criticized by several leading lawmakers and praised by an industry group.

The Fed has been faulted for failing to use all its consumer protection authority during the housing boom that ended in 2005, and lawmakers are threatening to take back some of those powers.

The proposed regulations would require that lenders confirm a borrower can afford a home loan by verifying his income and assets with tax records, payroll receipts, and other documentation.

The new rules are aimed at ending the recent practice of so-called "stated income" loans in which borrowers state their income without any evidence.

The proposals would also limit the penalties imposed when a borrower pays off a home loan early. No "prepayment penalty" would apply, for instance, if a loan is refinanced less than 60 days before its interest rate resets higher.

The proposed rules also require that borrowers receive details of their brokers' compensation and be billed monthly for annual charges, such as property tax and insurance, that are placed in escrow.

The Fed plan also contains sweeping new standards for home appraisers and targets abusive practices by loan servicers.