The prohibition on prepayment penalties, part of a broader Fed response to the collapse of the subprime mortgage market, targets high-cost loans with interest rates that reset in the first four years, the person said. Rules also would limit charges when borrowers seek to pay off mortgages in the first two years on other types of high-priced loans, the person said.
The Federal Reserve Board of Governors will vote July 14 on a series of rules to strengthen protections for borrowers taking out subprime home loans. Lenders use prepayment penalties to discourage borrowers from refinancing their loans and can trap borrowers in loans they can't afford, consumer advocates said.
``This is a move in the right direction but still falls short of what consumer groups have advocated which is an outright ban on prepayment penalties for all subprime and non- traditional mortgages,'' Allen Fishbein, director of housing and credit policy at the Consumer Federation of America, said yesterday in a telephone interview.
Banks and their trade groups said prepayment penalties let borrowers pay lower interest rates and make mortgage-backed securities more valuable to investors.
Dodd Pressed Fed
Senate Banking Committee Chairman Christopher Dodd has pressed the Fed for a set of lending rules based on a 1994 law that protects consumers in mortgage lending. This led the Fed to propose the mortgage rules in December as foreclosures reached record levels.
The initial draft limited penalties when borrowers sought to pay off their loans early, required the escrow of taxes and insurance and banned loans made without verification of income or assets.
The Fed's proposal covers all high-cost mortgages, which are defined as loans with rates at least 3 percentage points higher than a comparable Treasury security for first mortgages, and 5 percentage points for second loans, or home-equity loans.
Dodd had criticized the Fed for not going far enough in its proposal in addressing prepayment penalties when the central bank proposed its rules.
``It raises serious questions as to whether the Federal Reserve is the appropriate institution to house consumer- protection functions,'' Dodd, a Connecticut Democrat, said in a December statement.
Fed Chairman Ben S. Bernanke told the House Financial Services Committee on July 10 that the rules would be ``effective'' at addressing lawmakers' concerns.
``It would be better if it had been earlier, but we have responded,'' Bernanke said.
The rules are part of the Fed's push to bolster consumer protections following criticism from Congress that the agency had neglected to assert its authority and let borrowers fall victim to abuses in mortgage and credit-card lending.
In May, the Fed proposed rules to prevent ``unfair and deceptive'' credit-card lending by limiting fees and interest- rate increases. House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, had prodded the agency to use its authority under the Federal Trade Commission Act to ban ``unfair or deceptive acts or practices.''
Separately, the Fed in May proposed rules to require creditors to offer consumers risk-based pricing notices for credit cards and mortgages when the terms are less favorable than those for other customers.
Foreclosure filings increased 53 percent in June from a year earlier, and bank seizures grew the most on record as deteriorating property values and higher rates on adjustable mortgages forced more people to give up their homes. One in 501 U.S. households entered the foreclosure process, RealtyTrac Inc., a seller of default data, reported on July 10.