Fed to tighten up lending rules

The central bank is expected to propose regulations that would offer greater protections for home buyers and curtail abusive lending.

The Federal Reserve on Tuesday will propose a much stricter set of rules for mortgage lenders as part of the central bank's effort to avert abusive lending.

The proposed rules are expected to crack down on lax practices in a number of ways. Among them, the rules are likely to:

Prohibit giving people unaffordable loans. One reason for the spike in foreclosures among those with subprime adjustable-rate mortgages (ARMs) was that lenders measured borrowers' ability to repay the loan based on the low introductory loan rate, but not on the higher rate that the loan would reset to. The Fed may propose that lenders base affordability on a borrowers' ability to repay a loan at the reset rate.

Restrict use of "liar" loans. The Fed is also expected to restrict the use of so-called "liar loans" or "stated income loans." When lenders make such a loan, they don't verify the income of the potential borrower. The end result: home buyers end up with homes they never could afford in the first place, let alone when their rate resets.

Prohibit or limit prepayment penalties. Homeowners who want to refinance into a more affordable loan are often prevented from doing so because of a punitive prepayment penalty - which can amount to the equivalent of six months of mortgage payments.

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