Stricter Guidelines for Sub Prime Loans

[May 28, 2008.]

 

In an effort to counter act the trend of payment delinquencies and foreclosures the Federal Reserve has suggested a new set of guidelines directed at sub prime lenders.

Sub prime loans are used for high risk borrowers who may otherwise not be eligible for a mortgage loan. The most common of the sub prime loans is the adjustable rate mortgage loans or (ARMs).

These types of loan will fluctuate according to current interest rates. Bad credit loans use the ARMs as a way to entice high risk borrowers into an agreement that, at first, features a very low interest rate. However, after the adjustment period the interest rate will rise often times to an amount that the borrower simply can not afford. This has led to countless foreclosures and is believed to be one of the main causes of the current house market slump.

The Federal Reserve would like to see stricter guidelines used when determining the eligibility of the borrower. Critics have stated that if the Federal Reserve's guidelines were to be formally adopted then fewer borrowers would be approved. However many federal regulators claim that such guidelines are needed to help balance the current crisis.

Among stricter eligibility guidelines, the Federal Reserve would like to see that lenders disclose more information to potential sub prime borrowers about the benefits and risks of that type of loan.

Freddie Mac seems to be leading the way in following the Federal Reserves wishes as it will no longer purchase sub prime loans that they determine to present a risk.

While the new Federal Reserve guidelines are not yet formally in place many lending companies are expected to adopt them in hopes of staving off further economic downturn that may lead to a recession.

These guidelines are expected to be in place soon and will dramatically change the way sub prime lending is done.