New Truth in Lending rules approved in 2008 by the Federal Reserve should foster more responsible mortgage lending and give consumers additional protection from predatory mortgages. The combination of tougher regulations and stronger consumer rights are also designed to help prevent a future credit-based housing crisis, but consumers will have to demonstrate greater responsibility when it comes to borrowing for a home. They must come to the table with documented evidence they can truly handle the costs of homeownership.

HOEPA was enacted in 1994 to target abusive practices in home equity lending -- second mortgages. The new rules, an amendment to Regulation Z (Truth in Lending), extend HOEPA-like rules and consumer protections to home acquisition mortgages -- first mortgages, and especially subprime loans. To some extent, the new rules effectively codify actions that risk-adverse lenders have already instituted. The stiffer underwriting actions by lenders have been designed to shore up portfolios battered by questionable home loans largely blamed for both the economy's credit crunch and the bust in the housing sector.

Lenders have until October 1, 2009 to fully comply with rules that will keep lenders from backsliding once the market improves. Most of the new rules apply only to higher-priced mortgages -- mortgages that have higher interest rates due to a borrower's poor credit, low down payment, or jumbo loan amount. Here are the key regulatory provisions and how they impact consumers.

Stricter Screening and Repayment Analysis

Lenders are prohibited from making home loans without regard to borrowers' ability to repay the loan from income and assets other than the home's value. Compliance requires a lender to assess repayment ability based on the highest scheduled payment in the first seven years of the loan.

This forces lenders to more closely scrutinize a borrower's debt-to-income ratio, looking for less debt, more income and savings, larger down payments and other liquid assets the borrower can fall back on if necessary. Lenders today already want to see sound financials from consumers applying for mortgages.

Consumers will now have to take more time to save larger down payments, pay off more debt, and maintain a pristine credit report for longer periods before buying a home.

More Documentation Required

Lenders must now verify income and assets used to determine repayment ability. Many so-called "no-doc" loans -- loans granted without documenting qualifying financial information -- are already history. Consumers can no longer just pencil in an arbitrary income amount, but must solidly document income and assets and their source as well as the viability of the numbers and the source. That means longevity on the job and more time holding assets.

This provision especially squeezes home-based business owners, self-employed people, contract workers, and others who don't get a regular pay stub. Lenders already ask many of these borrowers for a certified public accountant's or other tax professional's certified profit and loss statement to reveal income viability. A tax return is often no longer sufficient proof.

New Rules on Prepayment Penalties

Prepayment penalties that often came with low-initial cost and subprime loans were common before and during the housing boom. The exorbitant penalties had to be paid by borrowers who wanted to refinance or sell the home after holding the mortgage only a few years. Homeowners were often compelled to refinance because the same loans that came with prepayment penalties also could be negatively amortizing mortgages or loans with a balloon mortgage payment that warranted escape. However, with penalties so high -- equal to interest payments for six months -- they locked borrowers into an unaffordable loan, even when a more affordable loan was available.

The new rules ban prepayment penalties on some loans from changing in the first four years. On other loans, the new rules prevent a prepayment penalty period from lasting for more than two years. That is, after the two-year period, the borrower is free to refinance or sell the home without penalty.

With the new prepayment penalty restrictions, lenders will offer a narrower variety of loans, forcing many consumers out of the market and other consumers to spend more time shopping around. Shopping around, of course, is a smart practice.

Escrow Accounts for Principal and Interest

Lenders must now establish escrow accounts for property taxes and homeowners insurance on all first mortgage loans. That means the full mortgage payment will include not only principal and interest, but also taxes and insurance (PITI).

Up to now, most lenders required escrow accounts only when the buyer put down less than a 15-20% down payment. This provision won't be phased in until 2010, but it's probably a better approach to paying these housing costs than the gamble many homeowners use. Homeowners will have these costs spread out over 12 monthly payments rather than struggling to pay large insurance and tax bills in one lump sum; this should make the monthly cost of home ownership more self-evident before the loan closes.

Where to Find More Information

Additional highlights of the final Federal Reserve rules that amend the home mortgage provisions of Regulation Z (Truth in Lending) can be found on the Federal Reserve website.

For more information on researching, choosing, and qualifying for an affordable mortgage, see Nolo's Essential Guide to Buying Your First Home , by Ilona Bray, Alayna Schroeder, and Marcia Stewart (Nolo).