WASHINGTON (Reuters) - Lenders would be required to make sure prospective borrowers have the ability to repay their mortgages before giving them a loan, under a proposal released by the Federal Reserve on Tuesday.
The rule, which is required by the Dodd-Frank financial reform law, is intended to tighten lending standards and combat home lending abuses that contributed to the 2007-2009 financial crisis.
The rule would establish minimum underwriting standards for most mortgages and lenders could be sued by the borrower if they do not take the proper steps to check a borrowers ability to repay the loan.
The law does provide protections from this type of liability if a loan meets the specific standards that are part of a "qualified mortgage."
In its proposal, the Fed is seeking comment on two possible ways of defining a qualified mortgage.
Under the first scenario the loan could not include interest-only payments, a balloon payment and regular payments could not result in the principle of the loan increasing.
Under the alternative, the loan would have to meet all the standards laid out under the first option and meet additional requirements such as having the lender verify a borrower's employment status and debt obligations.
The proposal lays out a general standard for complying with the rule, including verifying a borrowers income, their employment and the amount of debt they have.
Mortgage originators who serve rural and underserved areas would be allowed to give out loans with balloon payments.
"This option is meant to preserve access to credit for consumers located in rural or underserved areas where creditors may originate balloon loans to hedge against interest rate risk for loans held in portfolio," the Fed said in a statement.
The Fed is seeking comments on the proposal through July 22.
The final rule will be implemented by the Consumer Financial Protection Bureau, which opens its doors on July 21.
(Reporting by Dave Clarke and Corbett B. Daly; Editing by Neil Stempleman and Tim Dobbyn)