Texas Comptroller Carole Strayhorn

Home Equity Credit Lines a Potentially Bad Idea (April 2003).
by Dara Pollicoff

A recent proposal by Texas Comptroller Carole Strayhorn to allow home equity lines of credit in Texas raises concerns about expanding home equity lending without addressing existing problems first. (See: http://www.window.state.tx.us/
specialrpt/homeeqty03/).

Nationally, subprime lenders make about 20 percent of all home equity loans as compared to 30 percent in Texas. These lenders often target minorities, the elderly, and people with blemished or limited credit histories. Subprime loans carry a higher rate of interest than standard loans.

"There is a danger that expanding home equity to include line of credit loans would expand the abuses that exist in the market," said Rob Schneider, senior staff attorney with Consumer Union's Southwest Regional Office. "For example, though Texas caps fees for home equity loans at 3 percent of the loan, this does not include fees that are termed 'interest,' like discount points. We see high fees added to loans for many consumers, and we need to focus on fixing this and other abuses in the market first."

Currently, Texas only allows home equity loans as a lump sum. Since 1998, Texas law has allowed homeowners to borrow a loan in a lump sum and repay it in monthly installments with low fixed interest rates. Combined with their first mortgage, homeowners can only borrow a maximum of 80 percent of the fair market value of their house.

Consumers who take out home equity loans run the risk of foreclosure if they miss payments. Safeguards in the law help to protect against this, but many of those safeguards have not worked as originally envisioned. The risk of taking out home equity lines of credit may be higher because of a variable interest rate.

Home equity lines of credit loans differ from lump sum loans in that lenders approve a loan for a borrower up to a certain limit. The homeowner can then borrow only as much as he needed at any one time.

"While lines of credit loans can be a good thing for some consumers," Schneider said, "lenders have yet to acknowledge that serious problems exist that need to be fixed first before we can move on."

For example, the 3 percent cap fee on home equity loans is easily avoided and does not include discount points or origination fees. Sometimes lenders insert credit insurance and other high cost add-ons.

"You see 12 percent loans with 10 discount points added," Schneider said.

Schneider opposes the legislation until legislators take steps to correct problems in the existing home equity market, including loans made by subprime lenders.

"A significant chunk of interest is going to these high-cost lenders, so it's not going to buying groceries or saving for the future," Schneider said. "We need to address the predatory practices that have emerged in the market so we don't end up accidentally expanding the number of victims by adding new kinds of home equity loans."

SJR 52, introduced by Sen. Royce West, D-Dallas, proposes to do just that by limiting fees charged to home equity loan borrowers and prohibiting certain predatory practices.

"That's the one we like," Schneider said.