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by Rob Schneider
Senior Staff Attorney
Consumers Union Southwest Regional Office
I am Robert Schneider, Senior Staff Attorney for the Southwest Regional Office of Consumers Union.* I am here today on HB 447 and HJR 44.
Consumers Union is generally supportive of home equity borrowing in Texas, but only if sufficient consumer protections are in place. We appreciate the efforts made in HB 447 and HJR 44 to put in place consumer protections, but we believe additional protections are needed to prevent unnecessary hardship on consumers.
Our publication, Consumer Reports, has published numerous articles on the best ways for consumers to borrow money. We recognize the benefits associated with home equity borrowing, but we have repeatedly warned consumers about the dangers sometimes found in these loans. Our office in Texas is directed to represent the interests of consumers, and especially low-income consumers. Often, it is low income consumers who face the worst abuses in the home equity lending market.
Low Income Consumers Lack Equal Access to Mainstream Financial Services
Increasingly, mainstream financial services have become less available to low income consumers. Throughout the 1970s and 1980s the number of households without bank accounts, and therefore without direct access to the payment and credit services of mainstream financial institutions, increased. In 1977, 9.7 percent of families did not have a bank account. By 1989 the share of households without a bank had increased to at least 13.5 percent. According to a 1988 GAO study, as many as 17 percent of families did not have a bank account by the end of the eighties.
While higher low balance fees, bounced check fees, and withdrawal fees have made accounts less affordable, recent studies of bank representation in low income and minority areas confirm that banks withdrew from certain lower income and minority areas by closing branches in some cities. Particularly in Texas, the number of branch banks in low income and minority zip codes decreased significantly between 1985 and 1993, according to a recent Texas A&M study. Using data for branch bank and savings and loan locations in Texas, researchers found that the number of branch banks in high income zip codes statewide (the highest income quartile zip codes) remained constant over this period, but declined by 11 percent for low income zip codes (the lowest income quartile areas). Further, predominantly white zip codes statewide experience a 4 percent increase in the average number of branches, while minority zip codes experienced a decline of over 10 percent.
As traditional banks moved out of low-income areas, alternative lenders, including pawn shops and finance companies, moved in. Beginning in the mid 1970s, so-called fringe banking services (finance companies, pawn shops, check cashing services) began to grow throughout the country. By the close of the eighties non-bank lenders accounted for nearly 30 percent of traditional (closed end) home equity lending, and served borrowers with lower income levels and less equity in their homes. According to the 1993-94 household survey, the average family income of home equity borrowers at finance companies was $46,000, compared with $59,000 at commercial banks and savings institutions. Finance company borrowers also typically had less home equity than depository institution borrowers: $39,000 compared with $97,000.
Lower income borrowers served by finance companies are frequently offered a closed end loan--for a preset amount over a contracted term--at higher than standard interest rates, even though studies indicate that lower income consumers do not default more than higher income borrowers. According to the 1994-1995 Factbook of the Mortgage Insurance Companies of America, "Studies show that when low- and moderate income people have the opportunity to own a home, they will go to great lengths to pay their bills on time. MICA data shows that families who buy less expensive homes tend to default less than those who buy more costly homes." A 1993 study examining the performance of community reinvestment loans also came to a similar conclusion.
Benefits of Tax Deductibility of Interest on Low-Income Consumers
While low income people who borrow from non-bank lenders frequently pay higher interest rates, they typically do not itemize their taxes, so they gain little benefit from the deductibility of their new debt. Only 18.2 percent of Texas filers take any tax deductions currently, and only 15.7 percent deduct interest. Low and moderate income Texans rarely deduct interest (7.2 percent of filers earning less than $50,000 deduct interest, and only 3.4 percent of filers earning under $30,000 deduct interest).
Although increased access to home equity loans might encourage more Texans to deduct, the overall numbers of low and moderate income people who choose to do so is likely to remain low. Although every state but Texas allows greater home equity lending, national tax statistics confirm that the tax benefits fall mostly to upper income families. Nationally, while 29 percent of all taxpayers deduct, only 13.5 percent of filers earning less than $50,000 deduct mortgage interest, and only 6.5 percent of those earning less than $30,000 deduct mortgage interest.
Home Equity Abuses Disproportionately Affect Low-Income Consumers
Public hearings before the U.S. Senate Committee on Banking, Housing and Urban Affairs in 1993 and 1994 brought problems in home equity lending to the front pages of the nation's newspapers. Estimates in the early 1990s indicated that more than 100,000 homeowners in 20 states nationwide lost most or all of the equity in their homes because of home repair and home equity lending fraud.
Many consumers testified to fraudulent marketing practices that saddled them with much larger loans than they needed for their purchases. Mr. D., 95, and his wife Doris, 82, lived in Los Angeles on a small fixed income. Mr. D. had no formal education was mentally incompetent. With the help of a loan broker, the couple consolidated and refinanced credit card debt, existing home improvement loans and a new bathroom under a new $30,000 home improvement loan. The couple only needed $15,000, but the broker kept the rest for brokerage fees. By the end of the process, Mr. and Mrs. D. had liens on their home totaling $92,000 and a new loan they could not afford to pay. The lender foreclosed.
Though they were able to save their home with legal help, most of those testifying before the Congressional committee were not. One woman who lost her home closed her testimony by saying, "I hope that the United States Congress can do something to protect people like me whose only mistake was to trust people who sounded honest."
Lawsuits have been filed in more than 21 states against lenders associated with fraudulent home equity loans. One of the largest and most publicized settlements involved Fleet Finance of Georgia. In December of 1993, the company agreed to a settlement of up to $115 million for allegations from 18,000 borrowers. Jury verdicts in Alabama against Union Mortgage reached $57 million in 1991; a Ford subsidiary paid nearly $3.4 million to settle claims in Arizona, and Chrysler First, a subsidiary of NationsBank, had jury verdicts in Alabama reaching $2.15 million.
Financing Based on Value of Equity, Not Ability to Repay
One theme common in many home equity scams is that the loan is made not on the ability of the borrower to repay it, but on the underlying value of the equity in the home. Though regulators of depository institutions are likely to object to such types of loan underwriting because of solvency concerns, non-depository institutions have no corresponding solvency regulation.
An abusive loan may be structured so that the loan payments are "affordable" even though the person may a fixed or low-income that would have disqualified the person from a bank loan. In such situations, the loan may negatively amortize, meaning the interest and principal are not paid down, and the principal actually increases, resulting in a balloon payment that the borrower may be unable to repay. This may result in foreclosure or refinancing, again with negatively amortized terms.
Home Equity Abuses Already Exist in Texas
Predatory second mortgage lending in Texas occurs despite Constitutional protections, because Texans may already use their home as security for home improvement loans. In a national survey of Legal Aid attorneys conducted by the non-profit consumer organization Public Citizen, the Texas office had the largest number of home equity lending scams relative to other states surveyed. One Dallas legal aid office reported 764 home-improvement-related cases of second mortgage lending fraud over a five year period.
According to plaintiff's attorneys and lawyers with the Attorney General's Office, home equity lending fraud proliferated during the economic downturn of the mid- to late- eighties. Typically, loan brokers and contractors solicited elderly and low income consumers in their homes, offering pre-approved loans for siding, home repairs, and other work and sometimes offering to rebate cash back to the borrower. A short time later, these homeowners found themselves deeply in debt, with high interest loans and repayment terms they could not afford, while the contractors walked away from unfinished or poorly finished jobs.
Between 1988 and 1990, consumers in both Travis county and Dallas county sued Goldome Credit Corporation after the lender attempted to foreclose on their homes. According to the complaints, Goldome Credit offered home improvement loans in excess of the value of the work, and then foreclosed on the homes even if the work had not been completed as promised. In one case, Goldome allegedly initiated foreclosure even though the consumer had already repaid the debt in full.
Specific Examples of Home Equity Lending Abuses in Texas
Green Tree Financial Corporation
In the spring of 1990, Apollo Industries, a home improvement contractor, solicited 75 year old Sallie Mae Ware repeatedly at her home in Dallas. According to court filings, the company told Ms. Ware that it helped older, low income families make repairs to their homes that they would otherwise be unable to afford, and offered cash bonuses to those homeowners who hired Apollo for such repairs. Ms. Ware, who had not considered home repairs until this solicitation, signed a contract for roofing work, storm door installation and storm windows. Apollo charged her $14,000 for these repairs and asked her to sign a note, assigned to Green Tree at the time of its execution, at an interest rate of 15.5 percent (APR) payable in ten years for total payments of nearly $28,000.
According to the complaint, Green Tree allegedly sought out Apollo and in 1989 entered into a contract under which Apollo assigned all its retail installment contracts to Green Tree. Green Tree sent Apollo to solicit home repairs. When Mrs. Ware agreed to home repairs with Apollo, Green Tree required Ms. Ware to grant it a first lien on her home, in violation of the Consumer Credit Code which prohibits the grant of a first lien to secure a retail installment contract. Ms. Ware, living on a fixed income from social security of less than $13,000 annually and supporting two minor children, made the monthly payments of $233.15 as required, but Apollo completed the work in a shoddy way using defective materials. Ms. Ware's roof warped and the wood beneath rotted, requiring new repairs. Mrs. Ware sought legal assistance from the Southern Methodist University School of Law Civil Clinic and sued Green Tree. Green Tree settled the case out of court.
The Longoria Case
Arthur and Alice Longoria of Travis County purchased siding for their home, and allowed the contractor to attach a second lien to secure a $10,496 loan. However, according to documents filed in the case, the Spanish speaking couple did not understand that they had risked their home for the improvements. Mr. Longoria, who cannot read, did not understand the term "mechanics and materialman's contract." "I did not know when the contract was signed that it meant someone could take my home," he stated in court documents. According to the complaint, the siding was defective and the work inferior. When the couple stopped making payments on their loan, Goldome foreclosed. Unfortunately, they were unable to pursue their grievance through the sometimes lengthy legal process and in 1989 they withdrew it.
Major Funding Corporation
In 1985, the Texas Attorney General filed suit against a lender, Major Funding Corporation, alleging conspiracy with a number of contractors to deceive consumers and evade the protections of the Homestead Act. Major Funding purchased contracts providing for liens on consumers' homes. The contracts were inappropriately procured by Major Funding's agents, and the contractors never finished or only partially completed the home improvement work as promised.
According to the complaint, contractors solicited homeowners through advertisements in Houston newspapers and TV guides. The ads claimed that homeowners could qualify for cash loans, typically in the amount of $3,000. When homeowners responded to the ads, they were instructed to sign loan documents for the purchase of a burglar alarm system. Valued at more than $8,000 on the loan documents, the burglar alarms were available in local retail stores for $300. "The forms signed by the consumers list a cash price of between $8,800 and $9,800 payable over 120 months at 18% per annum interest, for a total sale price of between $19,292.40 and $21,486.00," the state alleged. "A lien in the amount of the total sales price was placed on the consumer's homes. The contract forms do not reflect the $3,000 cash loans to the consumers." Major Funding carried the notes and liens on Houston homes.
The attorney general settled the suit in 1990. By the end of the settlement process in 1993, 1,196 Houston area homeowners received $4.8 million in restitution and many home owners were saved from foreclosure.
The Rivas Case
In 1985, Maria Rivas of Lockhart signed a retail installment contract for home improvements costing $7,200.40, including a $1,250 premium for credit life insurance. The loan payments, at 15.25% (APR) totaled $12,504 over 96 months. At the time she signed the contract, which was secured by a lien on her home, she owned the home outright.
As a nurse's aid, with two children and a monthly income of just over $400 per month, Ms. Rivas soon dropped behind in her new payments. Goldome initiated foreclosure, although the credit code explicitly prohibits lenders from securing a retail installment contract with a first lien on a homestead.
Ms. Rivas first sought protection for her home through a Chapter 13 bankruptcy reorganization, but was again unable to maintain the required payment schedule. With the help of an attorney, she sued, and the court held in a hearing for partial summary judgment that indeed Goldome held an illegal and invalid lien. Goldome settled the case out of court, extinguished the debt and released Ms. Rivas from its claim on her homestead. Goldome also promised to refrain from foreclosure on any other home improvement contract in Texas secured under a retail installment agreement which granted a first lien on property.
Sol Construction
In 1993 the Attorney General's Office in San Antonio sued Sol Construction and two private investors. According to the fourteen individual cases cited in the complaint, the contractor charged high prices for poor workmanship and frequently failed to complete jobs while requiring certificates of completion from homeowners. The contractor sold the consumers' debts and liens to individual investors, also defendants in the case. In one instance, when the disgruntled borrower stopped paying the debt because the work was unfinished, the investor demanded payment then foreclosed, even though he knew or should have known that the contracted work had not been done. In July 1996, the 57th District Court of Bexar County entered a judgment against the investors and Sol Construction for violations of the Deceptive Trade Practices Act, and fined them $15,000 in penalties and attorney's fees.
Additional Consumer Protections Needed to Address Abuses
Limits on interest, fees and other costs of loans
By limiting the costs of equity loans, borrowers will not face excessive costs associated with abusive equity loans. The Major Funding case cited above shows why reasonable limits should be placed on equity loans. In addition excessive fees are cited as the reason many loans become excessively costly. Fees on loans should be limited. Limits on interest, fees, and other costs will also encourage lenders to scrutinize the ability of borrowers to repay, and make loans based on the person's ability to pay, rather than on the equity of the home.
Negative Amortization and Balloon Payments
Disclosure
Disclosure of the risks a borrower faces is a fundamental consumer protection. The Longoria case, discussed above, shows the importance of understandable disclosure, in the language the solicitation was made.
Reverse Mortgages
Foreclosure, Redemption, and Deficiency
Revising foreclosure procedures is critical to assure consumers are fully protected when they face the loss of their homes. All of the cases cited above demonstrate the importance of judicial foreclosure. The Sol Construction case illustrates the importance of subjecting subsequent purchasers of equity loans to the claims and defenses of the original lender.
Several common foreclosure reforms adopted in states across the country would give Texans who face foreclosure additional protection. At least 13 states require lenders to file a court action to obtain a judge's order authorizing a foreclosure sale, a process called judicial foreclosure. At least eight states allow the homeowner to redeem the home within a specified time after the sale by paying the purchase price plus interest and costs. Several states extend the time period during which the homeowner may get current (cure the default), both providing more notice and allowing the homeowner to cure the default right up to the day of sale.
In about half the states mortgages are always foreclosed by judicial action, either because of state law requirements or local custom. In judicial foreclosure states the lender must file an action in court to obtain a judicial decree authorizing a foreclosure sale. Generally the lender must prove that there is a valid mortgage, that the borrower is in default, and that the proper procedure has been followed. The homeowner then has the opportunity to raise procedural and substantive defenses, such as fraud, usury, tender of payment, or Truth in Lending violations.
Purpose of loans
Borrower's ability to repay loan
In many of the cases cited above, the lender made the loan based on the value of the equity in the home, without regard of the person's ability to repay. This increases the likelihood that that low-income borrowers may lose their homes.
Other Consumer Protection Provisions
In many of the cases cited above, the amount the borrower paid was substantially greater than the value received. This principle of gross disparity should be included in consumer protections. In addition, the Deceptive Trade Practices Act should be an avenue for relief for borrowers who are victims of illegal practices.
Lender Reporting Requirements and Access to Financial Services
Texas currently has little information about the practices of financial institutions in Texas and the availability and pricing of these services.
Conclusion
Often low-income consumers become victims of home equity predatory practices. These loans end up being high-cost and having abusive terms, sometimes resulting in people losing their homes. We appreciate the efforts made in HB 1188 and HJR 70 to put in place consumer protections, but we believe additional protections are critical to prevent unnecessary hardship on consumers. I appreciate the opportunity to provide testimony.
