March 1997

Rich House, Poor House:
The Two Faces of Home Equity Lending

This article was written by the Consumers Union Southwest Regional Office.

Recommendations for Texas

Many states have enacted legislation to protect consumers, by limiting interest rates, points, fees, and other charges, prohibiting unfair contractual provisions and unfair practices, and by providing remedies to consumers who are harmed from abusive lending practices. Although a variety of federal laws limit state regulation of equity lending, several options remain open for Texas.

At the time a consumer borrows, the law should ensure:

• that the lender offers terms and conditions the borrower can reasonably be expected to fulfill;
  Prohibit (as a deceptive trade practice) loans where there is no reasonable expectation that a person will be able to repay the note. Consumers should be protected from unfair and deceptive actions on the part of lenders, but currently the definition of a "consumer" under DTPA does not clearly include consumers of financial services. Amend the DTPA to define lending as a service. This will clarify that borrowers are consumers of "goods and services" under the scope of the Act.
• loan fees for home equity loans and interest rates on loans secured by secondary liens are reasonable;
  Texas may still opt-out of federal preemption related to the costs associated with loans, and federal preemption of laws capping interest rates applies only to loans secured with first liens. Texas should limit loan fees and other costs associated with home equity loans to no more than 3% of the total amount of the loan, and limit interest rates on loans secured by second (or lower priority) liens to 6% above the treasury bill rate of comparable maturity period. The legislature should also prohibit lenders from refinancing old notes into a new first lien in order to circumvent these interest rate caps. Points, fees and charges should be limited to three percent of the principal amount, and should in all cases be reasonable. Alternatively, it may be possible to circumvent the federal pre-emption problem. Home equity loans are substantially more secure than unsecured loans or loans secured with other forms of collateral. These limits on rates and fees gives lenders adequate flexibility to loan money to higher risk borrowers and still profit from the loans.
• borrowers have adequate notice of right to reject the loan within three days (including the right to a full refund), and of their additional cooling off period with limited refund rights.
  Federal law gives consumers three days to consider the loan terms and get a full refund of all fees paid (including fees paid to third parties) if they reject it. An additional twelve day cooling off period should be created for borrowers to cancel and lose only the payments to third parties. These cancellation periods must be clearly disclosed, including the consumer's right to a full refund of all payments within the first three days.

In the event of default, the law should ensure:

• that consumers can pursue lenders under the DTPA for abusive lending practices;
  If a lender's action results in a gross disparity between the value received by the borrower and the consideration paid, the consumer should be able to file a claim against that lender.
• foreclosures will be governed by the courts through a judicial foreclosure process;
  Require lenders to use a judicial foreclosure procedure for all mortgages and deeds of trust. As the system currently exists it is difficult for the borrower to assert counter claims against the lender if the loan was unfair or deceptive once the home enters foreclosure. Judicial foreclosure allows counterclaims to be made against the lender, such as claims involving fraud, unfair practices, or other mishandling of a home equity loan.
• borrowers will have adequate time to pay the past due amount before the lender initiates foreclosure;
  Create a six month "right to cure" or pay up the past due amount and regain control of the home. Provide general notice of this right in the contract, and specific notice to the borrower upon default with the specific amount needed to cure the default. A six month "right to cure" period would enable many borrowers to get back on their feet and save their home, or sell it for an adequate price necessary to pay off the loan.
• borrowers who lose their homes can redeem them by paying the lender the amount of the successful bid at foreclosure within a one year period after the foreclosure sale;
  A redemption period after the sale gives borrowers additional time to arrange repayment without damaging the position of the lender, who is made whole in the end. Borrowers who have made substantial payment on the loan should be granted extra time to redeem the home.
• subsequent purchasers of loans will be subject to all claims and defenses of the original lender;
  This would lead subsequent purchasers to review carefully the practices of those from whom they buy equity loans and would give borrowers the ability to raise legitimate claims about the loans.
• borrowers may access a centralized Home Equity Consumer Complaints Hotline.
  Currently, consumers who wish to complain about their home equity lender or broker must determine which of several federal or state agencies regulates their lender. Consumers with unregulated lenders have no agency to call. All consumer complaints related to home equity loans should be consolidated into a single home equity loan hotline. Consumers will be better served, and regulators will be better able to assess the implementation of this new law, if all complaints enter and are handled by a single agency.

To ensure fair treatment of all credit customers:

• create the Office of Access to Financial Services;
  Independent public counsel offices have been highly successful in representing Texas consumers before utility and insurance regulators. With modest budgets and staffs, the public counsels have saved Texas ratepayers millions, while providing a voice to balance the interest of the well-funded and well-represented regulated industries. The presence of a technically trained and focused public advocate allows regulators to make balanced and reasoned decisions after reviewing both the industry's and consumers' recommendations. Consumers need similar representation in the area of financial services, especially as more consumers risk their homes through the expansion of home equity lending.
• direct the Office of Access to Financial Services to study home equity lending;
  The Office of Access to Financial Services can become a clearing house for data and analysis of home equity lending as it takes hold in this state. The Office should be authorized to collect annual disclosures by home equity lenders and brokers of their equity loan activity (including programs offered by lenders in different neighborhoods compared to the race, ethnicity, income, and other factors of such neighborhoods). Such annual reports should be public, just as insurance company statutory annual statements or federal CRA data is public. The Office shall review the data and release an annual report on issues in Texas home equity lending, and recommend regulatory or legislative action and draft proposed rules to protect consumers.

  Consumers of financial services have few options for independent advice on the complex terms and conditions of a loan contract. Consumers considering home equity loans who want additional information about their rights and the suitability of the loan should be allowed to call the Office of Access to Financial Services for direct borrower counseling.

• eliminate "reverse redlining" by requiring banks to offer life line accounts and creating CRA-style reporting requirements for all lenders in the home equity market;
  Reverse redlining occurs when low-income and minority areas are targeted for high cost loans. As we expand access to home equity loans, Texas must develop additional information about the prevalence of reverse redlining in this state, require independent analysis of the data including recommendations for change, and encourage mainstream banks to provide low cost checking to low income families to encourage greater lending to these customers.
• require banks to offer "lifeline" checking accounts.
  Texans who remain segregated from mainstream banking services will always be vulnerable to finance companies, unregulated mortgage companies and others who offer them high cost loans. Over the past two decades the costs associated with a regular deposit account and ordinary checking have increased, while the proportion of the population with a regular bank account has decreased. The number of Texans who are defrauded by fringe lenders may decrease substantially if more families have access to regular, and regulated, banks through low cost "lifeline" checking accounts with low minimum balance requirements and low fees.

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