If you're looking for ways to tap your home equity for quick cash in 1981, second mortgages or deeds of trust could be an efficient way to do it. But watch out for a trend that state financial regulators say is growing around the United States: rate-gouging of unsuspecting consumers by small-scale second-mortgages lenders.
One of the most extensive investigations of the problem was conducted recently in Connecticut. The state banking department there studied the 1980 loan activities in 114 of Connecticut's 400 licensed second-mortgage brokers and turned up an eye-opening variety of techniques used to boost effective annual loan rates to the 30 percent level or even higher.
Investigators found dozens of cases where homeowners thought they had gotten a $10,000 to $20,000 second mortgage at 17 percent or 18 percent -- the rate prevailing in the market at the time -- but in reality the rate had been boosted to nearly double that by nonrefundable brokers' fees, prepaid "bonuses" and discount points.
Banking Commissioner David H. Neiditz says one $17,000 second mortgage the study turned up in the city of Bridgeport, carried an 18 percent interest rate plus $5,476 in "points" to the lender and $1,020 in loan-brokerage fees.
The homeowner-borrower ended up with only $10,504 of the contracted $17,000 in his pocket and paid an effective annualized rate of 34 percent for his funds.
Other more common cases involved brokerage fees and point totaling 14 percent to 20 percent of the loan amount -- raising the effective annual charge to consumers to 26 percent and higher.
Some of the up-front fees quoted by brokers were clearly understood by consumers to be "refundable" upon repayment of the debt, according to Neiditz. But in fact, they were usually only refundable if the loan was paid off at the end of its term -- five years or more from the date the money was disbursed. The fees were forfeited automatically if borrowers paid off the debt earlier -- which happens to be what most homeowners prefer to do when they take out a second loan on their property.
Connecticut investigators emphasized that the abuses they documented were rare among major, nationally known second-mortgage firms operating in the state, particularly those involved in consumer finance. Firms like these tend to avoid "points" or large brokerage fees and charge annual, simple-interest rates that currently average about 18 percent.
Neiditz now pushing for state legislative and regulatory reform that will set limits on the amount of upfront fees and charges that can be assessed by mortgages lenders, and he hopes for action from the legislature some time this year.
Regulation of the burgeoning second-mortgage market varies widely from state to state but often consists of little more than firms and individual money lenders filling out pro-forma applications from state banking departments. They are then free to advertise loans and terms in major newspapers with little real supervision. California regulates its second-trust-deed lending industry relatively closely, but most states don't look hard at equity lenders until consumers complain, as they did in Connecticut.
Data compiled by the National Consumer Finance Association suggest that home "equity loans" have turned into a $12 billion-per-year business nationwide, up from an estimated $2 billion to $3 billion in the mid-1970's.
Homeowners strapped for funds to pay college education bills or to make investments have turned increasingly to their own homes, whose equities have ballooned with inflation. They take out second (or even third) loans secured by their house, converting unused wealth into immediate purchasing power.
Although the overwhelming bulk of second trusts and mortgages available in the commercial marketplace probably conform to state guidelines on maximum interest rates, unscrupulous lenders find it easy to mislead borrowers with placement fees, point, brokerage add-ons and similar techniques.
Consumers often "hear the interest rate, and that's all they care about," says the head of an equity-loan brokerage firm based in Northern Virginia. "But the ball game is in those fees," in his words. "A 17 percent loan with $5,500 in brokerage fees tacked on it may be a 35 pecent loan -- but an individual broker doesn't necessarily always explain it that way when nobody's watching very closely."
Under Virginia and federal law, the broker is required to disclose the effective annual rate. And that seems to be the key to the whole problem, whether it's in Connecticut, Florida, New York, Texas or California. Until state regulators crack down on the rip-off artists in the second-mortgage field, borrowers will have to keep their eyes fixed on the bottom line -- and remember to factor fees and points into annual interest costs.