Last week's half-point spurt in the prime rate could help speed changes in the rules of the home mortgage game, particularly in the red-hot equity loan field.
That's the analysis of consumer advocates on Capitol Hill who are pressing for immediate changes in the federal standards governing local mortgage lenders. The rate increase "underlined the problem we're trying to get people to focus on," said Anthony Weiner, legislative aide to Rep. Charles E. Schumer (D-N.Y.). "When your house is tied into unpredictable changes in the prime rate, with no protections whatsoever, you've got some heavy risk."
Schumer has drafted a tough new bill to regulate home equity loans, scheduled for introduction this week. His measure joins a companion bill authored by Banking Committee colleague Rep. David E. Price (D-N.C.). Both are targeted at a key objective: The need to establish nationally applicable consumer protection rules for any lender offering home equity mortgages, in any form.
Schumer, Price and other legislators here feel a special urgency about the equity-loan issue for three reasons: The sheer volume of new equity loans. New lines of credit and second mortgages are jumping off the charts -- up by an astounding $40 billion in the past year alone, according to federal estimates.
The extensive use of aggressive advertising techniques by lenders via newspapers, television, direct mail and radio.
The relative dearth of federal consumer-protection rules to deal with seductive equity loan features such as deep-discount "teaser" rates, interest-only payment plans and indefinite-term lines of credit with no payback dates. Compared with regular first mortgages, in the words of one staff member, the second-loan industry operates in a "regulatory Garden of Eden: Nobody's really looking over lenders' shoulders yet because everything's so green and new."
A subcommittee of the House Banking Committee held a hearing on Price's bill last week. Price and Schumer both are pushing for full Banking Committee and House floor action this fall. Whatever ultimately is passed will likely incorporate features of both bills.
Here's a quick rundown on the legislation:
Both bills seek to force lenders to tell consumers what they're signing up for before they take out a home-equity line of credit or second mortgage. That means a disclosure statement, in plain language, that describes how the loan's teaser rate operates, when it disappears and what it turns into. The bills also require accurate descriptions of the rate-setting mechanism on the loan. The index the lender will use to adjust the rate, for instance, must be identified, and -- in Schumer's bill -- outside the control of the lender.
According to research by Consumers Union and the Consumer Federation of America, some banks change the rates on consumers' home-equity loans whenever they like or use their own prime rate, set by the board of directors. Schumer's bill would ban such practices and require that all indexes be publicly available, independent of the bank or savings and loan.
Both pieces of legislation also target the slick advertising campaigns typical of the home-equity boom. Lenders touting the "tax-free" or tax-deductible characteristics of their loans would also have to include a description of the limitation of the deductions under the Tax Reform Act of 1986. Moreover, they'd have to warn consumers, a la tobacco advertising, that the unrestricted rapid upward rate movements possible on equity loans can be harmful to their financial health.
Schumer's bill takes several additional regulatory steps beyond disclosure. It would require rate caps on home-equity loans -- such as the common 2 percent per year ceiling found on many adjustable-rate first mortgages. It would not, however, impose any overall life-of-the-loan rate ceiling on equity lines. Your loan could jump indefinitely by two points a year until you smartened up enough to bail out.
Schumer would also ban interest-only payment plans. The problem here, according to Schumer, is that borrowers paying interest only are lulled into a false sense of affordability. Their monthly payments are artificially low because they're not reducing their principal debt. When the lender suddenly demands repayment of the principal in a lump sum, they wake up in deep trouble.
What do the Schumer and Price bills mean to you? At the very least, consider them a warning bell: Home-equity loans can be trickier and riskier than you assumed. Look hard at the rate index to which your lender is tying you. Look long at how it would perform in a rising-rate scenario over two to three years. That's what's coming, and the preservation of your home equity could depend on the right choice.