The House and Senate have made substantial strides in efforts to tighten the rules banks and savings and loans must follow when making home equity loans.
New regulations governing loans secured by a borrower's home were part of banking legislation passed this week by the Senate and also part of a bill approved last week by the consumer affairs subcommittee of the House Banking Committee.
Consumer groups said the Senate legislation closes more loopholes and provides more protection for borrowers than the House bill. The full House committee, however, is expected to strengthen the legislation before it is sent to the House floor for a vote, a committee spokesman said.
The borrowing boom kicked off by 1986 tax changes increasing incentives for consumers to use home equity loans rather than consumer loans has produced some horror stories of owners who lost their homes or were faced with gigantic debt they had not expected. Calls for more consumer protection led to the current legislative proposals requiring that borrowers be given more information before loans are closed and that lenders be restricted in the changes they can make in loan terms after the loans are signed.
The deductibility of consumer interest is being phased out over the next three years by the 1986 tax reform act, while the mortgage interest deduction remains untouched. By using home equity loans, which actually are second mortgages because they are secured against the house, consumers can retain interest deductions for many kinds of spending.
Home equity borrowing "is leveling off" now, probably for seasonal reasons and because homeowners "have tapped a large share of the potential" credit in their homes, said Wayne F. Bengston, vice president and director of consumer lending for the U.S. League of Savings Institutions. "But there is a tremendous market yet" and borrowing is expected to pick up, he added.
Bengston said he has few objections to the House legislation, sponsored by Rep. David E. Price (D-N.C.). "I don't think it's going to change anything" in home equity borrowing, Bengston said. The Senate bill, however, contains more objectionable provisions, including the prohibitions against forcing borrowers to pay off loans before they are due and balloon payments, Bengston said.
The American Banking Association has "concerns with some of the specific restrictions" in the two bills, said Edward L. Yingling, executive director of the association. He would not identify the restrictions but said the ABA does "not believe it is in the consumers' interest to alter components of the product which have made it effective and unique."
Many home equity loans are lines of credit against which borrowers can draw over a specified period. Under the Senate bill, banks and savings and loans would no longer be allowed to change the terms of a loan after the contract is signed and would be prohibited from unilaterally demanding full payment before a loan is due except in cases of borrower fraud or of failure to meet repayment terms. Consumer advocates said these reforms, which are not included in the House bill, are among the most important changes needed in home equity lending.
Most contracts that consumers are now required to sign permit the bank or savings and loan to demand full payment of a loan at any time, even when a borrower has complied with the loan agreement, they said. The contracts also allow lenders to change the terms for repayment and other aspects of the agreement at any time after the contract has been signed.
Permitting banks and savings and loans to make unilateral changes in loan terms "negates the benefit" of the House bill, said Michelle Meier of Consumers Union. She said the bill "doesn't do enough to protect consumers. It doesn't prohibit some fundamentally unfair contract terms -- it only makes the lenders tell you about them."
A borrower faced with changes must accept them "or lose the line of credit and the hundreds of dollars she paid for it," said Leslie Gainer of the U.S. Public Interest Research Group.
Both the Senate and House bills would require lenders to tell prospective borrowers the periodic and lifetime interest-rate caps and a five-year history of the index on which the lender bases rate changes. Under the Senate legislation, lenders would have to disclose additional information, not now required, about loan terms and fees. The House bill, however, would allow lenders to withhold some information until after the contract is signed, including whether a balloon payment, or lump sum payment of the outstanding balance, is required.
The Senate legislation calls for lenders to give consumers a full list of the fees and charges for the loan before the loan is signed, while the House version mandates only that a partial list of fees must be disclosed. Fee levels can vary widely, from $400 to more than $1,000, consumer groups said.
In another important change, the Senate bill would prohibit a bank from basing the interest rates it charges on an index that is controlled by the bank.
Most home equity loan rates are set at 1 1/2 or 2 points above the prime interest rate.
The prime "is the most common index used by banks" for home equity loans, and in many cases banks use their own prime rate, which they can change at will, according to Stephen Brobeck, executive director of the Consumer Federation of America.
Lenders can continue to change interest rates monthly, "subjecting consumers to payment shock and possible default" if rates rise sharply, according to Consumers Union and the U.S. Public Interest Research Group. The Senate bill, however, requires extensive disclosure of terms and conditions of rate changes.
Both pieces of legislation contain regulations for home equity loan advertising, which consumer advocates say is often misleading. The House bill, however, "is not even as tough" as the policy the American Bankers Association advises its members to follow, according to Consumers Union.
Lenders report there is a "direct correlation" between advertising and the pace of borrowing, making it possible "to turn on the market" with ads, according to Bengston.