Consumer Group Warns of Equity Loan ‘Pitfalls’ : Lenders, However, Say Homeowners Are Cautious Despite Marketing Push
Many California financial institutions are encouraging “frivolous” use of home equity loans and failing to disclose “dangerous pitfalls,” leaving consumers under-informed and exposed to higher-than-intended risks of losing their homes, a survey to be released today contends.
Consumers are being encouraged in brochures and other advertising to use home equity loans for such short-term spending items as clothing or vacations, when they should be used only for such longer-term needs as home improvements and children’s college educations, or medical emergencies, said Ken McEldowney, executive director of Consumer Action, a San Francisco-based organization that conducted the survey.
Of 24 brochures received from California lending institutions, 13 encourage homeowners “to view equity as an untapped gold mine,” the group said. However, the brochures often fail to mention such things as the true costs of the loans and how lenders can unilaterally change loan terms.
“Until these pitfalls are removed from home equity lines of credit . . . we think consumers should use extreme caution,” McEldowney said.
Savings industry officials, however, challenged the survey’s findings, saying statistics show that lenders are actually very conservative in giving out the loans and that delinquencies are far more rare on home equity loans than on other types of consumer loans. They also said surveys show consumers to be using the loans conservatively--for home improvements or debt consolidation--and generally not for frivolous purchases.
“There has been some aggressive marketing in encouraging consumers to look at the loans, but banks have taken a fairly conservative approach to underwriting,” said Nancy Sheppard, a spokeswoman for the California Bankers Assn. The pitches “may get you in the door, but don’t necessarily mean you will get a loan.”
The survey is the latest consumer group salvo at home equity loans, which have boomed since the passage of the 1986 tax reform act, growing to $19.37 billion in loans outstanding at the end of July from $13.91 billion a year earlier, according to Federal Reserve Board data.
The loans’ popularity has taken off because tax reform is phasing out deductibility of interest on non-mortgage borrowings, such as credit card and auto loans. However, deductibility of home equity loans has generally been retained, prompting many consumers to take them out to pay off other loans.
Consumer activists’ concerns about marketing excesses and lack of safeguards and disclosure prompted federal legislation last year. Both the Senate and House passed separate bills this year going further in regulating the loans, but the fate of those bills is uncertain.
Consumer Action said traditional second mortgages--which provide cash up front to borrowers to be repaid in often fixed monthly payments--are usually safer than home equity loans, which provide revolving credit lines and usually carry variable rates. Pitfalls of home equity loans include:
Survey Available Free
- Interest caps covering the life of the loan are too high to provide any real protection against double-digit inflation. Such caps--required by Congress last year to limit how high interest rates can rise above the initial rate--ranged from a low of 5 percentage points (at such institutions as Bank of America and California First) to as high as 10 points (at Security Pacific National Bank). By contrast, the highest cap on second mortgages was 6 points.
- Annual percentage rates, or APRs, understate the actual cost of loans. These APRs typically do not incorporate setup fees that can run as high as $1,531 (at Union Bank) and annual fees as high as $100 (at Security Pacific), Consumer Action contended.
- Lenders can unilaterally change the terms of the loan. Consumer Action said 14 of 25 firms surveyed said they are free to unilaterally change all terms in contracts, including the indexes to which they tie variable rates, spreads between indexes and rates charged to borrowers, and repayment terms. Twenty-one of the 25 said they can change at least one condition unilaterally. By contrast, only five firms said they can unilaterally change one or more terms on second mortgage contracts.
Such findings parallel the national scene for home equity loans, said Robert Heady, editor of Bank Rate Monitor, a North Palm Beach, Fla., newsletter that surveys banks nationwide. “The average consumer needs to be a bloodhound with 20/20 vision” to ferret out all the potential pitfalls of the loans, he said.
However, Sheppard of the California Bankers Assn. said that the ability to unilaterally change loan terms is standard with many types of revolving credit lines, including many business loans. This allows lenders to adjust for changes in borrowers’ credit-worthiness, such as a loss of a job, but in practice has been rarely used, she said.
The survey, which polled 11 commercial banks, 13 savings and loans and four savings banks, and was accurate as of May 10, is available free to those sending a self-addressed business-size envelope with 45 cents postage to Consumer Action Home Equity, 693 Mission St., San Francisco, CA 94105.
