What to Expect From New Equity Loan Rules

Home equity loans have been one of the fastest growing types of consumer borrowing. But they also have been rife with abuses, such as misleading or incomplete advertising.

Fortunately, new rules taking effect early next month will make it easier to shop for the loans and give you more protection once you get them. However, the rules may also make it harder for you to get a loan, and you may have to pay higher rates and fees.

Spurred in part by the Tax Reform Act of 1986, which reduced the deductibility of interest on non-mortgage loans, about one out of every 10 homeowners now has a home equity loan. More and more companies--including credit unions and mutual fund companies--are offering them.

These loans typically offer a line of credit similar to a Visa or MasterCard, secured by the equity you have built up in your home. Rates usually are adjustable, tied to banks’ prime lending rate or some other index.

Most consumers take out the loans to finance home improvements, but the loans are increasingly being offered for other purposes. Some lenders are tailoring home equity loans to help borrowers pay for car purchases, while others may soon offer them as a way to pay for children’s college education, says Frank Diekmann, editor of Bank Advertising News, a newsletter in North Palm Beach, Fla. There is even talk of “portable” home equity loans that you keep when you change residences, Diekmann says.

But this growth has been accompanied by numerous abuses. Some lenders have offered low, introductory “teaser” rates or low payments without telling you how high the rates can eventually go. Some have also unilaterally changed terms of loans or arbitrarily demanded immediate payment.

Starting Nov. 7, new regulations under the Home Equity Loan Consumer Protection Act will curb many of these transgressions. This law, passed by Congress last year, will put home equity loans on par with adjustable rate mortgages in terms of consumer safeguards. They will require greater and more standardized disclosure on advertisements, direct mailings and other materials.

Among the improvements mandated by the new rules:

- Advertisements touting a favorable rate must disclose other key costs and terms. For example, ads promoting a low teaser rate must also say what the maximum rate might be. And if a lender talks about minimum payments, it also must disclose that there could be a large, lump-sum “balloon” payment at some point.

- When you apply for a loan, lenders must disclose such items as fees, repayment terms including balloon payments, how much payments could rise and fall, how long teaser rates are in effect and how variable rates are adjusted. You must be given a table providing a 15-year history of the index used to determine your rate, if it is variable.

The lender must also explain repayment options, including an example based on a $10,000 balance. That should help you choose the most affordable and least expensive way to pay off the loan, according to an article in 100 Highest Yields, a North Palm Beach, Fla., newsletter.

Lenders will also be required to give you a brochure, approved by the Federal Reserve Board, detailing loan features and warning of potential risks, such as losing your home.

- Lenders can unilaterally freeze or lower the amount you can borrow only if the value of your home declines, your ability to pay changes or you violate the loan agreement. Lenders could also do that if the government prevents it from continuing to charge the interest rate or lessens its rights to property securing the loan.

- Lenders can demand full and immediate payment only if you fail to make payments, commit fraud or misrepresentation or commit acts that put your house at risk, such as dropping homeowners’ insurance or vandalism.

- You may cancel a loan within three days of opening an account.

These rules sound great. “If the lender decides to change terms, the consumer probably has more ammunition on his side because of the new regulations,” newsletter editor Diekmann says.

But the new rules are not a panacea. They don’t eliminate the risk of the loans, including the possibility that you can lose your home if you fail to make payments.

The new rules also may lead to lender changes that aren’t so good for you.

Some credit unions and small banks, finding the new rules onerous, may decide to stop making home equity loans altogether, says Fritz Elmendorf, spokesman for the Consumer Bankers Assn.

Some lenders may not be as aggressive in offering deep discount teaser rates. They also may shorten loan maturities, now typically 10 to 15 years, because they will have less flexibility to change terms once loans are issued. They may raise rates or annual fees so they can pass along higher costs of administering new rules.

They also may tighten lending standards. Lenders may make closer credit checks to see if you qualify or, once you have taken out the loan, if you are still creditworthy.

The new rules also mean more work for you in reading and understanding the disclosures. Loan contracts will get longer with a lot more fine print as lenders spell out in greater detail your obligations as a borrower. You still will need to shop carefully, looking for the best fees, rates and protections against rising rates. You also must compare such things as closing costs, penalties for late payments, default provisions and penalties for early repayment.

For more tips on how to take advantage of the new rules, write for a free copy of the Fed’s brochure “When Your Home Is On the Line: What You Should Know About Home Equity Lines of Credit.” It’s available from: Publications Services, Board of Governors of the Federal Reserve System, Washington, D.C. 20551.