A Major Remodel of Loan Practices at Household Finance

Before Ameriquest, there was Household Finance.

The mortgage lender and its corporate sibling, Beneficial, were accused in 2002 of charging exorbitant fees and excessive penalties on home loans.

The charges led to a $494-million settlement in 2002 by parent company Household International Inc. -- an industry record, easily topping the $325 million Orange-based Ameriquest Mortgage Co. in January agreed to pay for alleged lending abuses, such as last-minute changes in loan terms that raised costs to borrowers.

Besides agreeing to large restitution payments, both companies promised to modify their business practices to guard against customers paying too much or getting stuck in loans they can’t afford.

Household has since become part of HSBC North America, whose group executive for consumer lending, Tom Detelich, oversaw what he described as a total overhaul of the corporate culture at the Prospect Heights, Ill.-based lender.

Detelich reflected recently on what those changes meant for his company and the industry.

Question: Household has refused to write certain types of loans it considers inappropriate. These include loans that charge interest only for the first few years, which other lenders offer to so-called sub-prime borrowers who can’t get a prime bank loan because of poor credit or other issues. Why is that?

Answer: In California, something like 40% of the sub-prime market is loans where the customer pays interest only at first. We all know what’s happened to home prices in the state, and everyone is looking for creative ways to help people afford loans.

But I have trouble believing that 40% of sub-prime customers are well-served by taking out interest-only loans. Because it doesn’t last forever -- eventually you have to start paying more, often a lot more on these loans.

I don’t believe sub-prime customers with modest incomes -- and in many cases getting loans based only on stated income without documenting it -- can benefit from a loan that’s going to have that kind of an adjustment. I think that’s the kind of risk that isn’t good for the borrowers and isn’t good for us.

So we gave up some market share. Less than 1% of our loans nationally are interest-only.

Q: Household spent $50 million to automate the loan process, essentially trying to leave branch employees no leeway to overcharge customers or land them in bad loans. Why did it cost so much?

A: We could have spent less than $50 million. But our standard was that there would be zero tolerance for error. On pricing, our product selection now includes sub-prime loans, near-prime loans and prime. Which loan any customer gets is decided by our automated systems. There is no salesperson or underwriter making a judgment about the quality of the customer. This takes out the risk of people getting “steered” into more expensive loans than they deserve.

Another example is appraisals. When one of our loan officers needs to have a property appraised, the request is transferred to an outside vendor. We have broken the link so that our loan officers cannot have contact with [and influence on] the appraisers.

We also have built in systemic controls so that we know each loan provides a net tangible benefit to the customer. And we automated our compliance with federal disclosure laws so that the good-faith estimate is generated automatically at the central office. If any part of the application changes, a new good-faith estimate goes out.

Q: You have been surveying customers six months after the loan is made to evaluate what they like and don’t like. What are the top findings?

A: The thing that is probably the most important is for us to meet expectations. Customers don’t want surprises. We had been working hard to shorten the time to close a loan, try to get it to seven days. What the customers told us is that’s not so important. They actually want more than seven days to think over the loan. They say what’s important is that if you tell me it’s going to be 20 days have it take 20 days. So we diverted energy from the speed-up and put it into meeting promises.

Another factor is trusting your loan officer. They need to be well informed, able to explain other people’s products as well as mine. If someone is getting a sub-prime or near-prime rate, they want to understand the reasons why they don’t qualify for prime. And they want a sense of having the opportunity to migrate to a better loan.

Q: Your agreement with the 50 states requires your loans to provide a “net tangible benefit” to borrowers, while Ameriquest’s promises only a “benefit.” The net tangible benefits standard is supposed to require lenders to evaluate the total circumstances of the loan, but many lenders consider it too subjective.

A: We think we’ve taken the subjectivity out of the [net tangible benefit] test by coming up with eight factors that can benefit customers and then working out a system that weights them depending on the type of loan. There are a lot of different circumstances and different products out there, so the same test can’t apply to every loan. So for a refinance, where the borrower cashes out some home equity, the test is different than for a new customer.

When we took our regulators through our procedures, the demonstration was 20 pages long and took 90 minutes to present. It wasn’t developed overnight -- it took us 12 to 18 months to get to where we thought it was very good. And we’re still reviewing it and will make changes if that makes it better.

Q: The practice of wrapping high fees into sub-prime mortgages has drawn a lot of criticism. Your agreement limited lender fees to 5%, but that sounds awfully high by today’s standards. What are your fees typically running these days?

A: On average it’s about 3%. There’s a lot of pricing driven by competitive pressures. The market is very efficient, and it’s no secret that the margins in the mortgage business and in sub-prime specifically have been compressed over time.

Q: Some of the attorneys general in the Ameriquest talks thought the best solution would be to duplicate Household’s settlement, saying it was all that was needed. Your thoughts?

A: I’m pleased if it’s seen as a good thing, but I want to emphasize that we have done considerably more than it requires. If we were only complying with the multi-state agreement today we would be incredibly disappointed. We have changed the corporate culture to make it more focused on what our customers want.

Q: What’s an example of how you went beyond the settlement terms?

A: The agreement said we had to have someone close the loan who was not part of the sale of the loan. That way, it could have been handled in-house. But we decided to completely outsource the closing process so the customer would have a neutral third party to ask about the loan. If the customer decides not to go through with the loan it makes no difference. We pay the third-party closer for showing up, whether or not the loan closes.

Q: Did you see anything in the Ameriquest settlement worth duplicating at Household?

A: I didn’t see anything important that we are not already doing. We try to never miss an opportunity to learn from others, but by and large we feel pretty good about where we are right now.