Two federal lawmakers, hoping to create more safeguards for consumers and possibly to prevent the foreclosure of thousands of homes, have introduced separate pieces of legislation aimed at beefing up government regulation of home-equity loans. The two bills, introduced by Reps. David Price (D-N.C.) and Charles E. Schumer (D-N.Y.), would amend the federal Truth in Lending Act to apply to all home-equity loans in addition to most other types of mortgages. Currently, most home-equity loans are not subject to the consumer safeguards the act builds into other real estate loans.
Both bills would require lenders who make home-equity loans to give consumers a clearly written disclosure statement. The statement would explain any fees associated with setting up and maintaining the account, how long the initial interest rate will last and how the rate would be adjusted.
If a loan has no limit or "cap," on how high the rate could go each year, the disclosure statement would have to say so. The lender would also have to clearly spell out the maximum amount the borrower would have to pay in a "worst-case" scenario caused by soaring interest rates.
Both bills would also require lenders to tell the borrower which index the lender will use in making periodic interest-rate adjustments.
Caps on Loans
Schumer's bill is viewed as much tougher than Price's legislation. Unlike Price's bill, Schumer's legislation would require annual caps on home-equity loans, much like the caps lenders currently place on other types of adjustable-rate mortgages.
It would also ban so-called "interest-only" payments because Schumer believes such repayment schedules give borrowers a false sense of security: They think the principal amount of the loan is being reduced every time they make a payment, even though it really isn't.
But perhaps the most important difference between the two bills is Schumer's belief that changes in a home-equity loan's interest rate should be linked to an index that is not controlled by the lender.
According to Consumers Union, a consumer watchdog group that supports Schumer's bill, many banks currently make interest-rate adjustments on home-equity loans based on an index set by their board of directors or other insiders.
These banks have the power to change the interest rate and other terms of the home-equity loans they have already issued at will--a power that Consumers Union legislative counsel Michelle Meier says is "terribly frightening."
"Some of these lenders can raise your interest rate virtually overnight, regardless of which way all the other rates are going," Meier said. "That's dangerous to your financial health."
Bills in Subcommittee
The two bills are in the House's consumer affairs subcommittee, and there is no guarantee that they will eventually become law. Some lenders have already voiced their concerns about the proposals, and their opposition may grow.
If any consumer safeguards for home-equity loans are eventually signed into law, they probably would not become effective until next year or 1989, Meier said.
The proposed legislation has taken on an added sense of urgency because dozens of lenders are entering the home-equity loan business each month. By one estimate, the outstanding balance on home-equity loans will reach $80 billion by the end of this year--twice the amount outstanding only 10 months ago.
The phenomenal growth is largely attributed to last year's tax reform legislation. Tax writers agreed to continue allowing most deductions for mortgage-related interest payments, but decided to phase out deductions for other finance charges, such as credit-card debt and car loans.
Consumers who take out home-equity loans can use the cash to buy big-ticket items and may be able to write off most or all of their interest payments because the finance charges are linked to their mortgage.
Although Meier and other experts say a well-designed home-equity loan can be a godsend for a homeowner who has to pay pressing bills, they worry about lenders who are not voluntarily building consumer safeguards into their loans.
They also complain that many lenders are running misleading advertising campaigns to market their home-equity loans. Both the Schumer and Price bills would require lenders to follow certain guidelines when they advertise such loans.