Statement
of
The National Home Equity Mortgage Association
on
Home Mortgage Lending Disclosure Reform
before
the
Housing & Community Development and Financial Institutions & Consumer Credit Subcommittees
of
the
U.S. House of Representatives Committee on Banking and Financial Services

September 16, 1998

The National Home Equity Mortgage Association ("NHEMA") appreciates the opportunity to participate at this hearing on mortgage lending disclosure reform. We commend you for addressing this important issue and look forward to working with the Subcommittees to help you develop effective and workable legislative proposals.

NHEMA believes that current TILA and RESPA provisions and interpretations that apply to mortgage lending are seriously flawed and do not work well for consumers or for the mortgage industry. NHEMA supports replacing these provisions with comprehensive statutory reforms that will simplify and clarify disclosure requirements, reduce compliance burdens and costs and enable consumers to engage in effective, informed comparison shopping when seeking home mortgage financing. We also advocate enacting certain additional targeted statutory protections to prevent unscrupulous mortgage lenders and brokers from abusing unsuspecting consumers and from tarnishing our industry’s image. NHEMA is also working actively to ensure that our member companies follow high ethical standards and engage only in proper business practices.

In that regard, we have recently promulgated a new Code of Ethics¹ and issued a set of Voluntary Guidelines for Home Improvement Lending.² We also are expanding our consumer education efforts and have prepared a new booklet that explains home equity lending to consumers³ in an easy to understand format.

NHEMA and the Home Equity Mortgage Industry

Founded in 1974, NHEMA serves as the principal trade association for non-conforming home equity lenders. Our current membership of approximately 350 member companies consists of large nationally known lenders, smaller regional lenders, investment bankers and bank holding companies.

The home equity mortgage lending industry provides needed, fairly priced credit to millions of middle class Americans who rely on their home equity capital for funds to pay off other consumer debts----especially higher cost credit card debt----finance home improvements, pay for their children’s education and for medical expenses, start their own small businesses, and to fulfill numerous other important personal financial needs. In 1997, the home equity lending industry originated approximately 4.1 million loans totaling $268 billion. Most of these loans to consumers were made by NHEMA’s members.

It is important for Congress to understand the market that home equity lenders serve and the products we offer. In essence, we provide mortgage credit to your typical middle American homeowner. Our industry’s primary distinguishing factor is that our customers tend to be those who may have had some type of impairment on their credit record so that they can not qualify for the very best rates that are available to people without such credit blemishes. Our borrowers generally do present somewhat higher credit risks and require more costly hands on servicing, but they are still good customers who pay their debts. There are millions of Americans who fall into our market segment, and we are proud to serve them, just as you are to represent them in Congress.

Our industry can be better understood by knowing certain basic facts such as the following.

Home equity borrowers generally:

• Are 35 to 50 years old;
• Have annual incomes between $40,000 – $50,000;
• Have "A-minus" (65%) or "B" (25%) grade credit (i.e., they are still good customers, but fall below the "A" grade credit required for the so-called conforming or conventional mortgage market);
• Pay on time (about 94% are current on their monthly payments);
• Do not default (only 2% default);
• Are not low income consumers or senior citizens (only 10% are over 65 years old and only 10% make less than $30,000); and
• Are obtaining a first mortgage (over 80%).

Home equity lenders generally:

• Charge reasonable, fair rates based on their costs and consumers’ credit risks

• # Rates usually range, depending on credit risks, 2% to 6% above those available to "A" grade borrowers;
• # 1997 rates averaged around 11%, well below credit card rates, and today rates are even lower;

• Lose money on foreclosures about 93% of the time, and such losses run about 50% of the lender’s original investment.

Key Home Equity Mortgage Lending Facts

The typical home equity borrower is in his or her early 40s, compared to around 50 for all homeowners. Only around 10% are over 65 years old. Nearly 50% range between 35 and 49 years old. Around 25% are between 50 and 65, and 15% are under 35 years old.

60% have incomes over $50,000. Roughly 30% of the borrowers have household incomes of between $30,000 and $50,000; another 30% between $50,000 and $70,000; 20% between $70,000 and $100,00; 10% have incomes over $100,00; and only 10% have incomes less than $30,000.

Roughly 65% of the borrowers have relatively good "A minus" credit ratings. Another 25% rate in the "B" range, with 9% qualifying as "C" and only 1% as "D" credit risks. These borrowers’ credit ratings are clearly lower than those of most borrowers who qualify in the prime "A" level of the conventional agency market, and this means more risk and higher interest rates must be charged to offset this risk.

For a more detailed description of home equity mortgage lending and the customers we serve, please refer to Appendix #4 to this statement.

The home equity lending industry clearly generally is not charging consumers exorbitant rates, nor is it targeting senior citizens and vulnerable, low-income consumers with predatory lending practices, stripping away consumers’ home equity and throwing them out of their homes in foreclosure proceedings as some groups seem to be alleging.

Abusive practices are the exception, not the rule in this industry. However, NHEMA and top officials of the nation’s leading home equity mortgage companies have recognized that there are a few unscrupulous mortgage brokers and lenders who are engaging in improper practices. NHEMA and these industry leaders are firmly committed to forcing this rogue minority of "bad apples" to stop such improper practices. Therefore, NHEMA and its member companies have devoted a tremendous amount of time and resources to identifying specific problem practices and to analyzing what changes are needed in existing laws and industry practices to ensure all consumers are treated fairly.

As I will outline subsequently, last year NHEMA developed a set of comprehensive, targeted legislative proposals and other reforms to stop abuses by the "bad apples" in this business and to give consumers the clear, understandable and timely information they need for comparison shopping for the best mortgage terms and to ensure that they receive their promised interest rate and pay no more in closing costs than they are told. NHEMA has been an active participant in the so-called Mortgage Reform Working Group ("MRWG") and provided detailed proposals and suggestions to the HUD and FRB officials who prepared those agencies’ recently released joint report and recommendations on mortgage reform. We are continuing to work with other lender organizations and interested parties to further refine reform proposals.

We are committed to fighting hard for targeted protections and simplifications that will better serve both consumer and industry interests. At the same time, however, NHEMA strongly opposes unfocused or counterproductive proposals that add new levels of complexity and costs to the mortgage lending process----such as HUD’s recommendation for a new federal "UDAP"statute to allow anyone to sue whenever they think that a mortgage loan is somehow unfair or unsuitable----that will foster extensive, costly litigation and force lenders to raise credit rates and limit credit availability to needy consumers. Ultimately, it is only the consumer that will pay the cost of that litigation.

The Need for Comprehensive RESPA/TILA Reforms

Virtually every group, including NHEMA, that has undertaken a detailed review of the current RESPA and TILA requirements and how the home mortgage process works in the marketplace has quickly reached the conclusion that major reforms are needed. General agreement seems to exist on the nature of the major perceived problems associated with the existing laws and industry practices. However, various parties naturally differ on the magnitude of some of these problems, as well as how they should be addressed. In essence, the perceived problems include:

• Disclosures — Current disclosures are often untimely, incomplete, unclear, confusing, misleading, too complex and burdensome. Consumers generally do not or can not easily shop loan rates and closing costs. This lack of shopping frequently is caused by the lack of simple, meaningful disclosures and of a good comparative shopping tool (e.g., disclosure of a firm loan rate and closing costs). Consumers also are often surprised and angered by unexpected costs at closings.

• Loan Origination & Pricing — Some mortgage brokers and lenders are alleged to engage in frequent loan flipping or churning whereby consumers’ loans are refinanced repeatedly and the borrowers are charged repeated fees. Also, closing costs have been known to involve excessive charges for certain settlement services and include "junk" fees in some cases. In addition, senior citizens and other vulnerable groups are perceived as being targeted by certain predatory loan originators and given inappropriate loans that may lead to them losing their homes in foreclosure proceedings.

• Brokers’ Role & Compensation — Consumers are often confused or mislead regarding the role played by mortgage brokers. They mistakenly may believe that the broker is representing their interest as a fiduciary, and they do not know how the broker is compensated. On the other hand, brokers are entitled to be compensated for their services, and RESPA’s restrictions on what is a referral fee has caused businesses serious legal uncertainties and have generated scores of lawsuits over the payment of broker compensation. Again, the cost of which is ultimately passed on to consumers.

• Consumers’ Rights & Remedies — The present rescission right is often used to unfairly penalize lenders who make minor, unintended technical mistakes. However, consumers have few other mechanisms for correcting errors and resolving disputes with lenders. Also, some consumers are not given adequate counseling, workout or forbearance options to avoid foreclosures. On the other hand, lenders find that many consumers file costly lawsuits based on technical, unintended lender errors. Lenders frequently experience excessive penalties and serious compliance burdens, all at consumers’ expense.

• Conflicting Laws — Conflicts exist between certain RESPA and TILA requirements, and more significantly, due to many different state laws, which directly conflict with RESPA/TILA provisions, or at a minimum add additional levels of complexity to the transaction.

In addition, it is also important to recognize that the mortgage origination process is rapidly evolving. It is far different today than when the current RESPA and TILA provisions were enacted. Well over 50% of the mortgages are now originated through brokers, and many more institutions are competing to offer loans. Underwriting standards and processes are expanding and becoming much more automated and computer-assisted. New delivery channels such as the Internet have opened up, and are gaining acceptance.

NHEMA’s Mortgage Reform Task Force and Reform Proposals

In order to ensure that NHEMA could fairly and effectively reflect its membership’s view on reform issues and be a constructive participant in this process, last year Laura Borrelli, NHEMA’s President, formed a NHEMA Task Force on RESPA/TILA Reform. Member companies were invited to participate, and the Task Force held lengthy meetings in Philadelphia, New York and Washington to review perceived problems and possible legislative changes. After these initial meetings, the Task Force and its drafting subcommittee held three full days of meetings last Fall in Dallas. The Dallas meetings led to a specific set of proposals that were further refined through conference calls and meetings and endorsed by NHEMA’s Executive Committee.

NHEMA’s proposed reforms were developed to help ensure that consumers receive clear, understandable and timely information to enable them to comparison shop for the best mortgage. NHEMA’s goal was to ensure that prior to closing the consumer receives a more certain guarantee of the interest rate and pays no more in closing costs than promised. NHEMA’s comprehensive reform proposals include:

• Simplification and Guaranteed Costs and Rate — Loan documents and disclosures would be simplified and consumers would be given a firm guarantee of loan closing costs and rates⁴.

• Preventing "Loan Flipping" — Stopping "loan flipping" (i.e., abusive repeated refinancing) by precluding brokers and loan officers from receiving any significant fees on any loans refinanced within a 12-month period, regardless of who originated the loan; alternatively, loan flipping could be prevented by prohibiting the financing of such fees when loans are refinanced within a year. Flipping is the most serious improper sales practice occurring in the home equity lending industry. It can be and should be prevented by targeted remedies such as NHEMA is proposing both for the industry and the consumer. Flipping can occur when a mortgage broker or loan officer has an incentive for personal economic gain due to the commissions or fees they receive when a loan sale is made. Prohibiting the payment of such fees outright or indirectly by limiting the financing of such fees prevents the broker or loan officer from being able to make money by flipping the loan, and therefore prevents a potentially abusive practice from occurring.

• Foreclosure Protections — Abusive foreclosure situations, while relatively rare, would be prevented by encouraging workouts, forbearance and other loss mitigation tools whenever possible. Lenders would have to provide consumers with a notice of the availability of consumer credit counseling and options for workouts, etc. at least 30 days before commencing foreclosure proceedings except where there is a default in a senior lien. In addition, NHEMA is recommending the passage of a new federal statute (the "Home Equity Recovery Act", or "HERA") that will help ensure more consumers are able to recover a portion of their equity if a foreclosure is likely. Under this proposal, if a borrower’s outstanding indebtedness is not more than 80% of the current appraised value of the property, the borrower could have a 60-day period before the lender could proceed with foreclosure during which the home could be sold through a licensed real estate broker. The borrower would receive any profits from the sale after paying off the indebtedness and costs. This equity recovery procedure would not apply if the consumer was in bankruptcy, due to the Court’s jurisdiction over the matter, or if the property was not owner-occupied at the time of the proceeding.

• Consumer Rights & Remedies — Borrowers would still retain the right to cancel for three business days after closing but limit the current three year right of rescission. Borrowers would be given a right for correction of mathematical and other errors. Disputes generally would be handled first through mandatory arbitration following the rules of the American Arbitration Association. Lenders would have to offer consumers free referral to consumer credit counseling at critical points of delinquency during the loan servicing process.

• Licensing — All loan originators would be required to be licensed in all states pursuant to tough new federal minimum standards.

• Broker Role Clarification — Mortgage brokers would have to adequately disclose their role in the mortgage process and how they are to be compensated, but brokers could be paid for the services rendered without fear of being sued under the unclear requirements of Section 8 of RESPA.

• National Clearinghouse — A national clearinghouse would be established to help identify and stop unscrupulous lenders or brokers who had licensing revoked in one state from shifting their abusive practices to another state.

• Consumer Counseling & Education — Consumer credit counseling and educational efforts would be increased to help consumers better understand how to best shop for a mortgage and understand the borrowing process so that they can protect themselves from unscrupulous operators.

• Enhanced Enforcement — Existing statutory and regulatory protections would be enforced more aggressively and effectively by appropriate authorities as they are generally already ample in scope.

• State Law Preemption — Various conflicting and differing state laws would be preempted to ensure uniformity.

A copy of NHEMA’s comprehensive proposals, which were presented last December to MRWG participants and later to HUD and FRB officials, is attached as Appendix #5.

NHEMA believes that its proposed reforms offer a sound, credible and workable framework for mortgage law reform that would protect consumers’ interests, simplify the process and reduce compliance burdens. However, we wish to emphasize that we are not locked into supporting only our initial recommendations. After developing its reform proposals, NHEMA has continued to work within the MRWG and with other industry lender groups to come up with a joint package of reforms that incorporate and refine the various concepts put forth earlier by NHEMA and several other organizations. We believe that it is important to try to develop as much consensus as reasonably possible, and we are encouraged by the continuing efforts that NHEMA and other lender groups now are undertaking. Hopefully, a number of lender organizations will be able to agree upon and release a new comprehensive joint package of proposed reforms soon.

The HUD/FRB Joint Report on Mortgage Reform

As members of the Subcommittees know, HUD and the FRB have recently come forth with their long awaited joint report on RESPA/TILA Reform. NHEMA, like many other interested parties, gave extensive input to these agencies’ staff as they were preparing this report. We had hoped that they would come forward with balanced and workable recommendations that would serve as a solid basis on which Congress could build legislative proposals. We know that the HUD and FRB staff put a great deal of time and good faith efforts into this project, but we must candidly say that we are disappointed in what they produced. In essence, we feel that the report fails to offer the needed simplifications, clarifications and burdensome paperwork reductions that it could have and should have. It really does not advocate the type fundamental changes needed to simplify and streamline requirements and disclosures for consumers and lenders, nor to lessen lenders’ compliance burdens and liability risks. It largely calls for keeping much of the current outdated mortgage loan legal structure and layering on new requirements and increasing litigation exposures and penalties. In practice, it would force many lenders to curtail credit, and consumers often would no longer be able to secure a loan that they desperately need.

Let me illustrate how the HUD/FRB report falls short. It adds significantly to the complexity of the current process while doing little to simplify requirements and to give consumers better, more understandable information. The APR and Finance Charge disclosures, for example, have long been a prime source of confusion for shoppers and lenders alike. Even the FRB has acknowledged that the APR is misunderstood. Instead of eliminating these time-tested incomprehensible, litigation inspiring figures and using simpler figures such as the note rate, the report proposes to "reform" by adding more factors into the calculations.

Another key proposal that illustrates the report’s seemingly unfailing tendency to enhance complexity can be seen in its proposed dual disclosure scheme. Instead of endorsing a shift to the guaranteed bundled closing cost approach being advocated by many industry groups, which would lower consumers’ costs and greatly facilitate comparison shopping, the report recommends creating what many view as a parallel universe where confusion would abound. HUD and the FRB are recommending that we have both a guaranteed-cost scheme and a slightly modified version of the discredited current TILA disclosure and liability approaches, with new lender liability for violation of a new tolerance that would be applied to RESPA’s Good Faith Estimate. How would this simplify the process for a consumer?

The report’s most troubling recommendations from the perspective of home equity lenders, however, relate to adding HUD’s proposed so-called substantive protections to deal with alleged abuses. Despite industry’s announced support for tough, but carefully targeted provisions to address specific, real problems, the report largely disregards such good faith proposals and adopts the lawsuit generating concepts that some consumer advocacy groups and litigation attorneys have been peddling. In particular, HUD proposes significantly lowering HOEPA (Section 32) thresholds so that far more loans would qualify as HOEPA loans; adding new HOEPA "protections" including such things as requiring pre-transaction consumer counseling in certain cases; imposing new information data collection and reporting requirements on HOEPA lenders; and allowing HOEPA consumers to sue when they believed at some future date that an "unsuitable" loan had been made to them.

HUD’s recommendations call for enactment of a new federal "unfair and deceptive acts and practices" ("UDAP") statute to allow any borrower to sue for alleged "unfair or unconscionable" mortgage transactions. This new UDAP proposal, which many would consider a trial lawyer’s dream come true, would enable consumers to sue if, for example, a specified debt-to-income ratio was exceeded. NHEMA strongly opposes this litigation-inspiring approach. We do not believe that federal law should be interfering with companies’ underwriting guidelines. To the extent that flipping and other abusive practices occur, they can be curtailed more effectively and more efficiently by the targeted reforms NHEMA has proposed.

We also are concerned over other HUD recommendations that call for significantly expanding litigation activity under RESPA. Among other things, HUD proposes to expand the injunctive authority available to HUD and state regulators; increasing HUD’s authority to assess civil money penalties for violations; adding more criminal penalties; expanding private litigants’ rights to sue for damages; and allowing a lender’s competitors to sue for injunctive relief or damages for violations of RESPA’s Sections 8 and 9.

Conclusion

As summarized in this statement, NHEMA believes that RESPA/TILA reforms are needed. We believe that mortgage disclosures can be provided that are clearer, simpler, more understandable and more useful for consumers to shop for the most suitable mortgage products and services, and that lessen compliance costs and burdens and litigation risks for lenders and mortgage brokers. NHEMA also favors enacting certain additional targeted statutory substantive protections to prevent unethical mortgage brokers and lenders from engaging in improper practices. We have made a major, good faith effort to develop workable legislative proposals, educational materials for consumers and voluntary industry codes and practices to prevent abuses and to ensure that American consumers benefit from a new, better mortgage lending regulatory and operational framework. NHEMA will continue to work with all interested parties to help shape the legislative reforms that we hope are enacted in the next Congress.

____________________
¹NHEMA’s new Code of Ethics is attached as Appendix #1.

²NHEMA’s Voluntary Guidelines on Home Improvement Lending are attached as Appendix #2.

³This consumer education booklet is attached as Appendix #3.

⁴Consumers should receive more definite, understandable and meaningful disclosures of mortgage rates, terms and closing costs. NHEMA’s Task Force proposal recommends that the new disclosure rules should apply to both closed-end and open-end credit, and that confusing items such as the APR, Amount Financed and Finance Charge disclosures be eliminated.

• Pre-Qualification Disclosure — Under NHEMA’s proposal inquiring consumers would first receive a "pre-qualification shopping disclosure" that would enable them to compare and shop for the home mortgage that best meets their needs. The disclosure would include the note rate, monthly payment amount, term/type of loan, loan amount, whether the rate or payment can change, whether prepayment is allowed without penalty, assumability, servicing transfer rights, closing costs (if applicable) on a bundled, total amount basis, and a notice that credit counseling referrals are available to help the consumer evaluate their options. This initial disclosure, which would be given by the loan originator (who could be either a lender or a broker) before completion of a formal application, but after a credit report had been obtained by the originator, could be given in three different ways: (1) Guaranteed Settlement Costs & Good Faith Estimate of Rate and Discount Points - the disclosure could offer in writing a guaranteed maximum cost for a bundled package of settlement services, with certain items excepted, valid for five business days, together with a written good faith estimate of the anticipated note rate and discount points to be charged and including an explanation that the estimate is based on a particular type of loan, confirmation of the home’s value, etc.; (2) "All-In" Loan Cost Estimate - the disclosure could provide only a good faith estimate of an all-in note rate, including all points and closing costs on a bundled, non-itemized basis, again explaining that the estimate is based on a particular type loan, property valuation, etc. and no firm guarantee of rate/costs would be given until after application; or (3) "Borrower’s Qualification Package" - consumers who wanted a firm disclosure guarantee of both note rate and closing costs early in the shopping process could obtain one provided they first develop and submit a loan qualification package that provides essential information (e.g., appraisal; income verification; title evaluation) needed by lenders to provide such a guarantee.
• Pre-Closing Disclosure Guarantees — After the borrower has completed a loan application and the lender has received and confirmed all required qualification data, the lender in offering a loan would then give a written disclosure a minimum of five days before closing guaranteeing the loan rate and closing costs. This pre-closing guarantee would be valid for a minimum of three days so the borrower could shop further.
• Closing Disclosures — If the borrower then proceeds to closing based on the pre-closing guarantee, a final closing statement would be given that essentially repeats the pre-closing guarantee and reflects how funds are disbursed at closing. Consumers would also receive a written notice at closing of their right to cancel for three business days after the closing. Lenders could, of course, cancel the transaction at closing if they found that there had been a material adverse change in the borrower’s status (e.g., the borrower had run up huge new debts or quit his/her job).

Appendix #1

NHEMA Code of Ethics

Member companies of the National Home Equity Mortgage Association ("NHEMA") are committed to conducting their business affairs in a fair, professional, legal and ethical manner. NHEMA Member companies accordingly subscribe to this Code of Ethics and pledge:

1. To conduct business in a manner that reflects the highest professionalism, integrity, competence, courtesy and diligence and that is fair and fosters public trust and confidence.
2. We commit to make credit available to prospective borrower’s written regard to race, gender, marital status, religion, age or national origin; and to act in compliance with all current applicable laws and regulations; and to respect and protect the borrower’s confidentiality and privacy rights.
3. To refrain from engaging in any intentionally deceptive or misleading business practices; to provide to borrowers and prospective borrowers clear, accurate and timely disclosures of the terms, costs and contractual obligations of credit transactions; to draft written documents in as simple, clear and unambiguous language as reasonably possible and as permitted by law; and to promptly process loan applications, advise borrowers of their decisions and to complete credit transactions.
4. To evaluate the borrower’s ability to repay the credit obligation when deciding whether or not to extend credit and not to engage in the business of making loans for the sole purpose of acquiring the property offered as security for the proposed loan.
5. To help inform and educate borrowers and prospective borrowers about the lending process especially the obligations, potential risks and other factors they should consider when determining whether to obtain additional credit.
6. To encourage borrowers or potential borrowers to use credit responsibly and to seek advice from independent financial advisors, including when appropriate those who focus on helping senior citizens and other potentially vulnerable individuals, regarding the advisability of obtaining a home equity loan before securing such a loan.
7. To maintain truthfulness and accuracy in advertising their products and services.
8. To ensure that any offering of insurance or supplemental products is done in a clear and informative manner and that the purchase of any such product reflects a voluntary choice by the consumer and is never due to the extension of credit having been conditioned on such purchase.
9. To make a good faith effort to resolve disputes between Members and borrowers through negotiation, arbitration, and mediation whenever practical.
10. To comply with appropriate voluntary guidelines that may be adopted and amended from time to time by the Association.

# # #

In conjunction with the adoption of the Code of Ethics, NHEMA has approved the following series of consumer grievance procedures:

CONSUMER GRIEVANCE PROCEDURES

1. A permanent committee consisting of the current NHEMA President and the immediate past two (2) Presidents shall constitute the Grievance Committee.
2. Upon receipt of any signed, written, non-frivolous complaint about a Member, the information shall be forwarded to NHEMA’s General Counsel for prompt investigation.
3. The General Counsel shall report to the Grievance Committee the results of the investigation and make recommendations as to whether or not further action should be taken.
4. If the Grievance Committee, after reviewing the matter, finds that there is probable cause for action against a Member, the Grievance Committee shall promptly notify the appropriate federal, state or local agency possessing authority under law to deal with the complaint.
5. Final adverse action by a federal or state agency imposing sanctions against a Member which comes to the attention of NHEMA’s Grievance Committee may serve as the basis of recommendations to the Executive Committee regarding the future status of membership of such Member.
6. Final action by a federal or state agency permanently revoking the license of a Member shall automatically result in the termination of membership of such Member.

# # #

Appendix #4

HOME EQUITY LENDING

7/8/98

What Are "Home Equity Loans"?

The term "home equity loan" includes a wide range of home mortgage products. Usually, the borrowers are not obtaining money to purchase their primary home, but are using equity in their homes to secure funds to consolidate debt, finance home improvements or meet other financial needs. Included in this term generally are: (1) second mortgages ; and (2) first mortgages to refinancing borrowers who are unable to meet the strict underwriting standards required by the two government-sponsored enterprises ("GSEs"), the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"), that buy and securitized loans for the secondary market.

Lenders classify borrowers by their credit quality. The loans that Fannie Mae and Freddie Mac purchase which conform to their higher "A" credit standards, are called "A," prime, conventional or agency loans. By contrast, "home equity loans" are usually made to people who have some blemishes on their credit records that keep them from qualifying as "A" credit risks, or who do not conform to certain other underwriting requirements----such as debt-to-income ratios, loan size, or documentation requirements----of the conventional or conforming market. Thus, home equity borrowers tend to come within the lower "A-," "B," "C" and sometimes "D" credit grades, and home equity loans accordingly are often referred to as B&C, subprime or nonprime loans. Others are referred to as "Alternative – A (non-conforming)."

Home equity loans really should be viewed as custom loans because the lenders evaluate each customer and design a loan to fit the individual’s profile and needs. By contrast, in the conventional market, if the customer does not meet the more rigid criteria of the prime A credit borrower, they simply do not fit, or get, the loan.

History and Evolution of Home Equity Lending

Until the early 1990s, the home equity market was generally made up of relatively small balance second mortgage loans. During the past few years, however, a dramatic growth and evolution has occurred in this market. Today, the market is far larger, loans are significantly larger, and the trend is toward larger first mortgages for longer terms. Why have these changes taken place?

A number of factors have contributed to the home equity market’s evolution:

· An active, healthy secondary market for securitized home equity loans has developed and this has made far more capital available to fund such loans.

· Lower interest rates have allowed homeowners to refinance their existing first mortgages to take out a portion of their equity or to consolidate credit cards and other consumer debt and pay it on more favorable terms than non-mortgage consumer loans.

· The tax laws have been amended so that mortgage interest is the only remaining type of tax deductible consumer debt.

· Consumers have come to recognize the significant benefits and savings that home equity loans can offer, and far more have come to take advantage of these products.

· Also, many consumers who have substantial equity in their homes, particularly due to the inflation that occurred in the 1970s and early 1980s, have found that the only way they can utilize that equity and/or get lower mortgage rates is by obtaining a home equity loan because they can not qualify for a conventional loan as they lack an "A" credit rating.

· Many more lenders have begun to offer and market home equity loans in response to consumers’ needs and mark

· Lenders and borrowers have recognized the economies of first mortgage refinancing vis a vis the second mortgage option.

Market Characteristics and Segments

The home equity lending market is very diverse competitive, with literally tens of thousands of firms competing to originate these loans. Unlike some other segments of the financial services business, home equity lending is not concentrated in the hands of a few mega-firms. The largest home equity companies have no more than 3% of the market. Most home equity lenders tend to operate in distinct geographical areas, but a number have nationwide operations. Lenders and mortgage originators include mortgage banks, finance companies, credit unions, thrifts, banks and mortgage brokers.

In 1997, approximately 4.1 million new home equity loans were made. About 80% of the loans now are first liens. Loans last year averaged around $65,000 each. By comparison, five years earlier in 1992, 3.6 million such loans were originated, and they averaged only about $50,000. The average home equity loan is around $45,000 lower than typical conventional mortgages which ran about $110,000 in 1997. In addition, the loan terms are often 15 years instead of the more common 30 year period for prime conventional loans.

The home equity lending market, which totaled about $268 billion in 1997, consists of four major segments: traditional home equity loans (45%); home equity lines of credit (25%); bank portfolio loans (15%); and private portfolio loans (15%).

Home Equity Loans ("HELs") are usually closed-end first or second mortgage loans where the amount and term to maturity are known at origination. Most customers for HELs are considered "A-" and "B" credit risks, but there are a significant number of "C" grade and a relatively small number of "D" grade borrowers. Most HELs are made by mortgage banks and finance companies, and many are funded by asset-backed securities or debt.

Home Equity Lines of Credit ("HELOCs") are generally open-end revolving second mortgages loans where the borrower receives a line of credit that can be drawn down and paid back over time. A high proportion of these loans are made by banks and most are made to customers with higher credit ratings. Interest rates tend to be 2% or more higher than conventional loans that are sold in the GSE agencies’ market.

Bank Portfolio Loans are mortgages held by banks in their own portfolios because they typically can not be sold into the GSEs’ secondary market since they are slightly below the GSEs’ high credit standards and/or do not meet documentation or other agency underwriting requirements. Interest rates on these mortgages are slightly higher than agency loans.

Private Portfolio Loans are privately held mortgages that are made not by financial institutions but by private parties such as sellers of property, private investors or relatives. Many of these loans are second lien down payment loans, and they usually have very incomplete documentation and interest rates of 3% or more above agency rates. Financial institutions will often purchase these loans at a discount after a one year good payment history by the borrowers.

Loan Origination Process

Mortgage brokers now originate about half the home equity loans. Lenders purchase these loans at the wholesale level through the brokers. The remainder of the loans are generated at the retail level through in-house loan officers. Many lenders buy home equity loans through a correspondent relationship with another lender. Their correspondent uses a warehouse line of credit to fund the loan, and then the larger lender buys the loan, and often securitizes it or sells it in the secondary market. Today, a very active, healthy secondary market has been developed through Wall Street firms, and home equity lenders can now sell many of their loans in securities pools in the same way that the GSEs securitized and sell prime mortgage loans.

Loan origination expenses on home equity loans are frequently somewhat higher than those on a prime loan for borrowers with A credit. More time and effort is involved. In addition, since the loan amounts are typically significantly lower than those of purchase money and conventional mortgages, the "points" charged to cover such costs are frequently higher because points are a percentage of the loan amount. More points are required to cover the same amount of costs if the loan amount is smaller. For example, if origination expenses are $1,000 on a $50,000 home equity loan and $1,000 on a $100,000 conventional loan, the home equity loan would require "2 points" (2% of the loan), whereas the conventional loan would require only "1 point" (1% of the loan).

HEL Borrowers

Contrary to the very distorted picture that some consumer advocacy groups have painted, most home equity borrowers are not poor, uneducated, vulnerable senior citizens. The facts indicate that subprime borrowers are generally average Americans who can and do make informed judgments when they obtain a home equity loan.

The typical home equity borrower is in his or her early 40s, compared to around 50 for all homeowners. Only around 10% are over 65 years old. Nearly 50% range between 35 and 49 years old. Around 25% are between 50 and 65, and 15% are under 35 years old.

60% have incomes over $50,000. Roughly 30% of the borrowers have household incomes of between $30,000 and $50,000; another 30% between $50,000 and $70,000; 20% between $70,000 and $100,00; 10% have incomes over $100,00; and only 10% have incomes less than $30,000.

Roughly 65% of the borrowers have relatively good "A minus" credit ratings. Another 25% rate in the "B" range, with 9% qualifying as "C" and only 1% as "D" credit risks. These borrowers’ credit ratings are clearly lower than those of most borrowers who qualify in the prime "A" level of the conventional agency market, and this means more risk and higher interest rates must be charged to offset this risk.

• It is important to understand that home equity customers are generally solid citizens who try to meet their debt obligations. Many of these borrowers have credit problems not because they are irresponsible, or simply do not want to pay their debts, but because they have experienced some unfortunate life event----a divorce, a serious medical problem or lost their job (a situation that for many is more prevalent than previously with the re-engineering of America). This event places them, at least for a period of time, in a difficult economic situation, and they have problems meeting all their financial obligations in a timely manner.

Different criteria or standards may be used by different lenders so that one lender might rate a borrower as a "B" credit grade, while another lender might consider the same person a "C" credit risk. Credit history is also generally linked with debt to income ratios and loan to property value ratios. A typical underwriting matrix could be as follows:

In general, depending on the risk level, rates for these home equity loans will run from 2% to 6% higher than prime loan rates. Rates in 1997 averaged about 11.1% and for most home equity borrowers ranged between 8.5% and 14%.

Many borrowers in the lower credit ranges are able to achieve a better rating, and a significant rate reduction and lower monthly payments, if they are current on their mortgage payments for 12 months. Thus, moving from grade C to B can lower the borrower’s rate by around 2%. This gives borrowers a significant incentive to meet their credit obligations and refinance after their rating improves.

Borrowers use funds obtained from home equity loans for debt consolidation nearly 30% of the time. Home improvements are the purpose of another 20%; home purchase around 25%; and other uses (e.g., medical expenses; children’s education; etc.) about 25%.

Millions of borrowers have come to recognize that for many people it generally is far more cost effective for them to finance their consumer debt through a home equity mortgage than through credit cards, where interest may run around 20%, or higher rate bank loans. And, the interest on their home mortgage is tax deductible, whereas credit card and bank loan interest is not. In addition, as noted earlier, B and C grade home equity borrowers usually either have some credit deficiencies or debt to income ratios that prevent them from qualifying for A grade credit rates, and they therefore can not obtain a loan through the conventional market.

Delinquencies, Foreclosures and Servicing Costs

It is clear that home equity lenders do take greater risks than prime lenders whose customers have "A" quality. They experience more delinquencies and defaults, and have higher servicing expenses. This means they incur significantly higher costs. Thus, they must charge higher rates to offset these costs.

Homeowners normally seek to pay their mortgage loan obligations in a timely manner, but some get behind and some ultimately do not pay. Roughly 94% of home equity borrowers are current on their mortgage payments. This is slightly less than prime mortgage borrowers who are current 97% of the time, and slightly more than government-guaranteed loan borrowers (e.g., FHA or VA loans), about 92% of whom are current.

Home equity lenders have a somewhat higher default rate than prime lenders. Approximately 2% of home equity borrowers default and end up in foreclosure proceedings. This figure compares to 1% for prime loans and 3% for government-guaranteed mortgage loans.

Some consumer groups have contended that home equity lenders often make loans that are clearly unsuitable for consumers with the hope that borrowers will default so the lender can foreclose, sell the house and make a good profit on the sale. The facts show that these allegations are simple wrong.

Foreclosure proceedings are very expensive for lenders, and most lenders do everything they can to help customers get back on the payment track so foreclosures can be avoided. When home equity lenders are forced to take title to properties in cases of default, they end up losing money more than 93% of the time. They average losing roughly half of every dollar they have invested in the property. Lenders’ costs include the legal expenses for foreclosure, having to make interest payments on mortgage backed securities when the mortgage has been securitized, repair and maintaince on the property, taxes and real estate sales costs for disposing of the property.

Servicing loans made to B and C borrowers is significantly different----and much more expensive----than servicing those made to A quality conventional borrowers. Far more home equity borrowers must be given active "hands on" attention to help encourage and ensure payments are made. The cost of servicing B and C loans can easily be twice that of servicing A loans, and costs average at least 33% higher. Servicing employees for A borrowers can handle around twice as many loans as those for B and C borrowers. This much higher servicing cost is another primary reason why home equity loans require higher rates.

Conclusion

In conclusion, home equity lending is an increasingly important segment of the home mortgage finance business. Home equity lenders are meeting the needs of millions of Americans, most of whom can not obtain loans through the conventional mortgage market. These loans are provided by investors through their private capital and are not suitable for bank or other Federally insured or Federally supported (GSE) portfolios. They are efficiently and competitively supplied by a diverse marketplace.

Contrary to the misleading picture that some parties have given, borrowers are not primarily elderly, less-educated, vulnerable consumers who are being preyed on by predatory lenders. Most borrowers are under 50 years old, have good incomes, and they have obtained a home equity loan because they realize it makes sound economic sense and is in their best interest. Borrowers typically have somewhat lower credit ratings, but they are generally good customers and pay their home equity loan obligations in a timely manner. These customers have real financial needs and home equity lenders are helping them meet these needs. In doing so, lenders strive to offer them a customized loan that best fits their individual circumstances, and these loans are priced fairly based on the facts in each case.

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For further information about the home equity lending industry, contact Jeffrey Zeltzer, NHEMA’s Executive Director, at (202) 347-1210, or Wright Andrews, NHEMA’s Washington Counsel, at (202) 347-6875.