FTC Education Effort Focuses on Home Equity Loan Fraud

A home is often a consumer's greatest, single asset and home equity fraud can rob consumers of their homes and the equity they have spent years building. Because of an increasing number of consumer complaints about home equity fraud, including practices such as equity stripping, credit insurance packing, and loan flipping, the Federal Trade Commission has launched a new campaign to educate consumers about how to protect themselves when seeking home equity loans and reverse mortgages. This information is particularly important to Texas consumers who, for the first time, can now borrow against the equity in their homes.

"For many consumers, a home is their largest asset. Without good information about the pitfalls of home equity loans and reverse mortgages, consumers could lose their homes," Jodie Bernstein, Director of the FTC's Bureau of Consumer Protection, said. "Consumers often turn to these lenders at times of great financial need. The resulting stress increases susceptibility to predatory practices that can strip consumers of substantial sums of money and, ultimately, their homes."

The state of Texas, which was previously the only state in the country to prohibit home equity loans, amended its constitution to allow companies to offer general home equity loans beginning in January 1998. "Until recently, those of us who live in Texas have not been able to borrow against our homes, therefore we may be less familiar with this type of borrowing and the laws that govern it," said Tom Carter, Director of the FTC's Dallas Regional Office. "It is critically important that we educate ourselves about home equity loans before putting our homes at risk."

The Commission recently filed suit against one enterprise alleging it engaged in deceptive mortgage lending in the Washington, D.C. area, and has said that it will be reviewing practices of other lenders across the country, particularly those who lend in the subprime market.

Subprime lending refers to the extension of credit to higher-risk borrowers, a practice also commonly referred to as "B/C" or "nonconforming" credit. The Commission believes the subprime mortgage market has flourished because such lending has been profitable, demand from borrowers has increased, and secondary market opportunities are growing. While the enormous growth of the subprime mortgage industry has enabled many consumers to obtain home loans who previously would have had much more limited access to the credit market, the agency said there are potential pitfalls for unwary consumers.

"Elderly consumers, in particular, are often targets of some subprime home equity lenders, because they often have substantial equity in their homes, yet have reduced incomes. In many cases, those living in lower-income and minority neighborhoods -- where traditional banking services continue to be in short supply -- tend to turn to subprime lenders when, in fact, they may be eligible for loans with better terms," Bernstein said.

In two recently released Consumer Alerts, which are available in English and Spanish, the agency highlights in an easy-to-read format some of the issues for consumers to consider before using their homes to guarantee loans.

For example, in the alert titled "Home Equity Loans: The Three-Day Cancellation Rule," the agency explains the rule and notes that consumers applying for a personal loan and using their homes to guarantee repayment of the loans have three days to reconsider their decision and to cancel the deal without penalty. This "right to rescission" is guaranteed by the Truth in Lending Act. The brochure explains that consumers can rescind a contract for any reason. However, there are some instances, such as applying for a loan to buy or build your principal residence, when the right to rescission does not apply.

The alert about reverse mortgages, "Reverse Mortgages -- Cashing In On Home Ownership," outlines some issues for consumers to consider before applying for a reverse mortgage. Reverse mortgages are often of interest to older consumers who have paid off their mortgages and are living on fixed or limited incomes. A typical reverse mortgage is a loan where the lender pays the homeowner a monthly advance while the consumer continues to live in the house. The amount of such a loan depends upon the consumer's age, the equity in the home, and the interest rate the lender is charging. Among the facts to consider before applying are that:

• Reverse mortgages are rising-debt loans. This means that interest is added to the loan's principal balance each month because interest is not paid on a current basis. Therefore, the amount owed increases over time as the interest compounds.

• Reverse mortgages use up some or all the equity in your home, leaving fewer assets for you and your heirs.

In a third publication, "Home Equity Scams: Borrowers Beware!," the FTC explains some common fraudulent practices, including equity stripping, loan flipping, and credit insurance packing, and offers tips on how consumers can protect themselves. The brochure, which is available in English, notes that:

• Equity stripping occurs when a loan is made based on the equity in a property rather than on a borrower's ability to repay the loan. As a general rule, loans made to individuals who do not have the income to repay such loans usually are designed to fail. They frequently result in the lender acquiring the borrower's home and any equity the borrower had in the home.

• Packing is the practice of adding credit insurance or other "extras" to increase the lender's profit on a loan. Lenders often stand to make significant profits from credit insurance and, therefore, have strong incentives to induce consumers to buy it as part of a loan.

• Flipping occurs when a lender induces a borrower to repeatedly refinance a loan, often within a short time frame, charging high points and fees each time.

All three publications are free and are available on the agency's website at www.ftc.gov or by calling the FTC at 202-FTC-HELP (202-382-4357).

NOTE: The FTC regulates non-bank lenders and enforces several credit laws that protect consumers, including the Truth in Lending Act, Equal Credit Opportunity Act, and the Fair Debt Collection Practices Act.

Copies of the English and Spanish versions of "Home Equity Loans: The Three-Day Cancellation Rule" and "Home Equity Scams: Borrowers Beware!," and other consumer education materials are available from the FTC's web site at http://www.ftc.gov and also from the FTC's Consumer Response Center, Room 130, 6th Street and Pennsylvania Avenue, N.W., Washington, D.C. 20580; 202-FTC-HELP (202-382-4357); TDD for the hearing impaired 1-866-653-4261. To find out the latest news as it is announced, call the FTC NewsPhone recording at 202-326-2710.