The National Home Equity Mortgage Association ("NHEMA") appreciates the opportunity to
participate at this hearing on banking issues associated with Bankruptcy Reform Legislation. I
am Wright Andrews, a partner in the law firm of Butera & Andrews and Washington Counsel to NHEMA.
The key point that my testimony today will make is this--NHEMA believes that bankruptcy
reform legislation should be focused on issues that are directly related to bankruptcy. It should
not include provisions, as some advocated in the last Congress, that attempt to address certain
abusive mortgage lending problems indirectly through the bankruptcy process. Legislative
changes to help prevent such improper practices should be made by amending applicable
mortgage laws, not the bankruptcy law.
NHEMA urges that this Committee, and its House counterpart, come forward this year with
reforms to the mortgage lending provisions in Truth in Lending Act ("TILA") and the Real Estate
Settlement Procedures Act ("RESPA"). Such RESPA/TILA legislative reforms should include
adding substantive consumer protection provisions that are targeted at preventing abusive lending
practices. A few unscrupulous mortgage brokers and lenders are engaging in certain unethical
and/or predatory practices such as "loan flipping," and these bad actors must be stopped.
NHEMA abhors such practices and strongly supports targeted legislation and other actions to
protect consumers from these abuses. Such legislation should attack the problems directly
through amendments to the Truth in Lending Act ("TILA") and the Real Estate Settlement
Procedures Act ("RESPA"). These lending issues should not be dealt with in a back-door or
indirect manner in the bankruptcy bill.
Background on Home Equity Lending
NHEMA, which this year is celebrating its 25th Anniversary after being founded in 1974, is the
principal trade association for the home equity lending industry. This segment of the consumer
mortgage industry is often called "non-conforming" lending. Home equity loans generally
include non-purchase money first mortgages and second mortgage loans made to borrowers who
can not meet (i.e., do not conform to) the strict "prime" credit and other underwriting criteria of
the two giant housing government-sponsored enterprises, Fannie Mae and Freddie Mac, that buy
and securitize loans for the secondary market. The home equity market segment includes what is
often called "B/C" or "sub-prime" mortgage lending.
Today, home equity loans are originated through literally tens of thousands of different mortgage
originators. They include: mortgage brokers, mortgage bankers, finance companies, banks,
thrifts and credit unions.
Home equity lending has grown dramatically in recent years. This industry has become a principle source of credit for millions of Americans(1)
. In 1997, for example, this portion of the
mortgage industry originated approximately 4.1 million loans totaling nearly $270 billion.
NHEMA's 330 member companies originate the vast majority of these loans and provide
employment for several hundred thousand people throughout the nation.
Most of the millions of home equity loans being originated yearly involve no problems from a
consumer protection point of view. However, there are in fact some loans where unethical
originators engage in predatory lending or other improper practices. For example, some
mortgage brokers or loan officers engage in loan "flipping," which is essentially encouraging
consumers to repeatedly and unnecessarily refinance their loans so the sales person can make
sales commissions. A few lenders, including one in this area, also utilize improper techniques to
make undue profits in foreclosure proceedings.
Quite frankly, NHEMA wants these bad actors put out of business. They are hurting consumers
and unfairly tarnishing this industry's image. We are committed to driving them out of this
industry, and are now executing an aggressive three-part strategy for doing so. As I will explain
subsequently, NHEMA's efforts involve industry self-policing, consumer education programs
and targeted legislative reforms to protect consumers from certain specific abuses.
Bankruptcy Reform Legislation
There has been a significant and troubling increase in personal bankruptcy filings during the last
several years. Despite our nation's growing and healthy economy and low unemployment,
around 1.4 million people filed for bankruptcy last year. The need for reform measures has been
well documented in the extensive hearings of the Senate and House Judiciary Committees and
the work of the bipartisan Bankruptcy Review Commission.
Like most trade groups associated with the financial services business, NHEMA has been
generally supportive of bankruptcy reform legislation. NHEMA endorsed the Conference Report
on H.R. 3150, which was passed by the House, but not voted on in the Senate last year. As this
Committee knows, that report contained several provisions within your jurisdiction. It would
have amended TILA with regard to disclosures and certain other matters. This year, Rep.
George Gekas has reintroduced the Conference Report with those TILA/consumer credit
provisions in the House as H.R. 833. The Senate version of this legislation, S. 625, introduced
by Senators Grassley and Torricelli, does not contain such provisions that raise issues within this
NHEMA believes, however, that the Banking Committee's current consideration of these
banking related TILA and consumer credit issues is quite appropriate. Even if the Senate
Judiciary Committee does not add provisions that raise these banking issues, floor amendments
may well seek to do so. And, it appears likely that such banking related issues will be raised in
conference on the eventual Senate and House bills. Therefore, we hope that the Banking
Committee will carefully examine these issues and that your Members will weigh in with their
expertise and views as the legislation proceeds toward final passage.
Issues Relating to Home Equity Lending Practices
I would like to focus this Committee's attention on one particular matter that came up during last
year's debate, and that may well be raised again, especially during floor debate. This is the
matter of so-called "predatory lending" practices in home equity lending.
When the Judiciary Committee was marking up the bankruptcy bill in 1998, Senator Durbin
offered an amendment that had the stated purpose of discouraging predatory lending practices. It
was adopted and included in the Senate bill, but subsequently dropped from the Conference
The actual effect of the Durbin amendment, albeit well intended, would have been quite adverse
for both consumers and lenders. In essence, the Durbin provision provided if there had been a
violation of TILA Section 129 (the so-called "HOEPA" loan provisions, which also are
sometimes called "Section 32") then the principal amount of a secured mortgage loan would be
forgiven. The loan principal would not be allowed as a claim in a bankruptcy proceeding.
"HOEPA" is the acronym for the "Home Owners Equity Protection Act," which imposes
additional disclosure requirements and substantive restrictions on certain higher cost mortgage
loans(2). Unfortunately, HOEPA fails to include any provision for tolerances for minor,
unintentional errors, or for the lender to correct mistakes.
Under the Durbin Amendment, any violation----no matter how immaterial or technical----of the
requirements of TILA Section 129, would trigger this draconian "free house" provision. For
example, if a lender made a simple $20 mathematical error on a $100,000 HOEPA mortgage
loan, the debtor in a bankruptcy proceeding would not have to pay the mortgage debt. The debt
would be extinguished and the debtor would get to keep the property. The amendment as drafted
last year also appeared to have retroactive application to existing loans.
Such a penalty is extreme and unwarranted. HOEPA already gives debtors adequate protections
and a strong remedy by allowing them to rescind the loan if there are violations and to have all
interest payments and fees refunded. Allowing complete debt forgiveness of the loan principal
due to a HOEPA violation would create a huge incentive for many people to file bankruptcy in
order to try to have their mortgage debt canceled. Litigation also would be encouraged, and
bankruptcy judges would be having to decide TILA claims.
If an amendment of this nature was enacted, many lenders clearly would stop making HOEPA
loans because their risk of major losses due to minor errors would be too great. Others would
raise their prices to all consumers to offset the higher costs caused by the amendment. The net
effect would be to harm thousands of consumers who would have their access to credit limited
and the cost of credit , when they could obtain it, increased. These consumers would be the
"victims" not of predatory lenders, but of misguided legislation.
Lenders currently have strong incentives to ensure HOEPA compliance, but this is not always
easy. There is still considerable uncertainty as to how particular terms are to be interpreted.
Creditors do make honest mistakes in deciding whether or not a loan is a HOEPA loan.
Currently, as I mentioned earlier, this law contains no tolerances for minor errors, and it does not
provide any opportunity for the lender to correct or cure the violation. Few HOEPA violations
arise because the lenders include prohibited terms of practices (e.g., negative amortization
provisions). Instead, problems arise because of minor mathematical computational errors and in
determining whether certain fees or costs must be included when computing whether HOEPA's
closing cost threshold is met.
HOEPA loans are nor illegal nor do most involve any type predatory lending practices. The
practices that are generally considered as creating most of the problems (e.g., loan "flipping" and
foreclosure abuses) are not even dealt with in HOEPA. Furthermore, most HOEPA loans are not
targeted at vulnerable senior citizens, but are made instead largely to people in their 40s, who
have relatively good credit and income levels. In fact, the so-called "high-LTV" loans, which are
made primarily to younger, upper income consumers with very high credit ratings, often fall
under the HOEPA requirements.
NHEMA is committed to increasing statutory consumer protections in home equity lending.
However, we strongly believe that such protections should be added through targeted
amendments to RESPA/TILA and should not be included in bankruptcy reform legislation. Also,
I want to emphasize that NHEMA believes that legislative remedies can and must be crafted so
as to not unduly restrict the flow of credit to home equity borrowers or cause their rates to
Without question, out of the millions of home equity mortgage transactions each year, some
unscrupulous mortgage brokers and lenders do engage in what can be called "predatory," or at
least improper and unethical practices. NHEMA is convinced, however, that such abuses are
being perpetrated by only a small minority of brokers and lenders and are but a tiny fraction of
overall home equity mortgage originations. Nevertheless, we view any abuses as unacceptable.
NHEMA has been and is working hard to see that these practices are stopped. The association is
forcefully attacking these problems through a three-part strategy involving: (1) industry self-policing through the development of voluntary standards and practices; (2) consumer education
initiatives; and (3) tough, but targeted legislative proposals that will prevent particular abusive
In brief summary, NHEMA's efforts include:
Mr. Chairman, in summary, NHEMA is fully committed to seeing that workable targeted
legislative reforms are passed. Our association believes that improper lending practices are not
nearly so prevalent as some parties allege. Nevertheless, to the extent any abuses exist, we must
work to stop them. Such abuses are very harmful to both the home equity lending industry and
the consumer borrowers it serves. NHEMA will be presenting our specific legislative proposals
to the Members of this Committee within a few weeks, and we look forward to working with
each of you. Such additional substantive consumer protections should be enacted in mortgage
reform legislation coming from this Committee. The bankruptcy bill is not the proper vehicle for
attempting to address these mortgage lending issues.
1. Home equity loans, which may be either first mortgages when consumers refinance their homes or second mortgages, average around $65,000. Contrary to the distorted picture some parties have painted, most home equity borrowers are not elderly or poor highly vulnerable consumers. The typical borrower is in his or her early 40s. Only about 10% are over 65 years old. Roughly 60% have incomes over $50,000. Only 10% have incomes less than $30,000. About 65% 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 consumers' credit ratings are clearly lower than those of the "A" borrowers served by the so-called conventional or "prime" credit market. However, they are generally still solid citizens who meet their mortgage 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, such as a divorce, a serious medical problem or a loss of their job. These borrowers do have to pay a somewhat higher interest rate, depending on their individual records, to reflect additional risk Home equity lenders experience more delinquencies and defaults, and have higher servicing costs. Roughly 94% of home equity borrowers are current on their mortgage payments. This is a little less than the 97% figure that applies to prime borrowers, and slightly more than the 92% of government-guaranteed loan borrowers (e.g., FHA or VA loans). 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. Foreclosure is generally very expensive for lenders and most 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 foreclosure, they end up losing money about 93% of the time. Lenders average losing roughly half of every dollar they have invested in the property. Because home equity lenders incur significantly higher costs, they must accordingly charge higher rates to offset these costs. However, home equity loan rates are still generally quite reasonable and less than credit card rates. Generally, depending on the risk level, rates for home equity loans will run from 2% to 6% higher than prime loan rates. In 1997, home equity rates averaged about 11% and for most home equity borrowers ran between 8.5% and 14%. The background paper on home equity lending in Appendix # 1 explains this industry in much more detail.
2. For loans with an APR of 10% or more above the Treasury rate with a similar maturity, or 8 or more points, HOEPA mandates that a special disclosure be given to the borrower at least 3 days before closing and imposes the following substantive restrictions: (1) no balloon payment in the first 5 years; (2) no negative amortization; (3) no advance payments from loan proceeds of more than 2 periodic payments; (4) no increased interest rate upon default; (5) no refunds of interest on loan acceleration due to default by a method less favorable than the actuarial method; (6) no prepayment penalties unless (a) the penalty can be exercised only for the first five years; (b) the source of prepayment funds is not a refinancing by the creditor or its affiliate; and (c) at consummation, the total monthly debts of the consumer do not exceed 50 percent of the consumer's verified monthly gross income; (7) no engaging in a pattern or practice of extending credit to a consumer based on the borrower's collateral if, taking into account the consumer's current and expected income, current obligations and employment status, the consumer will be unable to make the scheduled repayments; (8) limitations on how home improvement contractors may be paid; and (9) no assignment or sale of the mortgage may be made without a notice saying: "Notice: This is a mortgage subject to special rules under the federal Truth in Lending Act. Purchasers or assignees of this mortgage could be liable for all claims and defenses with respect to the mortgage that the borrower could assert against the creditor."
3. Attached as Appendix # 2.
4. Attached as Appendix # 3.
5. The Committee's staff has been given copies of NHEMA's consumer guide.
6. Attached as Appendix # 4.
7. NHEMA's comprehensive legislative reform proposals have been given to the Committee's staff.
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