Hearing on Bankruptcy Reform and Financial Services Issues

Prepared Testimony of Mr. Wright H. Andrews, Jr.
Butera & Andrews

9:30 a.m., Thursday, March 25, 1999

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 Committee's jurisdiction.

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 Committee's bill.

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's Efforts

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 increase.

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 practices.

In brief summary, NHEMA's efforts include:

  1. Self-Regulation -- NHEMA promulgated in 1998 a new industry Code of Ethics(3). NHEMA, working in conjunction with the American Financial Services Association, developed a set of Voluntary Standards for Home Improvement Lending(4). Currently, we are working with several groups to craft a set of "best lending practices" that will be very helpful in setting proper lending standards.

  2. Consumer Education -- NHEMA also is expanding its consumer education initiatives. Last year, we issued a consumer guide on home equity lending(5). Earlier this year, NHEMA released "Home Equity Borrowing Tips For The Elderly"(6) to help seniors understand how best to take advantage of home equity borrowing and how to avoid improper sales practices. Currently, NHEMA is in the process of developing a substantial national consumer education program, the details of which we expect to announce within several months. It will greatly increase the industry's outreach efforts to the elderly, minorities and others who many perceive as being most vulnerable to the practices of unscrupulous brokers and lenders.

  3. Targeted Legislative Protections -- NHEMA has developed comprehensive legislative proposals for reforming the consumer mortgage lending provisions of TILA and RESPA, including adding effective targeted legislative provisions(7) to address the major abusive lending problems. And, just last week at NHEMA's Annual Meeting, the Board of Directors approved our going forward with a major legislative initiative that will involve strongly advocating that this Congress pass a number of targeted substantive consumer protections to prevent specific predatory lending practices such as loan "flipping" and foreclosure abuses.


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.

Thank you.


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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