U.S. Warns Lenders To Elevate Standards Agencies Cite Risks In Home Equity Loans By Kirstin Downey Washington Post Staff Writer Tuesday, May 17, 2005; Page A01
Federal banking regulators yesterday warned banks and other lenders to be more selective about who can get home equity loans and lines of credit because rising interest rates may make it harder for people to repay their loans.
Government officials said that while mortgage defaults remain rare, many institutions are loading up on high-risk loans.
They urged lenders to review interest-only loans, which allow borrowers to delay principal payments for years, and "no-doc" loans, which don't require documenting borrowers' assets and income. They also suggested that lenders that refuse to do so may find themselves facing heightened federal oversight.
For consumers, it could become tougher to get some kinds of home equity loans, such as those that amount to 100 percent of a home's value. "It may curtail the appetite of some lenders for taking risks and if it does, it would reduce the credit supply to some consumer groups," said Douglas G. Duncan, chief economist for the Mortgage Bankers Association.
"I think this is a policy that's long overdue," said John H. Vogel Jr., a professor of real estate at Tuck School of Business at Dartmouth University. "We've built an entire housing finance structure based on the belief that housing will always keep going up, and people are using home equity loans with the assumption they can always repay them when they sell their houses at an increased value."
The regulators' warning came in what is called a "guidance" to the lending institutions, issued jointly by the Office of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corp., the Office of Thrift Supervision and the National Credit Union Administration. They told the lenders they regulate that the institutions' "credit risk management practices have not kept pace with the products' rapid growth and easing of underwriting standards."
The regulators urged banks, thrifts and credit unions to use particular caution in making loans originated by mortgage brokers, who are not bank employees and who are paid by commission based on the volume of loans they complete.
"For control purposes, the financial institutions should retain appropriate oversight of all critical loan-processing activities, such as verification of income and employment and independence in the appraisal and evaluation function," the guidance said.
Similarly, lenders were also warned to be wary of loans purchased from financial institutions called "correspondents," which make loans on their own for resale to other lenders. Banking regulators noted that correspondents, too, "have an incentive to produce and close as many loans as possible."
Meanwhile, lending institutions should be monitoring the financial health of their home equity customers by periodically checking their credit scores, assessing the way people use their loans, monitoring home values in the neighborhood and using behavioral scoring to identify potential problem accounts. When such problems arise, lenders should refuse to extend additional credit or even reduce the credit limit available, the agencies said.
Some lenders do not see a looming problem.
"As long as the housing bubble doesn't burst, home equity lines should remain strong and remain safe," said Scott Stern, chief executive of Lenders One, a St. Louis-based cooperative of 60 mortgage companies that originate home-equity lines, including some that feature 100 percent loan-to-equity ratios. "As long as the bubble doesn't burst, there should be no serious problem."
Whether some or all of the country is experiencing a real estate price bubble, in which speculation causes prices to rise to a level that is unsustainable, continues to be debated among economists.
At issue is the fast-growing market for home equity lending, which rose to $881 billion at the end of 2004 from $492 billion at the end of 2000, up 79 percent, according to the Federal Reserve. Overall mortgage indebtedness nationwide climbed 57 percent, to $7.54 trillion at the end of 2004 from $4.8 trillion at the end of 2000.
With average wages growing less than inflation, many homeowners have turned to home equity loans or lines of credit to make purchases, renovate their residences, consolidate credit card debt and pay bills they otherwise couldn't afford, such as medical expenses.
High home-price appreciation, low interest rates and the deductibility of the interest have made such loans especially attractive to consumers at a time when two-thirds of all households own homes -- leading to a rush to spend burgeoning home equity.
Veteran banking consultant Bert Ely said the warning comes at a time when a growing number of industry observers think the real estate price appreciation bubble "can't expand further." He added that whenever home prices rise for a long time, "some lenders go overboard."
Lenders need to take the message seriously, Ely said. "Banks are learning that 'guidance' is increasingly a code word for 'regulation,' " he said.
The government warning was issued on the same day that the National Association of Realtors called for increased consumer education on the dangers of what the trade group called "toxic" loans with predatory terms that hurt homeowners, such as high-interest-rate loans that could cause them to lose their homes if they lost their jobs. The group said that banking regulators were doing little to protect homeowners.
"Consumers are also at risk, and the possibility exists that they could lose their homes" to foreclosure, said JoAnne Poole, president of the Maryland Association of Realtors.
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