Possible Dangers Lurk in Home Equity Loans, Survey Cautions

Many home equity loans offered by major California savings institutions lack protection against rising interest rates and carry high annual fees and other costs that may make them unwise for some consumers, a survey to be released today contends.

It also is difficult to compare loans between institutions because fees and other costs are often calculated differently and sometimes are not fully disclosed initially, the survey says.

“People should shop extremely carefully for home equity loans because of problems with disclosure and because they are dealing with their most valuable asset--their home,” said Ken McEldowney, executive director of Consumer Action, a San Francisco-based organization that conducted the survey.

The survey of home equity and second mortgage loan programs at 30 California banks and savings and loans, current as of April 3, is believed to be the first comprehensive statewide survey of these loans since passage of the Tax Reform Act of 1986. By phasing out tax deductions on non-mortgage borrowings such as credit-card and auto loans, tax reform has helped make home equity loans one of the nation’s fastest-growing financial products, with estimated borrowings of as much as $200 billion nationwide.

Home equity loans provide a line of credit secured by home equity. Because tax reform preserves deductions for interest on home equity loans and other mortgage-related loans, many consumers are using the loans to pay off credit card borrowings or to finance purchases of cars or other big-ticket items. And, because home equity loans are secured, their interest rates tend to be far lower than those on credit cards.

But the Consumer Action survey points out that home-equity loans are fraught with risks. One of the biggest risks is lack of protection against rising interest rates, Consumer Action said. All of the 25 home equity loan products listed in the survey carry variable rates tied to the prime rate, certificate of deposit rates or various indexes.

But none carries a limit, or “cap,” on how much the rate can rise in a given year. (Some institutions not surveyed, however, do offer annual rate caps.) Two of the 25 listed loans do provide interest rate caps over the life of the loan, but these are set at levels more than 6 interest points above their annual percentage rate, the survey said.

Without caps, a dramatic rise in interest rates could make it much harder for borrowers to pay off the loans, possibly leading to default and loss of the home through foreclosure, Consumer Action’s McEldowney warned.

Home-equity borrowers should “pray that rates do not return to the high levels of the past,” he said.

Second mortgages, which provide fixed loan amounts rather than lines of credit, are much safer, the survey said. Most institutions offering variable-rate second mortgages provide annual and life-of-loan caps on those loans, the survey showed. Rates on home equity loans also change frequently--with some changing weekly or even daily--while rates on variable-rate second mortgages tend to change only every three or six months.

The Consumer Action survey showed that fees on home equity loans vary considerably. Annual fees range from as low as zero at California First Bank and Citicorp Savings to as high as $125 at Far West Savings. One-time loan set-up fees, excluding points, range from as low as $150 at Home Federal Savings to as high as $1,300 at Citicorp Savings, based on a $25,000 home equity credit line with an outstanding balance of $10,000.

Such high fees and set-up charges make home equity loans a poor choice for consumers borrowing small amounts, McEldowney said. Fees can also wipe out any tax savings from interest deductions, he added. Fees on second mortgages tend to be lower than on home equity loans, the survey showed.

Annual fees and set-up charges on home equity loans often are not fully disclosed in advertising, McEldowney complained. Also, he said, many institutions do not initially disclose appraisal fees, document inspection fees and other home-borrowing expenses that are charged by outside parties.

Comparisons of annual percentage rates (APRs) among institutions are difficult because some firms exclude certain fees from their calculation of APRs while others include them, Consumer Action researcher Sheila Kolenc added. For example, Security Pacific National Bank excludes appraisal fees from its APRs; California Federal Savings and Gibraltar Savings include them, she said.

Inconsistent or inadequate disclosure of fees and rates “is an industrywide problem,” McEldowney contended, blaming the lack of standardization on the relative newness of home equity loans. “For loans with such potential danger, the disclosure problem has to be resolved.”

McEldowney also urged consumers to be wary of making interest-only payments on home equity loans. Such payments, allowed by many institutions, require consumers to make a gigantic “balloon” payment of principal when the loan term ends. A consumer who refinances that balloon payment instead of paying it off will have to cough up more new-loan fees, McEldowney said.

Nancy E. Sheppard, a spokeswoman for the California Bankers Assn., said the industry applauds efforts like that of Consumer Action to make consumers more aware of the variations in rates and fees. She added that while home equity loans do put borrowers’ homes at risk, actual defaults have been low.

Also, she said, consumers should take out home equity loans only for major expenses such as home improvements and children’s college education costs, not for purchases of autos or other goods that do not last as long as the term of the loan.

Consumers may obtain free copies of the survey results by sending a self-addressed, stamped envelope with 39 cents postage to: Consumer Action Home Equity, 693 Mission St., San Francisco, Calif. 94105.

HOME EQUITY LOANS AT SOME MAJOR CALIFORNIA INSTITUTIONS

Annual Percentage Annual Institution Rate Points Fee Bank of America 9.92 None $50* California Federal S&L; 10.05** None $35 First Interstate Bank 10.25*** None $50 First Nationwide Savings 10.13 None $50* Glendale Federal S&L; 9.75 None $35 Great Western Savings 9.75 1.5 $40* Security Pacific National Bank 10.22 1.5 $100 Wells Fargo Bank 10.45 None $45*

* Annual fee waived in first year.

** Promotional rate of 7.9% is available through Sept. 30, 1987.

*** Loan with 9.75% rate but higher fees is also available.

Source: Consumer Action; Los Angeles Times survey.

HOME EQUITY LOANS AT SOME MAJOR CALIFORNIA INSTITUTIONS

Minimum Monthly Balloon Repayment Institution Payment Terms Bank of America None while Open-ended loan; active monthly interest charged to account. California Federal S&L; None while Greater of: 1.75% of active loan balance or $100. First Interstate Bank None while Interest only plus active insurance or interest plus 2% of principal plus insurance. First Nationwide Savings Yes Greater of: $200 or month’s accrued interest. Glendale Federal S&L; None while Greater of: 1.7% of active loan balance or $100 or month’s accrued interest. Great Western Savings Yes Interest only. Security Pacific National Bank None while Interest only. active Wells Fargo Bank Not until Revolving: interest repayment only while acount is term ends open. Repayment: 20-year amortization, 7-year maximum repayment period.

Source: Consumer Action; Los Angeles Times survey.