Questions and Answers About Home Equity Loan Fraud

CBO leader's guide to accompany 'Don't Lose Your Home: How to Avoid Home Equity Loan Fraud' fact sheet

A manual for community and consumer advocates working to educate senior, low income and minority home owners about the dangers of home equity loan fraud. Topics covered include home improvements, hiring a contractor, warning signs of fraud and the possibility of losing your home through a home equity loan.

Introduction

Thousands of senior home owners nationwide have become the victims of scam artists who convinced them to sign away the equity in their homes in return for often unneeded repairs or high interest loans. The loss of homes is especially acute in the African American community and other minority inner-city neighborhoods, where mainstream credit opportunities are scarce and low income residents are vulnerable to fraud.

Home equity loan fraud comes in a variety of guises from home repair scams to deed forgeries to neighborhood loan sharks. While state and federal laws give home owners and their advocates some tools to fight back with, the most effective way to avoid home equity loan fraud is not to fall for it in the first place.

This manual is designed to educate staff members at community-based organizations and other advocates who are working with at-risk populations. It was created by Consumer Action with funding from The San Francisco Foundation's Bank of America Consumer Education Fund (BACEF) and can be used to help answer clients' questions about home equity loan fraud. For your clients, a consumer education brochure titled "Don't Lose Your Home: How to Avoid Home Equity Loan Fraud" is available in bulk at no cost to community-based organizations, in three languages: Chinese, English, Korean, Spanish and Vietnamese.

Your Home: A Valuable Asset

Older, low income, minority and other vulnerable homeowners often are not eligible for loans from banks and other mainstream lenders. Seniors, who are usually retired and live on Social Security or pensions, may not have the income necessary to borrow money without collateral.

Many senior homeowners have made years of hard-earned mortgage payments, and often own their homes "free and clear." The high rate of appreciation on real estate has in many cases left them "land rich, but cash poor."

While a home equity loan from a reputable lender may be an effective way to generate cash, homeowners have to be cautious and aware in evaluating any offer that jeopardizes the hard-earned cash value of their homes.

Q. What is a "home equity loan"?

A traditional home equity loan allows you to borrow money against your home's equity (usually the estimated value of the house minus the amount you still owe). Your home is the collateral to guarantee that you will repay the loan. If you are unable to make the home equity loan payments, you can lose your house when the lender exercises the right to foreclose on the property and sell it at public auction.

Mortgage Scams

Q. What is home equity loan fraud?

Any attempt to steal the equity in someone's home is home equity loan fraud. Swindlers have gotten quite creative about ways to do this. Here are just some of the ways homeowners have been defrauded:

• Home repairs: Door-to-door salespeople offer "easy financing" for home improvements and repairs, often working in cahoots with unscrupulous lenders. The work they recommend may not be needed at all and often they do a very shoddy or incomplete job. The loans they arrange are secured by your home and often carry very high interest rates and other costs. Often the required monthly payment is so far out of line with the borrower's income that failure to pay and foreclosure are almost inevitable.
• By caretakers, friends or family members: These people befriend senior homeowners and gain their trust. Then they convince the homeowners to sign over the houses to them or set up home equity loans and lend them the proceeds.
• Refinancing scams: Homeowners are solicited by brokers to refinance their existing mortgages, replacing them with loans that the homeowners cannot afford. The broker makes money off commissions, upfront fees and closing costs, and may convince homeowners to borrow more money than they need and to roll the closing costs into the loan, resulting in defaults when the home owners cannot meet the monthly payments.
• Deed forgeries: Scam artists forge the home owner's signature on a blank "grant deed" in order to transfer ownership of a property. Much of the information that swindlers need to fill out the form is available through public records. Using the phony grant deed, crooks can go to a bank and borrow against the equity in the home before the real owners even realize they were defrauded. In an attempt to deter this fraud, a state law now requires notaries to take a thumb print of anyone having a deed notarized.
• Foreclosure consultants: People facing foreclosure often fall prey to this scam. In one scenario, the consultant takes a large fee to "save" the house, but instead vanishes with the money. In another scheme, the consultant convinces the homeowner to sign over the deed to him or her in order to save the house, and then begins eviction proceedings to kick the victim out.
• Home equity skimming: A home seller agrees to finance the sale for the buyer (owner financing). The buyer gives the seller a small downpayment. When the house is sold and the deed recorded, the new owner goes to the bank, takes out a home equity loan, and disappears with the money. If the seller had recorded the lien on the new deed, no bank would have made a home equity loan to the new owner.
• Blank documents: The homeowner is tricked into signing a lien document or deed transfer disguised as other paperwork, such as a service contract or registered mail receipt.
• Phony fly-by-night lenders: They set up offices in low income and minority neighborhoods, get homeowners' signatures on loan documents and then disappear with the loan money. To add insult to injury, the loans may be resold to another lender who then forecloses on the homes.

Q. Why are seniors so often the target of home equity loan swindlers?

Many seniors have paid off their mortgages and own their homes "free and clear." Often, senior homeowners are widows who never had much to do with the family's finances, and who are unsophisticated in dealing with complex issues of credit. Sometimes, seniors are easy targets for scams because they were raised in an earlier time when people were more trusting of each other. And sometimes seniors are lonely and therefore open to abuse by caretakers and younger family members.

The Home Owners Equity Protection Act

Q. Is there a law to protect people from home equity loan fraud?

In 1995, the federal Home Owners Equity Protection Act (HOEP) went into effect. An amendment to the Truth in Lending Act (TILA), it covers only closed-end loans that are secured by the consumer's principal dwelling. (The law by definition does not cover home equity lines of credit, which are not considered "closed-end loans." Reverse mortgages are also excluded.)

The terms of a covered loan must include at least one of two triggers:

• An annual percentage rate (APR) that is more than 10 percentage points above the yield on Treasury securities with comparable maturities.
• Upfront points and fees, including broker's fees, of at least $400, that exceed 8% of the total loan amount.

In addition, the following terms are generally prohibited:

• Prepayment penalties, except in the first five years of the loan. It also prohibits prepayment penalties during refinancing with the same creditor or an affiliate.
• Any terms that make it impossible, or nearly impossible, for homeowners to cure a default or that attempt to unduly inflate the amount due on a loan after default.
• Balloon payments with terms shorter than five years and negative amortization (when the original loan amount is increased because the monthly payments do not ccover the interest due).
• Extending credit without regard for ability to pay.
• Payments to be made directly to home improvement contractors.

HOEP allows for enforcement by state attorneys general and prohibits unfair trade practices. The law prohibits several loan terms. If any of these prohibited terms are included in a home equity loan contract, the contract may be rendered unenforceable and the security interest in the home removed. The law's remedies include the possibility of civil liability for damages, attorneys' fees and costs, enhanced damages for all finance charges and fees by the homeowner.

Q. Is there a "cooling off" period during which I can cancel a home equity loan contract without liability?

TILA gives consumers a "right of recission," allowing them to cancel a home equity loan contract within three days for any reason.

The three days (excluding Sunday) begin only after all three of the following things happen: the loan contract is signed, the signer receives disclosures of all loan terms as required by TILA, and also receives two copies of a "Notice of Right to Cancel," explaining the right of recission. If you choose to cancel, your closing costs will be refunded to you. The lender must remove any liens placed on your property within 20 days. You will be required to return any loan proceeds that have been advanced to you.

Q. What is a fair interest rate on a home equity loan?

In early 2000, according to BankRate Monitor, the national average APR was 9.01%. To find up-to-date rates and national averages, visit the BankRate web site (www.bankrate.com) and click on home equity loans.

Home Improvements & Hiring a Contractor

Q. Is a home equity loan a good way to pay for urgently needed home repairs when I don't have the cash?

Home equity loans can be a good way to pay for repairs. However, since they are secured by your house and property, you could lose your home if you cannot meet the terms of the loan. Make sure you can afford to make the monthly payments.

Other avenues you might want to explore are: borrowing against your life insurance policy or annuity, a low interest rate credit card, federal home improvement loans or state veterans loans (if you have at least 90 days of active military duty). Some cities have interest free loan programs to finance home repairs by low income residents. Also explore the rehabilitation services offered by non-profit organizations such as Habitat for Humanity.

Q. A contractor came to my door and said I needed a new roof and that he could get me a loan. Should I trust him?

This is the approach used by con artists. Organized groups of criminals often go door-to-door in the aftermath of floods, earthquakes and other disasters. They prey especially on seniors. Victims are often conned into making home improvements with loans secured by a second mortgage. The crooks tell victims that there's something seriously wrong with the house, and that they can fix the problem and recommend a lender who will loan the homeowner money for the work.

Be cautious about anyone who comes to your door uninvited, and be extra cautious about using a lender recommended by a contractor, or vice versa. Never hire a door-to-door contractor until you have first asked for competing bids by other contractors, and always check out their licenses with the state.

Q. What is a mechanic's (or contractor's) lien, and can I lose my home because of one?

Even if you do not borrow money for the repairs, most home repair contracts can result in a lien on your home. If you do not make full payment to the contractor, you could lose your home. (It is illegal for a contractor to take a security interest in your home for any work that is not a permanent part of your home. For instance, a contractor could put a lien on your property for a new roof, kitchen or bathroom, but not for installing carpeting, drapes, water filters or satellite dishes.)

If local laws permit, you can ask to have a "release of lien" clause added to your contract, requiring the contractor or subcontractors and suppliers to waive the right to a mechanic's lien by giving you a "certificate of waiver of lien." You could also place your payments in an escrow account until the work has been completed and subcontractors and suppliers have verified that they have been paid. The risk of mechanic's liens is greatly reduced by protecting yourself with a contract bond (which guarantees that the job will be completed and all labor and materials paid for) and/or use of a joint control company (a licensed escrow company that specializes in handling funds for construction jobs).

Q. What can I do to protect myself from unscrupulous contractors?

If you live in one of the 36 states that require contractors to be licensed, don't neglect to check if the license is valid and current. If a contractor shows you a document with a license number on it, ask to see a driver's license or other photo ID that proves the contractor is really the licensed individual or employee named on the license.

Make sure your contractor gets the appropriate building permits and check them yourself by calling your local building inspector. Research the laws of your state they may limit the amount of the downpayment that a contractor can ask for when you sign a contract.

Ask any potential contractor for a list of references and call at least two of the people. Also ask for the addresses of some of the contractor's recent jobs that are visible from the street, so that you can drive by and see the work that was done.

Do not sign a certificate of completion or pay any final installment until the job is completed to your satisfaction. Keep copies of all contracts, permits, change orders, etc.

Warning Signs of Fraud

Q. I was approved for a loan, even though the monthly payments are close to half of my income. The lender said I was approved because my home will serve as security for the loan, even though my income isn't very large. Isn't this poor business judgment?

This lender probably knows and may be counting on the fact that you will have trouble making your payments every month. People need enough to live on and pay their other bills. Because of this, most reputable lenders won't approve applicants for housing-related loans that require payments of more than 28% of their gross income for all such loans in total. If you default on your loan agreement, the lender can take your house away from you, sell it and keep any profits from the sale. Scam artists are usually more concerned about the value of the collateral than about the borrower's ability to repay. Under federal law, lenders who show a pattern of making loans without regard to whether the borrowers can repay the loan may be subject to legal action.

Q. I was pressured into signing a contract for a home equity loan. When I got home, I realized that I don't want the loan. What can I do?

Federal law gives you three days after signing a home equity loan contract to cancel the deal, for any reason. Write a letter notifying the lender that you want to cancel the sale and post it by the three-day deadline. To be safe, also fax the letter immediately, or send a telegram letting the lender know of your intention to cancel. (See The Home Owners Equity Protection Act.)

Q. My son-in-law was having trouble supporting my daughter and grandchildren, and he convinced me to take out a home equity loan on my house so he could use the money to start a business. He said he would make the payments on the loan, but now he is two months behind. What can I do?

Family members often talk seniors into taking out or co-signing loans on their homes. All seniors have an understandable desire to help family members. But remember that this is the roof over your head and your most valuable asset that you are jeopardizing.

You are responsible for the loan along with your son-in-law. Let your children know that you are worried about foreclosure if the loan is not paid. Point out to them that you might lose your house and they might lose any inheritance represented by the home's value. You may want to consult a lawyer. Attorney's consultation fees usually are not high, but if you have a low income, contact your local legal aid society or Consumer Credit Counseling Service office for assistance in averting foreclosure.

Q. Should I get a lawyer to review my home equity loan contract before I sign it?

A home equity loan means you are putting your house on the line. It is always a good idea to have a lawyer look at such an important contract. If you cannot afford a lawyer, call your local bar association and ask how you can find low-cost legal services. Some non-profit senior organizations will review home equity loan contracts and advise you. (See "For More Information".) If the lender will not allow you to take a few days to look over the loan agreement, just walk awaychances are the lender is up to no good.

Q. How can I check if a lender is legitimate before I get involved in a home equity loan contract?

The best way to find out about home equity loans is to shop around. If you speak with several providers, including both small and large banks, you will have a much better idea about how the industry works and be in a better position to choose a lender. (See "For More Information".)

After you have determined that the loan terms are competitive, check with the agency in your state that licenses mortgage lenders to make sure the company is legally able to do business in your state. The Federal Trade Commission (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. (See "For More Information".)

Q. I thought we had been given all the information about our home equity loan, but on the day of the closing we were asked for extra money for "points" and "closing costs." What happened?

By law, when you take out a home loan or mortgage, you must be given a "good faith estimate" of all the terms of the loanincluding fees, points (upfront fees based on the amount borrowed) and closing costs. Once these disclosures have been made, the loan's terms cannot be changedotherwise the security interest in your home will not be enforceable.

Glossary of Important Terms

• Annual percentage rate (APR): Cost of borrowing money, expressed as an annual percentage.
• Balloon payment: Final payment of a debt that is much larger than the payments preceding it.
• Closed-end credit: Loans of a fixed amount of money that is advanced at the beginning of the loan term. These loans have set repayment schedules, such as $200 per month for 60 months.
• Closing costs: Expenses involved in transferring real estate or in acquiring a mortgage, such as bank fees, lawyer's fees, survey charges, title searches, title insurance and fees to file deeds.
• Collateral: An asset, such as a house or car, pledged to a lender until a loan is paid.
• Deed of trust: A document that gives a lender a security interest in your home equal to the amount you borrowed. (See also "Power of sale.")
• Default: When a borrower fails to meet the repayment terms of a mortgage or other loan. In this case, a borrower receives a "notice of default" from the lender.
• Equity: The estimated value of your home, minus the amount you still owe.
• Foreclosure: The process of selling a home whose owner has missed mortgage payments or failed to pay a contractor's lien. For three consecutive weeks a "notice of sale" must be published in a local newspaper and posted in a public place, usually the local courthouse.
• Grant deed: A document used to transfer ownership of a property to another person.
• Home equity loan: A loan guaranteed by the homeowner's equity (usually the estimated value of the home minus the amount still owed to a bank or other lender). Most home equity loans are second mortgages.
• Interest: The cost of borrowing money, usually expressed as an annual percentage rate (APR).
• Late charge: An additional fee that a borrower must pay if a monthly loan payment is made after the due date.
• Lien contract: An agreement, usually with a home improvement contractor, which gives the contractor a security interest in the home and may give the contractor the right to force a sale if the final bill is not paid.
• Mechanic's lien: In many states, a contractor has the right to make a claim against a property if the contractor is not paid in full. If the property is sold, the contractor is paid from the proceeds.
• Negative amortization: When the amount borrowed for a mortgage or other loan increases because the monthly mortgage payments are not large enough to pay all of the interest due.
• Open-ended credit: A loanor line of creditin which all of the borrowed funds are not advanced at the beginning of the credit transaction. The borrower may draw advances up to the credit limit when money is needed, and payments are based on the current outstanding balance.
• Point(s): Upfront fees paid at the closing of a loan which often slightly reduce the interest rate the borrower will pay. A point is one percentage point (1%) of the amount borrowed, two points is 2%, etc.
• Prepayment: When the principal (original amount borrowed) on a mortgage or home equity loan is paid off in full, such as upon sale of the property or refinancing, or by paying more each month than agreed upon.
• Prepayment penalty: A provision in a mortgage or home equity loan contract allowing the borrower to be charged extra money for paying the loan off early or refinancing.
• Principal: The face value of a debt, or original amount borrowed, separate from any interest owed.
• Promissory note: Written promise signed by a borrower, outlining the terms usually the principal, interest and repayment schedule under which the loan is being made.
• Power of sale: A legal agreement, usually part of a deed of trust, which states that if a borrower does not make the agreed-upon payments, the lender can foreclose on the property that secures the loan and sell it at public auction in order to recover any losses.
• Quit claim deed: A document that transfers all or part of an interest in real property to another person.
• Reverse mortgage: A form of home equity loan which allows homeowners, usually seniors, to borrow against the equity in their homes without having to repay the loan until the owners sell the property, move or die.
• Reverse redlining: It is called "redlining" when lenders and insurance companies avoid doing business in low income and minority communities. Reverse redlining is when unscrupulous lenders purposely take advantage of unsophisticated or desperate residents of these communities by pushing high-cost loans.

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Published / Reviewed Date

Published: October 01, 2000

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Foreclosure   ♦   Fraud/Scams   ♦   Housing   ♦   Home Financing   ♦   Home Repair   ♦   Mortgages   ♦  

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