Income verification is crucial to successfully and honestly completing an application.
OCC Chief Urges a Tightening Up on Home Equity Loans
From: American Banker
By: Cheyenne Hopkins
May 23, 2008
WASHINGTON — Comptroller of the Currency John C. Dugan on Thursday suggested several improvements in home equity underwriting, including ending the practice of using the loans to finance down payments.
"We need to ask some hard questions about home equity product structure and underwriting criteria," he said in a speech sponsored by the Financial Services Roundtable's housing policy council. "In particular, we need to revisit the problems that landed lenders where we are today — particularly some of the 'shortcuts' established in reaction to aggressive competition."
After a huge growth spurt — home equity loans more than doubled from the 2002 total, to $1.1 trillion — loose underwriting and falling home values have combined to produce big losses. Losses spiked ninefold, to $2.7 billion, in the first quarter compared to the year earlier, he said.
Mr. Dugan urged lenders to improve the tools they use to value collateral and verify income and told them to steer clear of interest-only loans.
Regulators began waving a red flag on home equity lending in 2005, but Mr. Dugan said banks have been slow to change their practices. For instance, he said, questions remain on the use of collateral valuation tools such as automated valuation models.
These tools must be "closely managed, periodically validated, and supported with sound business rules," he said. "Cost alone simply cannot be the guiding principle for their use."
Mr. Dugan also criticized "reactive stated income," situations in which lenders require a borrower to detail income and authorize the lender to verify it, "as if the lender were really going to do just that," Mr. Dugan said. "Supposedly unbeknownst to the borrower, the lender deliberately chooses not to incur the additional time and cost of actually following through and verifying the income."
The comptroller stopped short of saying this practice should be stopped. "We need to think carefully about whether anything short of actual verification of income is acceptable from a safety and soundness perspective for most borrowers," he said.
The industry should also rethink interest-only structures, he said. The lack of "payment discipline encourages borrowers to assume greater levels of debt, often to the limit of their ability to make minimum monthly payments."
Mr. Dugan said banks must increase their reserves against home equity loans.
"With losses accelerating, those reserves are simply not going to be adequate, and that's why our examiners are encouraging more robust portfolio analysis and loss-reserve levels," he said.
Still, the Comptroller noted that loss rates on home equity loans remain lower than for other types of retail credit.
