There are already plenty of risks in many financial products, even when they are sold legitimately. You don't need a con artist to make them more dangerous. But this is what's happening with home equity loans. As tax reform and rising rates of home appreciation have made these loans increasingly popular, the crooks have gotten into the act. They've convinced people who often cannot afford more debt to take out sometimes large home equity loans - at interest rates that may run from 20 to 50 percent. They've even learned how to work their deals two ways: conning both the homeowners and investors or banks.
``These are equal opportunity scams,'' says Fred Hoffecker, assistant attorney general for the state of Michigan. ``They get both sides. The people who borrow get hurt, and the investors get hurt, too.''
Many of the victims of these crimes are the elderly, who may own their homes free and clear but are living on fixed incomes, perhaps just social security, according to a recent report by the American Association of Retired Persons (AARP) and the National Association of Attorneys General.
The bankruptcy trustee overseeing the affairs of the Diamond Mortgage Company in Michigan recently discovered at least 625 people had applied to borrow against their home equity but never received any money. They figured their applications had been denied. Instead, Diamond had ``sold'' these loans to private investors but not distributed the money to homeowners. Normally, those investors would have claims against the borrowers' homes, but it's now up to the courts to sort things out.
A 79-year-old man living on $561 a month was talked into refinancing delinquent medical bills with a home equity loan. The loan included more than $7,700 in upfront fees. The man has since had to make several more refinancings, now owes more than $48,000, and his home is threatened with foreclosure.
An older couple in rural Virginia living on $502 a month from social security wanted to borrow $5,300 against the equity in their home. Insead, they ended up owing $7,900, which included a $2,100 origination fee at an interest rate of 25 percent. Their monthly payments on the loan came to $120.
These last two cases came from the files of Landbank Equity Corporation, a Virginia company that declared bankruptcy in 1985 and is under investigation for fraud. A bankruptcy judge recently issued a $71 million judgment against its founder.
Court records indicate Landbank peddled portfolios of its loans to more than 40 savings-and-loans around the United States and to the Federal National Mortgage Association.
``These are fairly new'' scams, says Lee Norrgard, senior program specialist in the consumer affairs section of the AARP. ``They are a stepchild of deregulation of banking and financial services.'' It's no longer necessary to go to a bank or savings and loan to borrow money; mortgage companies and a variety of private lending companies are aggressively looking for people who want to borrow money.
At the same time, tax reform removed many of the deductions for interest on loans, except for first mortgages and many second mortgages, or home equity loans. This change, combined with rising real estate values, has opened up a fertile new field for scam operators. A recent congressional report estimated that $600 billion of home equity is held by older Americans alone.
In many cases, according to the AARP and the attorneys general, homeowners are talked into signing first, second, or third mortgages. Often, they do not understand all the details of what they are signing, or are misled. The loans carry high up-front costs and high interest rates. Sometimes the loans have a balloon payment, with the entire balance due in a few years.
In addition to covering major expenses like medical bills or college costs, homeowners sometimes borrow to make home improvements, help children buy homes, or to meet other needs. Home improvements can be cause for trouble, too, as homeowners get involved with door-to-door contractors who talk them into expensive repairs, arrange a second mortgage to pay for them, and may or may not do the work.
Avoiding the home equity con artists is not that difficult.
``The most important thing is to know who you're borrowing from,'' Mr. Norrgard says. ``First, you have to decide if you really want to borrow this way and recognize that you can lose your house.
``Then, don't simply pick somebody out of the Yellow Pages or the classified newspaper ads.''
Although some of these problem lenders do run print, television, and radio ads, many others simply use the telephone and door-to-door salesmen.
There are other ways to see a case of home equity fraud coming your way:
Be especially wary of lenders that actively solicit loans, especially if they already seem to know about any financial difficulty you may be in, the AARP warns. Public land records often tell who might be threatened with foreclosure, and creditors often comb these records before sending unsolicited loan offers.
Avoid lenders who don't seem concerned with how much debt you can handle. Ads that tout no income or credit checks and say ``if you have equity, you qualify'' can lead to impossible debt burdens. Responsible lenders will not offer a loan unless they know the borrower can afford this and all other monthly obligations.
Look for irregularities in the loan papers. These papers should list both the current interest rate and the annual percentage rate. The APR is always slightly higher than the current rate, but some of these lenders have APRs that are several percentage points higher. Also watch for any lender charging more than one or two ``points'' for servicing the loan. A point equals one percent of the loan balance.
If you have any doubts, ask an attorney that you have selected to look over the papers.
For more information on home equity fraud and how to avoid it, send a post card to the AARP's Consumer Affairs Program Department, 1909 K Street, N.W. Washington, DC 20049. Ask for ``Home Equity Scams: The Cruelest Consumer Fraud.'' The eight-page bulletin discusses legal and illegal home equity loan procedures and looks at ways to evaluate your financial needs before putting your home at risk.