High-Loan-to-Value Lending

A segment of the financial services industry has since 1995 offered loans that are tied to the value of a borrower's house but that, in combination with preexisting first mortgages, exceed this value. The loans, referred to as high-loan-to-value (HLTV) loans, can reach 125 percent or even more of a home's value. As with unsecured consumer loans, HLTV lenders rely more heavily on borrowers' creditworthiness in making loans. Most borrowers use HLTV loans to consolidate credit card debt, according to industry officials. Some borrowers also use the loans to make home improvements. Data provided by a lender responsible for about one-third of HLTV lending showed that such loans averaged about $30,000 in 1997. The average interest rate for these loans was between 13 and 14 percent, with an average loan term of 25 years. GAO found that HLTV loans were made or managed primarily by 10 institutions. Regulated depository institutions were not heavily involved in originating HLTV loans. The involvement of these institutions would be important to any assessment of the potential exposure of federal deposit insurance funds to defaults of HLTV loans. Available data indicate that HLTV lending has grown since its introduction in 1995 but that it remains small relative to other consumer lending. Industry representatives expect HLTV volume to reach at least $12 billion in 1998, a fraction of the $3.8 trillion in outstanding residential mortgage debt. This report also discusses the benefits and risks associated with HLTV lending to the borrower, lender, and investors.

GAO noted that: (1) HLTV loans are considered hybrid loans because they have characteristics of both mortgage loans and unsecured consumer loans; (2) like mortgages, HLTV loans are secured by a lien on a house; (3) however, the lien itself may have less financial value than the amount of the loan in the event of a borrower's defaulting since the value of the HLTV loan and the original mortgage may exceed the value of the house; (4) thus, as with unsecured consumer loans, HLTV lenders rely more heavily on borrowers' creditworthiness; (5) according to industry officials, most borrowers use HLTV loans primarily to consolidate credit card debt or make home improvements; (6) while comprehensive industry data were not available, data provided by a lender responsible for about one-third of HLTV lending showed that, in 1997, HLTV loans averaged about $30,000; (7) the data also showed that the average contract interest rate was between 13 and 14 percent, with an average loan term of 25 years; (8) according to industry officials and GAO's review of the limited available industry data, from 1995 to 1997, HLTV loans were made or managed primarily by 10 institutions; (9) according to public- and private-sector officials, regulated depository institutions were not heavily involved in originating HLTV loans; (10) the involvement of these institutions would be important to any assessment of the potential exposure of federal deposit insurance funds to defaults of HLTV loans; (11) data indicate that HLTV lending has grown since its introduction in 1995 but remains small relative to other consumer lending; (12) data on the volume of HLTV loans were limited to those loans that were subsequently packaged into loan pools used to back securities sold to investors; (13) the volume of securitized HLTV lending has more than doubled from year to year from 1995 through 1997; (14) industry and securities firm representatives expected HLTV lending to increase again in 1998 to $12 billion or higher; (15) public- and private-sector officials pointed to several benefits and risks associated with HLTV lending to the borrower, lender, and investors; (16) while lenders and investors have benefited from the high rate of return on these loans, it is uncertain how these loans would perform during any future economic downturn; (17) if defaults were to increase, the rate of return would decrease; and (18) officials representing the two largest government-sponsored enterprises did not believe that HLTV lending posed greater risks to their portfolios than the existing credit card lending that the HLTV lending generally refinances.