PETER H. BELL
HOME IMPROVEMENT LENDERS ASSOCIATION
SUBCOMMITTEE ON HOUSING & COMMUNITY OPPORTUNITY
APRIL 30, 1998
Mr. Chairman & Members of the Subcommittee:
I appreciate the opportunity to appear before you today and commend you for convening a hearing on this particular topic, and Mr. Fox, in particular, for suggesting it. Everyone knows it is a good thing to own a home. Everyone also knows that it is a big nuisance to maintain or improve that home.
Home improvement projects can be time consuming, disruptive to our daily living, messy and inconvenient. They are also a time when many consumers find themselves most vulnerable to firms or individuals who might not have the skills necessary to do a job properly, or who perform without the integrity that their customers expect from them. Almost everybody knows somebody who has had a problem with a home improvement project. It might, in fact, be the most non-discriminatory experience shared by Americans of all faiths, races and incomes.
Fortunately, most incidents turn out to be solvable, though sometimes with greater inconvenience or additional cost to the homeowner. A small percentage turn out to be home improvement nightmares. It is on that subject -- what can we do to address, or to eliminate the nightmares -- that this hearing is focused.
The organization that I represent is the Home Improvement Lenders Association, a national trade association comprised of lenders who originate home improvement loans under both the FHA Title I and other conventional programs. The 300+ firms that are members of our association are responsible for over 90% of the loan production under the FHA Title I program. Our members are also increasingly involved in providing other types of non-FHA insured loan products to homeowners.
I am accompanied today by Marc Grayson, president of South Central Bank in Chicago and Mike McGuire, President of FirstPlus Bank in Tustin, CA. My colleagues bring a wealth of experience with the FHA Title I program and home improvement finance. South Central Bank, a community bank on Chicagos south side, has been making dealer-originated Title I loans for 32 years and has not experienced one single incident of dealer fraud in its program. FirstPlus Bank has been one of the most active participants in the FHA Title I program for the past 14 years. Mr. McGuire, the founding President of our association, is recognized nationally as one of the most knowledgeable individuals on FHA Title I.
Id like to set forth my testimony in three parts this afternoon.
The first part is to acknowledge some of the problems that occasionally arise with contractors that have been observed and reported by our members.
Second, I would like to explain how FHAs Title I program offers safeguards that help protect consumers and how those safeguards might be further enhanced.
And, third, I would like to suggest some safeguards that might be applied, across the board, to all home improvement transactions where the contractor is involved in the delivery of the financing. Some of these might be federal initiatives; others might require strengthening of state and local laws that govern the licensing and regulation of contractors. I would also like to suggest that a Task Force with representatives of consumer organizations, lender associations, the remodeling industry, state and local officials be formed to undertake a public education campaign on how consumers can best protect themselves in home improvement transactions, and to explore the possibility of developing model legislation governing home improvement for adoption by each of the states.
A commonly heard complaint is that a contractor has failed to complete the job. If it is a job being financed by a "dealer loan" where the funds are paid directly to the contractor by the lender, the job might have already been disbursed, is incomplete and the contractor is gone.
In such cases, the homeowner might decide to withhold payment on the loan until the problem is addressed. The lender, however, who might not be aware of the borrowers dissatisfaction with the job might move to collection and, if there is a lien on the property, proceed towards foreclosure. Some consumer advocates feel that this can be a fast-moving process, particularly in states which allow non-judicial foreclosure, leaving consumers with little time to explain their cases and protect their homes.
A second common complaint revolves around transactions where a completion certificate is utilized. Consumers are sometimes asked, pressured or enticed to sign the certificate before the work is done, sometimes even up-front while signing a confusing assortment of closing documents. Other times, contractors forge signatures on completion certificates.
A third set of complaints is about home improvements that have been overpriced. This is a hard item to address through legislation or rulemaking. To be protected, consumers must make informed decisions when shopping for home improvements. They must comparison shop to know if a price is fair. What we can do is work together to educate the public on managing home improvement projects by presenting a public information campaign on how consumers can get quality work done at fair prices and keep themselves protected.
FHA Title I Home Improvement Loan Program
The FHA Title I program has drawn some fire of its own recently, but actually includes a number of provisions which give consumers greater protection under the program than if they undertook the same home improvement projects outside of it.
It is worth looking at these provisions to see if any of them might be adopted as safeguards in other types of home improvement transactions besides Title I. It is also worth reviewing the Title I provisions to see how they can be modified to provide enhanced protection in FHA-insured transactions.
Title I loans are FHA-insured home improvement loans. The lender purchases insurance on its loan portfolio from the Federal Housing Administration. If a borrower defaults on the loan, the lender may file an insurance claim with HUD and be reimbursed for 90% of the outstanding principal balance on the loan. The lender is at-risk for the other 10% of the principal balance. Lenders are also restricted in their ability to file claims to 10% of the total principal balance in their portfolio. Title I is truly a risk-sharing program.
Title I loans are delivered through two mechanisms, dealer loans and direct loans.
In a dealer loan, a contractor "sells" a job with a retail sales installment contract and collects a loan application and credit information from his customer. The documents are forwarded to the lender which underwrites the "credit" and forwards an approval or a rejection. If approved, the "deal" is signed, the job is started, and when finished, a "completion certificate" is presented for the customers signature. The signed completion certificate is then forwarded to the lender, which disburses the funds directly to the dealer.
In a direct loan, a homeowner applies directly to a lender for the home improvement loan. The full amount of the funds are disbursed up-front, upon closing, to the borrower who then has six months to complete the improvements listed in the loan application. Lenders have the discretion to grant an additional six month extension for completing the improvements.
There are several key protections embedded in the Title I process which, when properly carried out, create strong consumer protections.
1.) Lender Monitoring of Contractors
Lenders must approve, monitor and review contractors. Lenders are only allowed to approve dealers who they consider to be reliable, financially responsible and qualified to satisfactorily perform their contractual obligations. There is a minimum net worth requirement. Lenders must collect and maintain information on each dealers trade name, place of business, type of ownership, type of business, names and employment history of owners, principals, officers and salespersons. A current financial statement must be reviewed by the lender. A commercial credit report on the business and consumer credit reports on the owners, principals and officers are required.
Each dealer must be re-approved annually and updated financial reports must be provided.
Lenders must supervise and monitor the dealers they work with and are required to visit each dealer once every six months. Lenders must maintain a file on each approved dealer with supporting documentation, information about borrower defaults, records of completion, inspections, correspondence concerning borrower complains and their resolution and records of the lenders periodic review of the dealer. Lenders can also require dealers to furnish records on individual loan transactions.
If a dealer does not satisfactorily perform its contractual obligations, does not comply with Title I program requirements, or is unresponsive to the lenders supervision and monitoring requirements, the lender must terminate the dealers approval and immediately notify the Secretary of HUD with written documentation of the facts.
The termination of dealers and notification to HUD is one point at which the current system has failed to work. Lenders have notified HUD of contractor terminations and no action has been taken by the Department, enabling the terminated contractor to simply go up the road and begin working with another lender.
2.) Completion Certificate
Under FHA rules, the contractor is required to have the borrower sign a Completion Certificate once the job is finished. No funds are disbursed to the contractor in a FHA dealer loan until that Completion Certificate has been received by the lender.
Sometimes a dealer will have an unsuspecting customer sign the Completion Certificate up-front by placing it in with a pile of other documents that must be signed to close the loan. Sometimes a dealer will forge the customers signature on the Completion Certificate. Sometimes a contractor will entice a customer to sign the Completion Certificate before the job is done by offering them some cash back. That is absolutely illegal in an FHA transaction, but is exactly what occurred in some of the cases covered in the Philadelphia Enquirer series.
Both contractors and consumers must be made to understand that it is illegal to falsely sign a Completion Certificate. HUD should impose stiff penalties for anyone caught doing so.
3.) Telephone Interview with Borrower
While not a requirement of the Title I program, many lenders conduct a telephone interview with the borrower after receiving the Completion Certificate to ascertain that the work has, in fact, been done and that the customer did sign the certificate at the appropriate time. Some lenders record the conversation to keep a record of the interview.
HILA recommends that a Telephone Interview with the borrower upon receipt of the Completion Certificate become a requirement under the Title I dealer program.
4.) Inspection of the Improvements
Current Title I rules require the lender to conduct a physical inspection to assure that the work that has been contracted for has been done within 60 days of disbursing funds to the contractor. While knowing that there will ultimately be an inspection has deterred some contractors from performing improperly, this safeguard can be tremendously enhanced by requiring the inspection to be conducted before funds are disbursed to the contractor.
There are currently no guidelines or recommended procedures for how inspections should be conducted. It would be helpful for HUD to provide clarification on inspection requirements and perhaps issue a format to be utilized to assure uniformity in inspection reports. HILA would welcome the opportunity to work with the Department to design an appropriate inspection procedure.
5.) Protections for the Borrower in the Case of Default
Earlier in my testimony, I mentioned that some consumer advocates are concerned about the expeditious path that might be pursued from default to foreclosure, causing a family to lose its home. In a Title I transaction, the lender, after attempting all other remedies to bring a loan current, would file an insurance claim with FHA, not foreclose. The borrower would then face collection and enforcement efforts by the federal government, not by the lender.
Under Title I, lenders have a significant incentive to try to avoid filing claims. First of all, there is a 90% / 10% risk share on the loans. In the event that a loan goes to claim, the lender loses 10% of its outstanding principal balance on the loan. Lenders also have a portfolio limitation, restricting their ability to file claims to an amount equal to 10% of their overall loan portfolio. This is managed through an insurance reserve account established for each lender by HUD. Each time a claim is paid, the amount of the claim is deducted from the lenders insurance reserve account, reducing the amount of insurance they have left for future claims.
In no case will HUD pay a claim to a lender on a dealer loan if there is an outstanding consumer complaint about the work that has been performed. The lender must investigate the complaint before filing the claim and try to get it resolved by the contractor or another party.
Finally, the Title I rules proscribe procedures to be followed in the case of default on the loans. Lenders are also given the flexibility to work with delinquent borrowers who demonstrate good faith through refinancing or restructuring of payments.
Strengthening Consumer Protection Provisions Under Title I
Together, the aforementioned provisions provide significant consumer protections for homeowners who undertake improvements under the FHA Title I program. There are steps that can be taken, however, to strengthen the existing protections. Thats why our association has developed a legislative proposal which we refer to as the Home Improvement Consumer Protection Act. Our proposal includes several provisions which we feel would strengthen the Title I program, including both the dealer and direct loan portions of the program, that we have been recommending that HUD adopt for a few years.
1.) Mandating a telephone interview between the borrower and the lender prior to disbursement of funds.
2.) Requiring disbursements on dealer loans to be made by a jointly payable instrument made out to both the borrower and the contractor, requiring endorsement from both before being deposited.
3.) Require that an inspection be conducted prior to disbursement of funds to the contractor.
4.) Establishing uniform standards for property inspections.
5.) Establishing a registry for complaints against home improvement dealers.
6.) Increasing the mortgage insurance premiums to a level that assures the Title I program is self-sustaining,
7.) Increasing the lender approval and annual verification fees to a level that covers HUDs cost of administration of the program.
8.) Increasing the net worth requirements for Title I correspondents.
9.) Increasing the loan limits to allow more substantial improvements that enhance the value of a property to be financed with Title I.
A copy of our draft Bill is included with this testimony. I hope, should the opportunity arise this year to enact housing legislation, that our proposal will be given full consideration.
Creating Consumer Protections in Non-FHA Insured Home Improvement Transactions
Even if we were successful in strengthening the consumer protections that exist under the FHA Title I program, we would only be touching the tip of the iceberg. American homeowners are estimated to spend approximately $125 billion per year on home improvements. Approximately 40% of that amount, or $50 billion, is estimated to be financed. Title I finances $1.3 billion of that amount.
If our goal is to implement consumer protections that will protect American homeowners on a broad scale, more must be done than simply making changes to the Title I program.
Recent meetings between consumer advocates and various organizations representing lenders that have been convened as an offshoot of the Mortgage Reform Work Group have highlighted certain problematic areas in home improvement deals generally. In response to the concerns articulated there, an ad hoc committee of lender organizations has begun to draft voluntary standards for lenders purchasing home improvement dealer loans or retail installment contracts. These voluntary standards would cover all transactions, whether or not they are FHA-insured.
The proposals in the draft voluntary standards include:
1.) Requiring a standardized completion certificate to be signed by both the borrower and the contractor before a retail installment contract will be purchased.
2.) Lenders will arrange, prior to funding, a property inspection of any home improvements exceeding $10,000 that are financed with a retail installment contract.
3.) Lenders will respond to a written complaint from a borrower regarding problems the borrower may have with the contractor within 20 business days, by acknowledging receipt of the complaint. Within 60 business days of receipt of the borrowers complaint, the lender shall investigate and notify the borrower in writing of the lenders determination and proposed course of action.
4.) A new "crystal clear disclosure," entitled, "Things You Should Know If Your Contractor Is Financing Your Home Improvements," would be provided.
These provisions, particularly the inspection prior to disbursement, should eliminate a large majority of the problems that arise in dealer-financed home improvement transactions. It is our hope that lenders across the board can be counted upon to adhere to these voluntary standards.
There are two additional avenues that might also be explored if we are to fully protect consumers in home improvement transactions.
The first are the laws that govern home improvement contractors on both the state and local levels. There are numerous laws in many jurisdictions around the country and no licensing requirements in others. It would be helpful to achieve a higher degree of uniformity in these laws and their applicability. Furthermore, it would be extremely helpful to develop some sort of information sharing capacity so that contractors who are sanctioned for running afoul of the rules in one jurisdiction do not find it easy to move on to a new geographic area. Perhaps a National Home Improvement Task Force could work with the National Conference of State Legislatures and other interested organizations to develop a model home improvement statute that can be recommended for adoption by states and localities across the country.
Finally, there is just so much we can do as legislators, regulators, lenders and consumer advocates to protect individual homeowners. Consumers must assume some responsibility themselves. We can, of course, help them prepare to take on that responsibility by providing educational and informational resources.
Our organization, over the next several weeks, will be inviting a number of organizations which share our concern to join HILA in a major national consumer education effort to alert homeowners to the steps they should take to pick a good, qualified, dependable home improvement contractor. I would like to place into the record our "Top 10 Tips," which, if followed, go a long way toward eliminating the potential for a bad home improvement experience.
It is my hope that this hearing today, HILAs public education effort, and actions by other concerned parties will result in a home improvement environment in which more households achieve their dream home and fewer have a home improvement nightmare.
Thank you Mr. Chairman and members of the committee for this opportunity to appear before you today.