Mortgaging the American Dream: A Critical Evaluation of the Federal Government's Promotion of the Home Equity Financing

Abstract

In this Article, I advocate elimination of federal promotion of home equity financing, recommending that the federal government permit home equity financing without encouraging it. In Part Il of this Article, I discuss some of the problems caused by federal promotion of home equity financing. While home equity loans carry a risk to the borrowers of losing their homes, homeowners cannot properly assess this risk due to their tendency to underestimate the probability of default and foreclosure. Homeowners who do lose their homes to foreclosure may be devastated, both financially and psychologically. Despite the risks of a home equity loan, the total amount of home equity debt has increased drastically in recent years due, in part, to the deductibility of home equity interest under federal tax law. In addition, as a result of federal preemption of state consumer protection measures such as usury statutes, predatory lenders have been permitted to victimize homeowners in low-income neighborhoods and homeowners who, like the Dunckels, are in severe financial distress. Because of special privileges given to home equity lenders under bankruptcy law, home equity borrowers may not be able find relief in bankruptcy. In Part Ill of this Article, I discuss the federal government's home ownership policy because an understanding of the federal measures that promote home equity financing requires a comprehension of their relationship to measures that promote home ownership. In Part IV, I examine both the means by which the federal government encourages home equity financing under current law and the effects of these measures. In Part V, I weigh competing federal policies affected by home equity financing and propose the adoption of several measures designed to achieve a more appropriate balance. First, tax law should be changed to eliminate the deduction for home equity interest so that all consumer interest is nondeductible, regardless of whether it is secured by a lien on a home. Second, federal preemption of state usury ceilings on home equity loans should be eliminated so that states can regulate interest rates on home equity loans. Finally, bankruptcy law should be amended to permit homeowners in bankruptcy to modify their home equity loans as is permitted with other types of secured debt.

Keywords: Predatory lending, Subprime lending, Home mortgage, Home mortgage loan, Home equity loan, Real estate finance, Real property law, Mortgages, Real estate law, Secondary market, Secondary mortgage market, Bankruptcy law, Consumer law, Consumer protection. HELOC, Home equity line of credit