According to industry officials, HLTV lenders used credit scoring models as the primary basis for identifying creditworthy borrowers and thus for approving HLTV loans. Generally speaking, lenders used credit scoring models to evaluate credit risk—the possibility that borrowers would be (1) delinquent (i.e., make late loan payments) or (2) in default (i.e., cease to make loan payments). In general, credit scores have been developed by assessing various types of information from a large pool of borrowers, including borrowers with good payment histories and others with poor payment histories. Statistical analyses identifying the characteristics of borrowers who were most likely to make loan payments have been used to create a weight or score associated with each of the characteristics. For instance, borrowers who did not have a history of delinquent payments receive a higher credit score than borrowers who had many delinquent payments. Most widely used credit scoring systems have a range of scores from 350 to 900. Borrowers with higher scores are usually considered more creditworthy because they would be more likely to pay the loan on time, and in full, than would borrowers with lower scores. According to an official familiar with these proprietary models, a key variable associated with higher credit scores is home ownership. Homeowners tend to have better payment histories than borrowers with otherwise similar characteristics. Industry officials told us that homeowners acted as if they had a vested interest or “psychological drive” to make prompt loan payments in an effort to keep the homes in which they lived. In general, in making HLTV loans, lenders sought to assemble the HLTV loans into pools of loans, which then were used to back securities sold to investors. According to securities firm officials, about 95 percent of HLTV loans were combined into pools and securitized. In general, securitization involves a lender’s packaging financial assets—typically loans—into pools, the creation of securities based on the cash flows from the pools, and the sale of these securities to investors. Securitization is commonly done for a wide range of financial assets, including mortgages, car loans, and other forms of consumer debt. The process of HLTV securitization has three major steps. In the first step, the borrowers take out loans from the lender, and the lender organizes the pool and sells the HLTV loans to the pool. In addition, the lender hires a credit rating agency and a securities underwriter. The pool is established as a legal entity that is independent of the lender. Second, the credit rating agency rates the securities that will be issued by the pool and the securities underwriter sets initial prices for the securities, buys the securities from the pool, and immediately sells the securities to investors. Third, the lender services the pool by collecting payments from HLTV borrowers and disbursing payments to investors. This securitization process is depicted in figure 1. Since the pool is a separate legal entity, its credit quality is considered to be separate from that of the lender that formed the pool. The credit quality of the pool depends on the credit quality of the loans in the pool. In addition, the credit quality of the assets in the pool may also be enhanced, either internally or externally. One form of internal credit enhancement occurs if the value of loans in the pool exceeds the value of the securities sold; this is a form of over-collateralization. Common forms of external credit enhancements include insurance policies that pay in the event of loan defaults. HLTV loans have often been referred to as “hybrid” loans because they have characteristics of both mortgage loans and unsecured consumer loans. According to lenders, borrowers have used HLTV loans primarily to consolidate credit card debt or to make home improvements. Although industrywide data were not available, FirstPlus officials had compiled an “average HLTV loan profile” that identified the average amount of an approved HLTV loan, the interest rate charged, the duration of the loan, and the percent of property value the loan represented. Further, FirstPlus officials identified the “average HLTV borrower profile,” which was a creditworthy borrower (based on credit scores) who had a stable income. Officials representing federal regulators and a consumer advocacy group were not aware of any borrowers’ complaints about the disclosure of the terms and conditions of HLTV loans. HLTV loans have characteristics of both mortgage loans and unsecured consumer loans. On the one hand, HLTV loans share characteristics with mortgage loans in that both types of loans are secured with a lien on the property in the event of borrower default. On the other hand, HLTV loans are like unsecured consumer loans because, in both cases, the lending decisions are based primarily on the creditworthiness of the borrower. Creditworthiness is the primary basis for the lending decision because, in the event of a default, there might be little or no value in the house left to pay off the HLTV loan, once the first mortgage loan is covered by the sale of the house. Although industrywide data were not available, FirstPlus—which accounted for about one-third of the HLTV loan volume in 1997—provided us with information on its average HLTV loan profile. According to FirstPlus officials, the average HLTV loan they made in 1997 was for about $30,000 with a 25-year term. Also, in the same year, FirstPlus charged an average contract interest rate of 13 to 14 percent on its HLTV loans, but any origination fees or “points charged” would raise the effective interest rate of the loan. A FirstPlus official told us that FirstPlus charged an average of five “points.” Thus, a 25-year loan with a 13.5 percent contract rate and 5 points would have an effective interest rate of 14.3 percent. In addition, the average combined debt of a first mortgage and a FirstPlus HLTV loan with a second lien generally represented about 110 percent of a borrower’s property value, although some reached as high as 125 percent of value. Although there were no comprehensive industry data, FirstPlus provided us with information on its borrowers. Generally speaking, FirstPlus made HLTV loans to borrowers with a stable average annual income of $60,000. These borrowers had, on average, at least 5 years of job tenure and were in their late thirties. Also, while the borrower had an average of about $20,000 in outstanding nonmortgage debt, as previously mentioned, the HLTV loans were on average about $30,000. Virtually all of these borrowers occupied the house they were using as collateral. The borrower owed an average of about $110,000 on a first mortgage, backed by property worth about $130,000. However, a key FirstPlus official told us that approval of a HLTV loan was not strongly tied to the amount of equity the borrower had in the house; rather, it was primarily tied to the borrowers’ creditworthiness, as measured by a credit score. In addition, FirstPlus officials told us that they review the borrower’s credit histories, debt-to-income ratios, and disposable-income levels. Public and private sector officials—including representatives of FirstPlus—told us that credit scores for HLTV borrowers were, on average, about 680 and that this score was considered to be “high.” According to the leading provider of credit scoring models, a score of 700 predicts the odds of 30 to 1 that the borrower will be current on the loan payments. An official with a government-sponsored enterprise active in the secondary mortgage market told us that 85 percent of all mortgage borrowers have credit scores of 620 or higher. The Survey of Consumer Finances, a triennial survey of family finances sponsored by the Federal Reserve with the cooperation of the Department of the Treasury, provides a basis to compare the profile of the HLTV borrower with the broader U.S. population. In 1995, the most recent Survey at the time of our review, average family income was estimated to be $44,300 for all families and $54,600 for homeowners. The Survey also found that 64.7 percent of families were homeowners, with the median value of the house being $90,000. Further, 41.1 percent of the homeowners in the Survey had mortgages or home equity loans, the median total loan amount being $51,000. Credit cards were held by 47.8 percent of the homeowners in the Survey, who owed a median amount of about $1,500. A comprehensive comparison of the HLTV and Survey profiles was not possible because some Survey data on families are reported as medians, while the HLTV data are based on averages. Further, available data we obtained on HLTV borrowers were from the FirstPlus borrower profile; other lenders’ borrower profiles may be different. With these cautions in mind, however, some general similarities and differences between the HLTV and Survey profiles can be delineated. The HLTV borrower had a slightly higher average income: the FirstPlus borrower had an average annual income of about $60,000, while the average homeowner in the Survey had an income of $51,000. The average value of housing in the HLTV profile ($130,000) is higher than the median value of housing in the Survey ($90,000), although this comparison of an average and a median is inherently limited. Since housing values do not have an upper limit, the mean or average value would increase more than the median with the inclusion of high-valued houses. HLTV borrowers appear to have had higher mortgage balances even before taking on the HLTV loans: the FirstPlus profile reported an average first mortgage of $110,000, while the median mortgage and home equity balance for homeowners in the Survey was $51,000. Federal law and regulations set forth requirements concerning the information on a loan that must be disclosed to a borrower. In addition, state law may require disclosure to borrowers.