WASHINGTON -- Legislation to regulate mortgage refinancings advanced this week, as consumer organizations told a House panel that the process is riddled with abuses, from "kickbacks" for referra to overcharges for prepayments.

One complaint focused on the so-called rule of 78s, which some lenders use to calculate the amount of principal remaining when a loan is prepaid.

Consumer advocates argued that the formula makes consumers pay excessive interest early in the loan. Deborah Bell, a University of Mississippi law professor, and Carla Feldpausch, a research assistant for the Consumer Federation of America, both suggested the law should retroactively bar the formula even for existing contracts.

Questionable Math

"The rule of 78s is mathematically incorrect," said Ms. Feldspausch. "So even if the contract stipulates the use of the rule of 78s, if it is incorrect, I wonder, can another method be substituted?"

"The hidden penalty can be substantial," added Rep. Esteban Torres, D-Calif., chairman of the House Banking subcommittee on consumer affairs and coinage.

"If lenders need to cover the acquisition cost, the cost should be disclosed up front and not levied in the form of a hidden penalty" that could be "hundreds, if not thousands, of dollars."

Rep. Torres has introduced legislation that would require lenders to disclose all closing costs for a loan refinancing soon after an application is made.

It would also curb referral payments among lawyers, brokers, accountants, and lenders. It would prohibit the rule of 78s and require lenders to honor interest rate commitments, or "lock-ins."

Rep. Torres is expected to press the full banking committee to attach at least part of his bill to a housing reauthorization package that is expected to come before the panel for a vote in June.

The disclosure provisions are given a particularly good chance of passage, since the Senate has already passed a similar bill sponsored by Sen. William V. Roth, R-Del.

During Wednesday's hearing, Federal Reserve Governor Lawrence Lindsey urged the panel to leave most of the burden of regulating mortgage refinancings to the states, which he said have traditionally handled such issues.

Of the 3,300 consumer complaints the central bank has received since 1991, he said, only 13 dealt with problems in obtaining refinancing and another three dealt with prepayment penalties. No complaints were received about the rule of 78s.

Moreover, Mr. Lindsey said, consumers would not benefit overall from a ban on the rule of 78s, since lenders will recoup the same revenues through other charges.

The American Bankers Association argued that many lenders would find it impossible to comply with the disclosures that the Torres bill would require them to make three days after receiving an application.

The bill would also subject lenders "to additional liability for minor and harmless violations," which would likely increase the cost of credit, the ABA argued in written comments submitted to the panel.

Although the Torres bill is aimed primarily at mortgage refinancings, bankers see the legislation covering all installment loans.

Banks most often use the rule of 78s, for example, on prepayments of auto loans, the Consumer Bankers Association said in written comments submitted to the committee.

Rationale for the Rule

"An institution's funding costs are based on the full term of the loan, so the rule of 78s accounting method provides compensation for those loans that pay out ahead of schedule," the trade group said.

"The higher interest earned for early prepayment reflects the need to recover the original cost of booking the loan and the higher risk an institution assumes earlier in the loan term due to the higher balance and longer time to maturity," the organization added.

The Fed's Mr. Lindsey said he recently took a car loan he planned to pay off early, but accepted a higher rate of interest rather than a contract that called for use of the rule of 78s.

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