1 I n d u s t r y Tre n d s Nuts andbolts of Reverse-Mortgage Lending T he potential market for reverse mortgages borrowers 62 years and older is exploding. The Government Accountability Office (GAO) expects that the number of Americans over the age of 65 could increase from 34 million today to 70 million in Originations of home-equity conversion mortgages (HECMs) more than 90 percent of reverse-mortgage loans made surged by nearly 80 percent in fiscal year 2006 (ending Sept. 30, 2006). Last year, at least one leading reverse-mortgage lender saw its reversemortgage dollar volume more than double. Recognizing the opportunities, many lenders, servicers and purchasers are jumping on board. The number of lenders approved to make HECMs more than doubled in one year, from around 200 in 2004 to approximately 450 in 2005, according to Asset Securitization Report. And this past summer, that same publication reported, mortgage giant Countrywide Financial Corporation, Calabasas, California, announced its plans to enter and dominate the reverse-mortgage market. At the same time, many of these industry players are discovering that the reverse-mortgage business is not for the faint of heart. Reverse-mortgage lending and servicing are complex, and require significant expertise. Recent growth in the reversemortgage market heralds more to come. This article highlights a number of considerations that lenders, servicers and loan purchasers interested in this market may wish to take into account. Borrowers, lenders, servicers and buyers of reverse-mortgage loans face a complex set of challenges if they choose to enter this growth product area. BY LO R N A M. N E I L L A N D ST E V E N K A P L A N
2 Background What is a reverse-mortgage loan? Reverse mortgages allow borrowers aged 62 years or older to convert their home equity into cash as a lump sum, a line of credit or a monthly payment. Unlike a standard forward mortgage, the borrower does not repay the loan in periodic payments. Instead, the lender pays the borrower. The loan is due (usually as a lump sum) only when the borrower moves out, dies or sells the home securing the loan. The total amount due can never exceed the value of the home. Also, reverse mortgages are non-recourse, which means that no assets of the borrower (or his or her estate), other than the home, can be used to repay the debt. Reverse-mortgage loans can be closed-end (for a fixed term) or open-end (with no predefined maturity date). Most reverse-mortgage loans on the market today are open-end, maturing at the indefinite date of the borrower s death or departure from the home. What types of reverse-mortgage loan products are available reverse mortgages today? Three types of reverse-mortgage were rarely products are available today. First, the Department of Housing and securitized. Urban Development (HUD) sponsors HECMs, which are insured by the Federal Housing Administration (FHA). Second, Fannie Mae has developed its own reverse-mortgage products, called Home Keeper loans. Third, some private companies have developed proprietary reverse-mortgage products to offer larger loan amounts and alternative terms than are available under the HECM or Home Keeper programs. These include the Cash Account Advantage Plan jumbo reverse-mortgage loans offered by Irvine, California based Financial Freedom Senior Funding Corporation, and a new jumbo product offered by Seattle-based Seattle Mortgage Co. s Reverse Mortgage of America division. In addition, BNY Mortgage Co. LLC, with offices primarily in New York (but just purchased by Jacksonville, Florida based EverBank Financial Corp.) recently began offering an alternative HECM product with lower interest rates than those available with other HECMs. (HECM lending limits vary by county, but the 2006 maximum was $362,790 for high-cost areas. Home Keeper s 2006 limit was $416,000. As noted, HUD allows FHA to insure only 275,000 HECMs annually.) Borrowers can typically choose to receive the proceeds from these reverse-mortgage products in one of three ways: as a line of credit on which the borrower may draw at any time; in set monthly payments for a fixed period of time or for life, or a combination of these. What factors account for the growth in this industry? Growth in the elderly population in the United States is one of several factors that promise a robust reverse-mortgage market in the years to come. Another factor is that housing values have increased, leaving larger amounts of untapped home equity. Legal developments are also fueling growth in the reversemortgage market. In the current session, Congress is expected Until recently, to consider legislation to establish a nationally uniform maximum loan amount for HECMs and to eliminate permanently the cap on how many HECMs FHA can insure each year. The current number of HECMs that FHA can insure annually is just 275,000, which is not enough to meet current market demand. Congress enacted a temporary suspension of the cap earlier this year, which will remain in effect through Sept. 30, Some states are paving the way for more reverse-mortgage lending as well. In summer 2006, for example, Rhode Island enacted a bill that eliminates the state s 10-year term limitation on reverse mortgages and makes existing reverse-mortgage provisions less ambiguous. Finally, amendments to the internal revenue code in 2005 opened the door to reverse-mortgage securitizations within the real estate mortgage investment conduit (REMIC) structure. As with securitizations of other mortgage loans, securitizations backed by reverse mortgages spread out the risk, giving reverse-mortgage lenders greater financial leverage to make and market these loans. Securitizations of reverse-mortgage loans Private securitizations Until recently, reverse mortgages were rarely securitized. Fannie Mae purchased most HECMs and simply held HECMs and Fannie Mae Home Keeper loans in its portfolio, according to Asset Securitization Report. One of the earlier reverse-mortgage loan securitizations in the United States took place in 1999, and since then investors have closed just a handful of reverse-mortgage securitizations. More recently, reverse-mortgage securitizations have begun to pick up with New York based Lehman Brothers 2005 $503 million securitization of jumbo reverse-mortgage loans, according to Asset Securitization Report, which also reported that in 2006, Lehman closed a $598 million securitization backed by reverse-mortgage loans, among others. Both New York based Fitch Ratings and New York based Standard & Poor s rate reverse-mortgage securitizations. Until last year, private securitizations were mostly or wholly backed by reverse-mortgage loans that were not HECMs i.e., loans that were not insured by the government. This meant that only a small portion of the reverse-mortgage loan market was generally considered eligible to be securitized. Last August, however, Charlotte, North Carolina based Bank of America closed a $221 million securitization of HECMs. A second Bank of America HECM securitization in 2006 totaled $215 million. Ginnie Mae s securitization initiative Ginnie Mae announced this past fall that it, too, would begin securitizing HECMs, with Ginnie Mae President Robert M. Couch predicting that this once unique product will soon be a standard feature of American retirement plans. Ginnie Mae s proposed securitization structure would allow lenders of HECMs to securitize lump-sum payouts as well as monthly draws, and possibly servicing fees. Private securitizations of reverse-mortgage loans have required a large reserve fund to pay advances and mortgage insurance. By contrast, Ginnie Mae s securitizations would permit lenders to place lump-sum HECM payments in one mortgage-backed security (MBS), while placing monthly
3 payments and other monthly advances in another MBS. Participations in the HECM could be in multiple separate MBSs, with the proceeds going pro rata to each security. The minimum Ginnie Mae reverse MBS balance reportedly will be $1 million, with advances spread across multiple MBSs over the life of the loan, according to National Mortgage News. The Ginnie Mae reverse MBS is anticipated to be an accrual-class pass-through security with no payment schedule. The proposed MBS would accrue interest on the securitized principal until payoffs are received. This MBS could be sold to investors as a stand-alone security or be used as collateral for a Ginnie Mae REMIC. Benefits and risks for borrowers Reverse mortgages today may offer borrowers several unique advantages, including the following: Borrowers do not have to meet income, asset, employment or credit requirements. Loan repayment is not required until the home is no longer the borrower s principal residence. The loan amount due at maturity can never exceed the value of the home at that time. Cash advances can be used for any purpose. Interest accruing on the loan is tax-deductible, and equity income received is generally not taxable. Reverse mortgages are non-recourse loans, so no assets of the borrower or the borrower s estate other than the home can be used to repay the loan. A few downsides for borrowers may include the following: Late in life, the borrower s equity in the home begins declining as interest accrues on the reverse-mortgage loan principal. Reverse-mortgage loans can be more expensive than other types of mortgages. Reverse mortgages can reduce the inheritance of the borrower s heirs as the borrower s equity in the home declines. For lenders, servicers and purchasers, the reverse-mortgage market clearly offers the potential for significant financial rewards. It also comes with risks risks that may in part be overcome with adequate resources and expertise. Several considerations for lenders, servicers and purchasers follow. Benefits and risks for lenders Declining equity For lenders, the most obvious risk is that at the end of the day the home equity will be less than the loan amount. With reverse-mortgage loans, the outstanding principal, together with accrued interest, could exceed the home value. This risk is mitigated for HECM lenders, because they can assign HECMs to HUD once the loan-to-value (LTV) ratio reaches 98 percent. But if lenders want to make non-hecm reverse mortgages, such as mortgages that exceed the FHA s limits on HECM loan amounts, lenders have to shoulder the equity risk themselves. Lenders can opt to share the risk by securitizing their reverse-mortgage loans, but not so easily; for now, the private securitization market, while growing, remains small. Predatory lending/unfair and deceptive trade practices Reverse-mortgage borrowers seniors are often considered more vulnerable to predatory practices than other borrowers. Reverse-mortgage provisions can be complex, leaving room for charges that brokers or lenders engaged in deceptive sales practices. Consumer groups and others have raised concerns that information provided in sales pitches to consumers at times fails to communicate the complexity of loan features, especially for non-standard loan types. Reverse-mortgage lenders should be sure that information provided to consumers in marketing materials and orally comports with written disclosures and accurately conveys the loan terms. Some also have charged lenders with selling seniors unnecessary and overpriced annuities in tandem with a reverse mortgage. For example, in the 2001 California case of Black v. Financial Freedom Senior Funding Corp., the appellate court ruled in favor of homeowners who charged elder abuse, unlawful business practices, fraudulent concealment and negligent misrepresentation in connection with making a reversemortgage loan tied to an annuity. Another example is a 2005 Connecticut case, Patrowicz v. Transamerica Homefirst Inc., in which the plaintiff alleged annuity abuse, among other claims. The Patrowicz court ultimately dismissed this claim. An annuity is an insurance product financed by home equity that gives the borrower monthly payments right away or after a certain number of years. While annuities are lawful investment vehicles, an alleged concern with tying annuities to reverse mortgages is that reverse mortgages can be challenging for consumers to understand, so lenders could take advantage of elderly borrowers by charging a high price for an unneeded annuity. Payments may not be scheduled to begin until years later, perhaps beyond the borrower s reasonable life For lenders, the most obvious risk is that at the end of the day the home equity will be less than the loan amount. expectancy. If the borrower passes away before payments are to begin, neither the borrower nor the borrower s estate would see any benefit from the annuity. A few states have weighed in on the concern about tying annuities to reverse mortgages. California, for example, recently enacted a prohibition (approved by the governor on Sept. 5, 2006) on requiring the purchase of an annuity as a condition of obtaining a reverse-mortgage loan, which really is a simple tie-in prohibition. This legislation also prohibits a reverse-mortgage lender or broker from offering an annuity to the borrower or referring the borrower to anyone for an annuity purchase prior to the loan closing or before the borrower s right to rescind the loan expires. Housing counseling Reverse-mortgage lenders often need to make sure that reverse-mortgage loan applicants are educated about these mortgages. HUD and Fannie Mae mandate borrower counseling for HECM and Home Keeper loans, for example. (The recent federal regulatory agencies Interagency Guidance on Nontraditional Loan Product Risks, which includes provisions
4 on consumer communications and loan product education, does not apply to reverse mortgages.) A number of states also require lenders to ensure that reverse-mortgage borrowers obtain or are advised of the availability of counseling. HUD-mandated counseling for HECMs must be conducted by a HUD-approved housing counseling agency, to which the lender refers the borrower. Housing counselors must discuss a number of issues with the borrower, face-to-face wherever possible. These issues include, among others: the financial implications of entering into a HECM; a disclosure that HECMs might impact the borrower s taxes, estate and eligibility for state and federal assistance programs; other available home-equity options; and other available options for meeting the borrower s goals, such as alternative housing, social service, health and financial options. For its part, Fannie Mae requires Home Keeper lenders to ensure that the prospective borrower receives required consumer education. The lender can provide this education itself, but the education process must be separate from the loan application and origination processes. The curriculum used must be approved by Fannie Mae and must cover a number of specific items, including, among others: how the loan amount is calculated; how much money the borrower could receive under different scenarios; loan costs, including interest charged; borrower responsibilities, such as property taxes, insurance, property maintenance and repairs, and continued residence; default and possible foreclosure; and possible effects on taxes, estate and public benefits. States with housing counseling requirements for reverse-mortgage loans include, among a number of others, New York, Illinois and Massachusetts. Under the recently enacted California legislation approved by the governor on Sept. 5, 2006, reverse-mortgage lenders must refer a prospective borrower to a housing counseling agency for counseling and obtain a certification that the borrower received the required counseling prior to accepting a final application for a reverse mortgage or assessing any fees. The California rules require lenders to give each borrower a list of at least five housing counseling agencies approved by HUD and at least two agencies that can provide counseling by telephone. Real Estate Settlement Procedures Act (RESPA) Insurance companies, financial advisers and clubs or associations with elderly members can be good sources for reversemortgage applicants. Understandably, lenders may want to develop ties with these types of entities, but they must be mindful of RESPA rules. Specifically, RESPA prohibits giving or receiving compensation for referrals of settlement service business (which includes lending). Section 8(a) of RESPA prohibits the payment or acceptance Insurance companies, financial advisers and clubs or associations with elderly members can be good sources for reverse-mortgage applicants. of any fee, kickback or other thing of value under an agreement or understanding whereby one party refers real estate settlement service business to the other. The referral must be for real estate settlement services business related to a federally related mortgage loan secured by a first or subordinate lien on real property. Section 8(b) of RESPA prohibits any fee splitting or unearned fees for a real estate settlement service not related to any services actually performed. HUD interprets Section 8(b) to prohibit entities from giving or accepting any portion of a charge for which no services are actually performed. In Statement of Policy , HUD clarified that Section 8(b) prohibits not only fee-splitting arrangements between settlement service providers, but also: 1) a single settlement service provider charging a consumer a fee where no, nominal or duplicative work is done; and 2) a single settlement service provider marking up the cost of services performed by a second settlement service provider without providing additional, distinct services. HUD also noted in a footnote that a lender s review of another settlement service provider s service does not qualify as an actual, compensable service. In essence, these prohibitions mean that reverse-mortgage lenders cannot compensate third parties solely for sending borrowers their way. Similar state laws may apply as well. Lenders may be able to mitigate the risks of violating RESPA by carefully structuring their relationships with thirdparty organizations. Lenders could simply decide not to pay any fees to third parties that refer borrowers to them, for example. Lenders could also try to qualify for one of RESPA s exemptions for payments to third parties. RESPA does permit lenders to pay third parties fees that are reasonably related to the value of non-referral goods and services. A possible way that lenders might be able to qualify for this exemption is if the third party performs actual services, such as marketing services, for the lender, and the lender compensates the third party solely for the reasonable value of the marketing services. HUD has issued guidance for payments to mortgage brokers and other intermediaries. Truth in Lending Act (TILA) TILA requires reverse-mortgage lenders to provide disclosures prescribed for any open-end or closed-end loan, as applicable. In addition, reverse-mortgage lenders must give borrowers a special disclosure called the Total Annual Loan Costs disclosure (TALC). The TALC must contain a Good Faith Estimate of the total annual loan costs and related information. Accordingly, lenders need to have systems that are sufficiently sophisticated to generate the TALC, which requires projections for multiple assumed annual appreciation rates and loan periods. Also noteworthy is that lenders of open-end reverse mortgages (as defined in Regulation Z) are expressly prohibited from terminating and demanding repayment on a reverse mortgage unless the consumer defaults, transfers title to the property, ceases using the securing property as the primary dwelling or dies. Finally, most reverse loans are subject to the right that borrowers have under TILA to rescind the loan within three days of closing, because most are not purchase-money loans.
5 These loans also are subject to TILA s extended right to rescind if the loan documents materially violate TILA s disclosure requirements. A reverse-mortgage borrower who rescinds under the extended rescission period rules potentially could recover all loan fees and interest payments for up to three years after closing the reverse-mortgage loan. FHA requirements for HECM lenders Lenders of HECMs must comply with a wide array of FHA rules for HECM originations. In addition to the borrower-counseling requirements mentioned earlier, FHA requirements include, among others, restrictions on origination fees (the origination fee charged and financed in the loan cannot exceed the greater of $2,000 or 2 percent of the maximum claim amount) and thirdparty fees, repair administration fees, prohibitions on tax service fees and discount points, and requirements to establish a repair set-aside. To obtain approval for making HECMs, a lender must meet the When developing proprietary reversemortgage products, lenders also may want to consider fair-lending laws. standard approval requirements for direct-endorsement lenders but comply with separate test-case requirements (for m o r e i n f o r m a t i o n o n p r e - c l o s i n g t e s t c a s e s, v i s i t State requirements Some states have enhanced disclosure and other requirements for reverse-mortgage lending as well. Recently, for example, California began requiring reverse-mortgage lenders to provide a foreign-language translation of reverse-mortgage loan documents in certain circumstances. In addition to enhanced state disclosure requirements, reverse-mortgage lenders may be subject, as noted, to state counseling requirements and annuity restrictions. Finally, states may have special licensing and approval requirements for reverse-mortgage lending (and servicing). Reverse-mortgage lenders may enjoy pre-emption from state interest-rate laws, depending on the type of loan and lender. Fannie Mae s Home Keeper reverse-mortgage lenders subject to Office of Thrift Supervision (OTS) regulations under the Alternative Mortgage Transactions Parity Act, for example, are entitled to federal pre-emption of certain state law prohibitions. Federal pre-emption allows lenders to offer some loan types irrespective of certain state laws that prohibit the product. Fair lending When developing proprietary reverse-mortgage products, lenders also may want to consider fair-lending laws. The Equal Credit Opportunity Act (ECOA) prohibits discrimination on the basis of both age and sex. ECOA carves out an exception that allows lenders to consider the age of an elderly applicant when the lender will use that information to grant credit in favor of the applicant. The Fair Housing Act prohibits discrimination on the basis of sex, but not of age. Fair-lending laws may come into play especially when determining the maximum loan amounts or monthly payment amounts for applicants. Maximum reverse-mortgage loan amounts and monthly payments have traditionally been tied in part to life expectancy, and the data show that women live longer than men. Thus, depending on how a given proprietary product is designed, the product could raise issues of gender or age discrimination. (HUD s and Fannie Mae s reverse-mortgage guides do not indicate that gender is a consideration in determining maximum loan amounts or monthly payments for HECMs or Home Keeper loans.) Benefits and risks for servicers Detailed daily operations Ginnie Mae s president has acknowledged that the challenges of servicing reverse-mortgage loans are complicated. Standard servicing systems may not work for the reverse-mortgage product. As with forward-mortgage loans, reverse-mortgage loan servicers must provide appropriate state and federal servicing disclosures and monthly statements, as well as remit payments according to the different types of reverse-mortgage loans (line of credit, monthly payment, combination). They also must keep track of, among other things, property tax and insurance payments (most reverse-mortgage servicers do not escrow these items, but must send reminder notices to the borrowers to safeguard the collateral), interest-rate changes and interest accumulation, and servicing fees. Finally, because reverse mortgages are non-recourse, reverse-mortgage servicers must be diligent in monitoring the collateral to ensure that borrowers are meeting their contractual obligations to keep the home in good condition. State requirements Like lenders, reverse-mortgage servicers need to be mindful of any state-specific licensing and disclosure requirements that may apply. In Massachusetts, for example, making advances to a borrower with a reverse-mortgage loan can trigger a loan servicer registration obligation under the Debt Collector Licensing and Third Party Loan Servicer Registration Law. Investor remittances for securitized reverse mortgages For securitized reverse- mortgage loans, servicers are responsible for remitting a combination of pro rata payments to investors that are typically much more complex than for conventional mortgage securitizations. Investors in securitized reverse mortgages may not get paid until the loan matures, leaving ample opportunity for record-keeping mistakes that could have a major impact by the time the loan matures. Indeed, according to a Nov. 1, 2006, article in Origination News, Ginnie Mae May Securitize Reverses, Ginnie Mae has found that setting up a workable record-keeping system for remittances associated with separate securitizations of lumpsum payments and monthly advances (and possibly yet
6 another separate securitization for servicing fees) has slowed implementation of its HECM securitization plan. Benefits and risks for purchasers Declining equity Purchasers of closed reverse-mortgage loans (who may or may not securitize them) share with lenders the risk that the home equity will be less than the loan amount. With this in mind, a purchaser s first challenge is ensuring that the appraisal is accurate. Valuing reverse-mortgage loans is mathematically complex, and must account for the uncertain factor of equity risk. Assignee liability As with other loans, purchasers will want to be aware of whether lender violations might carry liability for the assignee. A full discussion of assignee liability is beyond the scope of this article, but a few points are worth noting. On the positive side, TILA s high-cost loan provisions, which carry assignee liability, expressly do not apply to reverse-mortgage loans (as defined in Regulation Z). Also, in general, purchasers of HECMs that have been closed and funded should not face a material risk of HUD enforcement for lender violations of FHA requirements. The government insurance that these loans carry may in essence even give purchasers greater protection certainly financially than a purchaser has for uninsured loans. On the other hand, as noted earlier, TILA s rescission provisions do apply to most reverse-mortgage loans. If the lender fails to provide accurate material disclosures required by TILA, the borrower could have the right to rescind the loan for up to three years after the loan is closed. Purchasers also may want to consider state laws to determine possible assignee liability. Some state high-cost loan laws, for example, do not exempt reverse-mortgage loans as TILA s highcost provision does. Further, the enforceability of reverse-mortgage loans could be impaired if the originating lender was not properly licensed or if the loan exceeded state usury maximums (if those maximums are not pre-empted for the lender). Summing up This article covers a few of the many legal compliance and other issues involved in making, servicing and buying reversemortgage loans. Forward-thinking lenders, servicers and purchasers are taking a hard look at growing opportunities in the reverse-mortgage market. But the smartest of these are realistically assessing whether they have the will and the wherewithal to take on the detailed operations necessary for the reverse-mortgage business. MIB Lorna M. Neill is an associate and Steven Kaplan is a partner in the Mortgage Banking and Consumer Credit practice group of Kirkpatrick Lockhart Preston Gates Ellis LLP (K&L Gates) in Washington, D.C. They can be reached at and NOTE: This article is for informational purposes and does not contain or convey legal advice. The information in this article should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. R E P R I N T E D W I T H P E R M I S S I O N F R O M T H E M O RTG A G E B A N K E R S A S S O C I AT I O N ( M B A )