CLE Alabama. 33 rd Annual Bankruptcy Law Update. Hyatt Regency Wynfrey Hotel Birmingham, Alabama Friday, November 14, 2014

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1 33 rd Annual Bankruptcy Law Update Hyatt Regency Wynfrey Hotel Birmingham, Alabama Friday, November 14, 2014 Common Uses of Reverse Mortgages as an Alternative to Other Housing Finance Solutions (Including Bankruptcy) Hugh M. Lee Elder Law Clinic and Foreclosure Relief Clinic The University of Alabama School of Law Tuscaloosa

2 Common Uses of Reverse Mortgages as an Alternative to Other Housing Finance Solutions (Including Bankruptcy) By Hugh M. Lee, Director Elder Law Clinic and Foreclosure Relief Clinic University of Alabama School of Law The reverse mortgage, as an instrument for financing a debtor s principal residence while making significant use of the equity in the home, has been around for quite a few years. 1 However, it didn t come into significant favor and use until HUD launched the Home Equity Conversion Mortgage Demonstration Program in 1989, through which HUD insured reverse mortgages. Since then, reverse mortgages have become an increasingly common way for seniors to resolve pressing financial concerns - whether one-time or continuing in nature - by using the equity in their homes during their lifetime. Although other reverse mortgage products are available, HUD-insured HECM loans are the most common and are the focus of this article. This article does not delve into all of the specific requirements of the HECM Program. However, for purposes of understanding the discussion below, the HECM Program requires that (1) the homeowner must be sixty-two (62) years of age or older; (2) the home must be occupied as the borrower s principal residence; (3) the homeowner must have significant equity in or outright ownership of the home; (4) the homeowner must have no delinquent federal debts; and (5) the homeowner must have sufficient resources to pay continuing expenses, such as taxes, homeowner s insurance, and homeowner s association fees. 2 The purpose of this article is to address why clients seek a reverse mortgage, how clients decide between reverse mortgages and bankruptcy, and the most important considerations affecting the homeowner s choice. The article also addresses some recent changes in reverse mortgage rules which may make them less attractive. Finally, the article closes with a couple of specific examples in which reverse mortgages are an attractive solution to a looming debt problem. I. Advising Clients About Reverse Mortgages One of the most important qualifications for obtaining a reverse mortgage is the requirement that the homeowner be sixty-two (62) years of age or older. 3 This necessarily means that all of those seeking reverse mortgages are older homeowners. Page 1 of 11 Lee - 1

3 Because reverse mortgages are designed to allow the homeowner to draw upon the present day equity in their homes without repayment, it also stands to reason that such reverse mortgages are intended to address a pending financial issue - whether that issue is the need for additional monthly income or the need to solve an immediate financial crisis (an expensive purchase, a medical bill, a credit card bill, a judgment, etc.). Thus, those homeowners inquiring about reverse mortgages are usually elderly homeowners with a significant financial problem. 4 In the last five years, every client who has sought assistance from the Elder Law Clinic or the Foreclosure Relief Clinic with a reverse mortgage has been in exactly that scenario. So reverse mortgages are generally sought for two reasons - to generate additional monthly revenue for living expenses or to receive some lump sum payment to pay off a significant expense, such as a hospital bill or other expense. A reverse mortgage can accomplish either of those two goals. II. How Reverse Mortgages Generate Revenue or Lump Sum Proceeds Once eligible for a reverse mortgage, a borrower may choose from five different payment plans. If the borrower selects tenure payments, he will receive equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence. If the borrower selects term payments, he will receive equal monthly payments for a fixed period of months. If the borrower selects a line of credit, the borrower receives a line of credit that may be accessed at any time and in any amount until such time as the line of credit is exhausted. The borrower can also choose combination plans called modified tenure and modified term, which combines the standard tenure and term plans with a line of credit. 5 A borrower may change between payment plans for a mere $ Therefore, the homeowner is able to generate a stream of income or a lump sum to pay a significant expense (including paying off their current mortgage). The analysis of a reverse mortgage as a viable solution does not end there, however, as the homeowner must also determine whether the reverse mortgage will generate enough monthly revenue or enough of a lump sum (after satisfying any initial liens on the property) to solve the problem presented. The amount of money that can be borrowed depends upon a variety of factors called the Principal Limit Factors or PLFs. These factors determine the maximum principal that may be borrowed over the lifetime of the borrower, and include the age of the youngest borrower, current interest rates, the appraised value of the home (currently capped at $625,500 for PLF purposes), and the amount of the initial mortgage insurance premium (which is the insurance charged to guarantee the viability of the loan). 7 Page 2 of 11 Lee - 2

4 Furthermore, the amount of money that may be borrowed also depends upon the type of loan chosen. In this regard, there have been many recent changes in the available HECM loans. For instance, the most popular reverse mortgage option over the last several years has been the HECM Standard fixed rate reverse mortgage. This loan guaranteed a fixed rate and offered the highest loan amount, though it also required higher upfront fees. However, the HECM Standard reverse mortgage with a fixed rate is no longer offered. There are still both fixed rate and adjustable rate mortgages offered under the HECM program, but the amount that may be borrowed and the amount and schedule of payments may be restricted, depending upon the product chosen. 8 Most borrowers choose to pay the costs associated with a reverse mortgage out of the loan proceeds. Costs associated include mortgage insurance premiums (initial and annual), third party charges, origination fee 9, interest 10, and servicing fees. The mortgage insurance premium will be either 2.5% at closing or 0.5% at closing, depending upon which product is chosen by the borrower. The borrower will also be charged the equivalent of 1.25% of the mortgage balance over the life of the loan. 11 Third party charges include an appraisal, title search, title insurance, surveys, recording fees, mortgage taxes and other fees. 12 These costs, if paid from the loan proceeds, will also reduce the amount of principal available to the borrower to solve their financial issue. In short, regardless of which HECM product is chosen, the borrower is unlikely to know how much they can borrow and on what schedule of payments until the borrower has spoken with a reverse mortgage counselor and completed mandatory housing counseling. The principal limit must be determined, the HECM product chosen and the upfront costs calculated before the homeowner can really know how much income he can generate or how much of a lump sum or line of credit he can draw. III. Reverse Mortgages Versus Other Solutions For clients requesting information about reverse mortgages, the careful lawyer will consider other ways in which to address their debt and income issues as well. Unfortunately, many of the ways that might normally be considered will not be available to the elderly borrower. For instance, the following solutions are probably not available:! Most elderly homeowners facing financial distress cannot qualify for mortgage refinancing to either lower payments or draw equity from their homes. 13 This is usually true because of their age, income or past credit history. Page 3 of 11 Lee - 3

5 ! Most elderly homeowners cannot increase their monthly income by taking on employment, as many are not able and the able-bodied face social security repercussions from significant employment before full retirement age. 14! Most elderly homeowners with equity in their homes cannot afford to ignore unpaid bills (even if they have non-garnishable income), as any unpaid creditors will likely obtain a judgment and file the judgment as a lien against the home.! Although some elderly homeowners may qualify for a modification under HAMP, HARP or a private loan modification program, such a modification will result only in an incremental reduction in their mortgage payment and will not sufficiently address debt or income issues. In short, an elderly homeowner with only the equity in their home as a significant asset may not be able to resolve their debt or income issues without turning to either a reverse mortgage or bankruptcy for relief. A. Resolving Income Issues For many seniors, their primary financial issue is lack of sufficient income, whether to meet unexpected expenses or rising medical costs. Increasing or maximizing their monthly disposable income may be necessary in order for them to make ends meet. For clients who cannot work or have no other source of income, there are primarily two ways to accomplish that - reducing their monthly expenses or increasing their monthly income. A reverse mortgage increases disposable income in two ways, by eliminating the homeowner s mortgage payment while also generating term payments to increase income. A reverse mortgage will not reduce the other debts owed by the homeowner, so as a debt consolidation and payment strategy, a reverse mortgage is a more limited tool (though more money is available to pay existing debt). But generally speaking, a reverse mortgage will be successful if the primary motivation is to create additional disposable income each month. So when would a Chapter 13 bankruptcy make more sense for a homeowner with significant equity in their home? Where the homeowner s monthly income is almost sufficient to meet their needs, but for existing debt, it may make more sense to file a Chapter 13 bankruptcy and pay their unsecured debt over time. During the term of the bankruptcy, the homeowner s expenses should be reduced. Upon discharge, the Page 4 of 11 Lee - 4

6 homeowner s monthly income should be sufficient. REVERSE MORTGAGE v. BANKRUPTCY TO RESOLVE INCOME ISSUES EXAMPLE A: An 80-year-old client has monthly income of $1,150 from Social Security as their only source of income. He owns his own home worth $100,000 and owes $45,000 on his only mortgage. He has the following expenses: $400 - mortgage, $200 - utilities, $100 - car insurance, $250 - car payment, $50 - water and garbage, $50 - cable television, $50 - phone, and $250 - groceries. Income is $200 short of expenses. Reverse Mortgage: Using HUD s principal limit factors, the homeowner s principal limit available with a reverse mortgage would be $65,700. This would allow him to pay off his mortgage and save his $400 monthly mortgage payment and would establish a line of credit upon which the homeowner could draw in the amount of $14,136. The total costs associated with this loan would be $6,564. This would create the necessary income that he needs to meet his monthly expenses as well as a line of credit upon which he could draw as needed. Bankruptcy: In this scenario, there are no debts to be consolidated and paid under a Chapter 13 plan. As a result, bankruptcy does not provide a good solution to this homeowner s monthly shortfall. Note that if a significant part of the client s monthly shortfall was unsecured debt, this analysis might change, as the discharge of unsecured debt might create disposable income that could be used to solve the problem. B. Resolving Debt Issues For other seniors, the primary issue to be resolved is the payment of outstanding debts. Some seniors have sufficient income but for the existence of significant consumer debt, unrelated to their monthly living expenses. In this scenario, both a reverse mortgage and a Chapter 13 bankruptcy may provide a good solution to the problem of significant consumer debt. A reverse mortgage could be used in this scenario to address the unsecured debt problem. The reverse mortgage will reduce the homeowner s monthly expenses by eliminating the mortgage payment. The homeowner could opt for term payments sufficient to make his monthly debt payments over time. Alternatively, the homeowner Page 5 of 11 Lee - 5

7 could opt for a lump sum payment or line of credit that he could then use to pay his consumer debt. The availability of lump sum payments allows the homeowner to negotiate down their unsecured debt in a way that mimics the advantages of a Chapter 13 plan that pays less than 100% of unsecured debt. There are some limitations to using the reverse mortgage, however. For instance, new HECM rules prohibit the homeowner from withdrawing more than 60% of the initial principal limit or, if prior liens exceed 60% of the initial principal limit, the value of those liens plus 10%. 15 So when would a Chapter 13 bankruptcy make more sense than a reverse mortgage to address outstanding consumer debt? When a debtor s income is more than sufficient to meet his monthly living expenses and his primary concern is eliminating outstanding consumer debt, a Chapter 13 bankruptcy may offer some advantages over a reverse mortgage. The bankruptcy offers the opportunity to pay down consolidated, unsecured consumer debt over time at a fixed interest rate and in a monthly payment amount that is usually significantly lower than making separate payments. Depending upon the amount and treatment of equity, it is possible that the debtor could pay less than 100% of his unsecured debt. In those cases in which the initial principal limit is not sufficient to satisfy all of the homeowner s debts, a Chapter 13 may be a better option. The debtor should also consider the costs associated with a reverse mortgage, as well. Finally, for a homeowner who is really committed to preserving his property for his heirs, bankruptcy may allow him to do that while still addressing his debts. The following example demonstrates the difficulty of choosing between a Chapter 13 bankruptcy and a reverse mortgage, when the homeowner needs no additional income, but rather a solution to their debt problems. REVERSE MORTGAGE v. BANKRUPTCY TO RESOLVE DEBT ISSUES EXAMPLE B: An 70-year-old client has monthly income of $1,850 from Social Security as their only source of income. He owns his own home worth $100,000 and owes $45,000 on his only mortgage. He has the following expenses: $400 - mortgage, $200 - utilities, $100 - car insurance, $250 - car payment, $50 - water and garbage, $50 - cable television, $50 - phone, and $250 - groceries. He has $500 in disposable income every month. However, he also has (1) an outstanding judgment for $8,000 resulting from a medical bill, and (2) outstanding credit card debt of $8,000 Page 6 of 11 Lee - 6

8 owed to three different credit card companies. He is being threatened with garnishment by his judgment creditor and being threatened with suit by the credit card companies. He has been trying to pay $ per month on these bills but has found it to be difficult. He is trying to decide whether to file for bankruptcy or whether to seek a reverse mortgage. Reverse Mortgage: Using HUD s principal limit factors, the homeowner s principal limit available with a reverse mortgage would be $57,600. This would allow him to pay off his mortgage, save his $400 monthly mortgage payment and establish a line of credit upon which the homeowner could draw in the amount of $6,736 to pay his debts. The total costs associated with this loan would be $6,564. In this scenario, the client is increasing their monthly disposable income available to pay debts, but they are not generating a significant amount of money up front to pay off their debts. Furthermore, depending upon the HECM product chosen, there may be a real limit on the amount that may be drawn on the line of credit in the first year. This may further delay the homeowner s ability to pay down debt. Finally, this HECM costs as much money as it generates and, depending upon the product chosen, may result in lost equity. 16 At best, a reverse mortgage in this scenario might be called a mixed bag. Bankruptcy: In this scenario, it may make more sense to refer this client to a bankruptcy attorney first, before considering a reverse mortgage. Even in a Chapter 13 plan that pays 100% of unsecured debt, the homeowner s monthly payments under a sixty month plan might be between $300 and $350 per month. This amount is within his current monthly disposable income, and without tapping the equity in his home. However, many bankruptcy attorneys might discourage a debtor from filing with such modest debts. C. The Special Problem of Foreclosure Foreclosure or threatened foreclosure poses a special problem when considering reverse mortgages. In many instances and under the facts of the two examples above, even a homeowner facing foreclosure has enough equity in their home to qualify for a reverse mortgage which would satisfy the homeowner s conventional mortgage. Often, the problem is a problem of timing. Can the homeowner complete the necessary steps and meet the necessary requirements in time to close and satisfy the conventional mortgage prior to foreclosure. In many instances, the homeowner must choose to file a Chapter 13 bankruptcy to receive the benefit of the court s stay while deciding how to proceed. 17 They may later choose to complete the Chapter 13 plan to discharge or continue pursuing a Page 7 of 11 Lee - 7

9 reverse mortgage. IV. Dark Skies for Reverse Mortgages? Troubling Recent and Coming Changes The reverse mortgage industry has been under increasing scrutiny, as the cost of HECMs to the FHA Mutual Mortgage Insurance Fund (which insures reverse mortgages) has increased dramatically. 18 In Fall 2013, FHA Commissioner Carole Calante reported that the HECM reverse mortgage program suffered five billion dollars in losses. 19 Some of the regulation of the reverse mortgage industry has been transferred from the Department of Housing and Urban Development (HUD) to the Consumer Financial Protection Bureau, as the result of the Dodd-Frank reform law. As part of the Act, the CFPB was required to study the reverse mortgage industry. 20 The CFPB began a close evaluation of the reverse mortgage market and, as early as the summer of 2012, indicated that changes may be forthcoming. 21 This later led to the Reverse Mortgage Stabilization Act of , which authorized HUD to implement many of the suggested changes to the HECM program. As a result of these fiscal problems and passage of the Act, there have been several significant rules changes that have made reverse mortgages perhaps less desirable. The following significant rules have occurred in the last two years:! Elimination of the HECM Standard Fixed Rate Program 23 - The elimination of this program eliminated the only fixed rate program that allowed the borrower to borrow a large lump sum up front. Now those seeking a lump sum payout must choose an adjustable rate product and can receive only more limited lump sum payouts.! Limitations on Initial Principal Payments 24 - Effective September 30, 2013, HUD limited the amount of the principal limit which may be disbursed in the first twelve months after closing to either 60% of the principal limit of the loan or the amount of any liens to be paid plus 10% of the principal limit (not to exceed the principal limit).! New Lump Sum Payment Program 25 - Having eliminated the most common program for obtaining lump sum payments, HUD initiated a new program for those who wanted to take a one-time disbursement of their equity and waive any right to further access their equity. Under this program, a homeowner may take a lump sum payment of up to 60% of the principal limit during the first twelve Page 8 of 11 Lee - 8

10 months, but may receive no more of the equity in the home.! Mandatory Set Asides 26 - Effective September 30, 2013 (for most loans), this provision allows the mortgagee to require the payment of the borrower s mandatory obligations (hazard insurance, taxes, repairs, etc.) from the borrower s proceeds at the time of closing.! New Financial Resource Test 27 - Faced with an increasing number of borrowers who were unable to meet their property tax, homeowners insurance and other financial requirements of the HECM program, HUD implemented a required financial assessment, effective January 1, This assessment is designed to ensure that the borrower has the resources to fulfill their obligations under the reverse mortgage with a mandatory set aside. The effect of all of these changes is to potentially reduce the amount that may be disbursed to the borrower, thereby making reverse mortgages less attractive than they once were. Furthermore, some experts believe that the reverse mortgage market is already self-correcting, as the traditional mortgage market improves and it becomes easier to borrow from one s home equity through more traditional loans. 28 V. The Conclusion The conclusion for the general practice lawyer is that it is a sound strategy to consult with a bankruptcy lawyer to determine whether a reverse mortgage or a Chapter 13 bankruptcy most effectively addresses the needs of a homeowner, when that homeowner has significant home equity but pressing financial problems. The reverse mortgage may be more appropriate when the homeowner needs to supplement their income for an extended period of time, and simple debt reduction is not sufficient to generate enough extra income to make ends meet. Nonetheless, the best solution to a homeowner's debt problems cannot be determined without actually evaluating all of the options available. 1. Ken Scholen, Retirement Income on the House: Cashing in on Your Home with a Reverse Mortgage (1992)(in which the author states that the first reverse mortgage was offered in 1961). 2. U.S. Dept. of Housing and Urban Development, FHA Reverse Mortgages (HECMs) for Seniors, (visited 10/10/14). 3. U.S. Dept. of Housing and Urban Development, FHA Reverse Mortgages (HECMs) for Seniors, (visited 10/10/14). Page 9 of 11 Lee - 9

11 4. This should not be surprising in light of the common goal of most elderly clients to leave their homestead to their children or heirs. To abandon that goal, a significant financial issue must be facing the homeowner. 5. U.S. Dept. of Housing and Urban Dev., HECM Protocol 5.D.3.b at (visited 10/14/14). 6. U.S. Dept. of Housing and Urban Dev., HECM Protocol 5.D.3.c at (visited 10/14/14). 7. To see HUD s current principal limit factors, download HUD s PLF Excel spreadsheet from its lender page at (visited 10/14/14). New principal limit factors were recently announced by HUD and took affect August 4, See U.S. Dept. of Housing and Urban Dev., Mortgagee Letter at (visited 10/14/14). 8. See U.S. Dept. of Housing and Urban Development, HECM Protocol 5.D.4 at (visited 10/14/14). See generally Consumer Financial Protection Bureau, How do I receive the money from a reverse mortgage loan? at (visited 10/18/14)(describing in a summary fashion some of the different ways that HECM mortgages work). 9. U.S. Dept. of Housing and Urban Dev., "FHA Reverse Mortgages (HECM) for Seniors," (visited 10/14/14). 10. Id. 11. See generally Consumer Financial Protection Bureau, Are there any limitations on the updront charges a bank can charge for a reverse mortgage? at (visited 10/18/14). 12. U.S. Dept. of Housing and Urban Dev., "FHA Reverse Mortgages (HECM) for Seniors," (visited 10/14/14). 13. Some may qualify for loan modification under the Making Homes Affordable Program, if they hold a qualifying loan. See, e.g. U.S. Department of Housing and Urban Dev., Making Homes Affordable Program at qovn67sto9s8-szbvm2ni7muaaqhv8p8haq (visited 10/14/14). 14. See Social Security Administration, How Work Affects Your Benefits SSA Publication No (2014). 15. U.S. Dept. of Housing and Urban Dev., HUD Mortgagee Letter at (September 3, 2013). 16. Consumer Finance Protection Bureau, "How do I receive the money from a reverse mortgage loan?" at (August 13, 2014)("with the fixed-rate, lump-sum option, you will receive your entire loan proceeds upfront and you will receive a fixed interest rate. However, you will only be able to access the amount permitted under the first-year withdrawal limits. The remaining loan amount is forfeited. This means most borrowers will not be able to borrow as much with a fixed-rate, lump-sum loan than with an adjustable-rate, line of credit or monthly payout option.") U.S.C. 362 (2014). 18. Andrew Miga, FHA needs $1.7B to cover reverse mortgage losses, USA Today at (September 27, 2013)(indicating that the shortfall was the first in the 79-year history of FHA). 19. Id. Page 10 of 11 Lee - 10

12 20. Dodd-Frank Wall Street Reform and Consumer Protection Act, H.R (111 th Congress)(Section 1076). 22. Mark Miller, More Red Flags on Reverse Mortgages, (Reuters July 6, 2012)(visited on 2/10/13). 22. Pub. L (2013). 23. U.S. Dept. of Housing and Urban Dev., Mortgagee Letter (January 30, 2013). 24. U.S. Dept. of Housing and Urban Dev., Mortgagee Letter (September 3, 2013). 25. U.S. Dept. of Housing and Urban Dev., Mortgagee Letter (September 3, 2013). 26. U.S. Dept. of Housing and Urban Dev., Mortgagee Letter (September 25, 2013). 27. U.S. Dept. of Housing and Urban Dev., Mortgagee Letter (September 3, 2013). 28. Michael Kitces, HECM Reverse Mortgages - Current Borrowing Limits May Not Last Much Longer, Nerd s Eye View at (December 4, 2013)(visited 10/18/14). Page 11 of 11 Lee - 11