What to Consider Before Developing, Marketing, and Originating Them

Transcription

1 By Phillip R. Rick Freer Jr., CRCM, and Calvin R. Hagins, CRCM, CRP, AMLP Shutterstock Reverse Mortgages: What to Consider Before Developing, Marketing, and Originating Them 6 MARCH APRIL 2010 ABA Bank Compliance

2 You have probably read articles on reverse mortgages and seen noted actors pitch them on television or heard about them in radio advertisements. Regulators and others have written articles covering reverse mortgages and the various issues that potential borrowers should understand before jumping into the product. Lenders, too, have been encouraged to consider the various product risks and reputation risk that can be associated with the product, and the financial regulatory agencies recently issued proposed reverse mortgage guidance for industry comment. Generally, the sentiment is neither all favorable nor all unfavorable. Those who register concerns with the product mention consumer protection issues, high costs, and the fact that the consumers could lose their homes. On the other side, proponents argue that this product may be good for some senior citizens and that consumer counseling and disclosures should adequately explain all the issues. Regardless of what you have heard or may think, financial institutions are offering both government-insured and proprietary versions of the reverse mortgage product in greater numbers. With the ever-increasing number of baby boomers reaching senior-citizen status, many financial institutions are wondering whether it makes sense to offer it. Whether a reverse mortgage product is a good idea for your financial institution and customers we will leave for you to decide. In June 2009 Comptroller of the Currency John C. Dugan discussed reverse mortgages during a keynote speech at the American Bankers Association s Regulatory Compliance Conference. While the comptroller emphasized a number of points related to the reverse mortgage product, we would like to focus on one that is the foundation for this article: While reverse mortgages can provide real benefits, they also have some of the same characteristics as the riskiest types of subprime mortgages and that should set off alarm bells. I believe that now is the time to get out in front of this issue before real problems develop so that reverse mortgage providers make these loans in a way that is prudent for both lenders and borrowers. 1 The purpose of this article is not to debate the pros and cons of this product or whether financial institutions should offer alternative products. Instead, our goal is to briefly explain the product and to discuss both consumer protection and safety and soundness concerns related to it. We will outline the compliance risk these products pose and how to develop the compliance risk management processes to ensure compliance with relevant laws and regulations and that the program is managed in a safe and sound manner. What Is a Reverse Mortgage? A reverse mortgage is a loan secured by a borrower s home that allows the borrower, generally 62 years of age or older, to convert the home s equity into cash. Usually the borrower owns the home outright or has a low loan balance with substantial equity. The loan funds can be used to pay off any existing mortgage balance or for whatever the borrower chooses. There are no borrower payments; instead, the lender pays money to the borrower in a number of ways depending on the reverse mortgage loan agreement. Reverse mortgages can be open-end or closed-end loans. The amount that a borrower receives under a reverse mortgage depends on the borrower s age, the value of the residential collateral, and the interest rate(s) at inception and throughout the life of the loan. The older the borrower, the greater the amount the borrower can receive consistent with the collateral value and amount of equity. Payments to the borrower can be set up as a lump sum at the beginning of the mortgage or at some time during the term, or can be made monthly or as needed under a line-of-credit arrangement. Monthly payments can be set for a certain term or throughout the life of the loan. Or the loan can be structured as a combination of any of those payment terms. Generally, repayment is accomplished upon the death of the borrower, when the home is vacated, or when it is sold. The costs associated with a reverse mortgage can be high. As with any home mortgage product, borrowers pay interest and closing costs related to appraisals, inspections, and title activities, along with other costs typically associated with loan consummation. There is also a monthly servicing fee and, with government-insured products, mortgage insurance fees. All of these fees are added at the front end, which makes the use of the funds more costly than a regular mortgage loan, also called a forward mortgage. Generally, all of these fees can be added to the mortgage balance rather than paid by the borrower at consummation. Currently there are two reverse mortgage products available: home equity conversion mortgages (HECM) ABA Bank Compliance MARCH APRIL

3 Because the lender is basing the loan on the value of the underlying collateral, borrower credit scores and credit history are not as important for qualifying borrowers as with traditional mortgages. and financial institution proprietary products. The HECM is insured by the Federal Housing Administration (FHA) and accounts for the vast number of such mortgages today. However, some financial institutions are starting to offer or are considering offering their own proprietary reverse mortgage products. The HECM product is limited in dollar amount available and provides insurance protection for both the lender and the borrower. However, proprietary products offered by financial institutions are not limited in size and do not provide insurance protection to either the borrower or the lender. Both the HECM and proprietary products have a maximum loan amount based on the value of the residential collateral. The HECM product maximum can increase depending upon the specific FHA program, but proprietary product maximums are set at origination based on the loan-to-value ratio. Before consumers can obtain HECMs, they must receive counseling from HUD-approved counselors. 2 No such requirement exists with proprietary products, although some lenders may provide for such counseling. Lastly, because borrowers retain title to their homes, they are responsible for paying real estate taxes, hazard insurance, and flood insurance if applicable, and maintaining the home s upkeep. This is true with either product and failure to manage these costs can result in foreclosure and the borrower losing the home. For more consumer and lender information on the HECM product, visit the Department of Housing and Urban Development Web site at sfh/hecm/hecmhomelenders.cfm. While we have briefly described the various aspects of the reverse mortgage product, it should be clear that there are both pitfalls and benefits related to the product from a consumer perspective. The costs are higher than with other mortgage products, terms can vary, and consumers can become confused and unsure what they are purchasing, especially if the lender is trying to cross-sell other products the consumer can use the reverse mortgage funds to purchase. Also, there is evidence that some consumers who purchased reverse mortgages later concluded that they did not need them and that they wasted significant amounts of money in the process. In some cases, these same consumers were sold other products not beneficial to them, and believing they may have been deceived or treated unfairly, they have sought relief though the courts. On the benefits side, despite the high cost of the product, many senior citizens conclude that a reverse mortgage will help them meet their financial goals in retirement, cover increasing healthcare costs, or otherwise improve their financial condition. Additionally, because the lender is basing the loan on the value of the underlying collateral, borrower credit scores and credit history are not as important for qualifying borrowers as with traditional mortgages. Consumer Protection Regulatory Requirements and Concerns A number of consumer protection laws and regulations apply to reverse mortgages essentially the same laws and regulations that apply to other mortgage loan products. These include the Federal Trade Commission, truth in lending, real estate settlement procedures, equal credit opportunity, fair housing, and flood disaster protection acts. There are also certain prohibitions on cross-selling other products as a condition of the loan, and specific state laws may also apply. Because reverse mortgages can be complex in that lenders may offer many options, some or all of which might be difficult for consumers to understand, marketing and relevant disclosures for the product can increase the likelihood of unfair and deceptive practices that are illegal under 8 MARCH APRIL 2010 ABA Bank Compliance

4 Section 5 of the Federal Trade Commission Act. Lending institutions should scrutinize the actions and activities performed by retail lenders, brokers, and other third parties involved in the reverse mortgage lending process. For a more complete discussion of unfair and deceptive acts and practices, we refer you to OCC Advisory Letter at You can also find similar discussions on the other federal financial institution regulators Web sites and the Federal Trade Commission Web site. One issue that has raised many concerns with the reverse mortgage product is the fact that proprietary products do not require potential borrowers to receive independent counseling. Such counseling could very well eliminate many concerns with proprietary products if consumers obtain accurate product information receive information on alternative mortgage products that may better meet their needs obtain answers to their questions and have their unique concerns addressed are encouraged not to purchase other products with the loan funds without understanding the consequences of such purchases on their financial situation Without these and other appropriate disclosures, consumers may experience predatory lending practices or become victims of unfair or deceptive acts or practices. Although independent counseling is not a requirement, it is a best practice in the proprietary reverse mortgage market. The more transparent the process, the more likely it is that consumers will be adequately informed on the reverse mortgage products they are considering. The Truth in Lending Act and implementing Federal Reserve Board Regulation Z also contain disclosure requirements and cost-of-credit calculation requirements. The general disclosure rules that apply to reverse mortgage products will depend on whether the product is open-end or closed-end, as well as specific requirements for all reverse mortgage products. If the loan has a variable rate, then certain other requirements also apply. Disclosures must be clear and conspicuous, in writing, and in a form the consumer can keep. Disclosures for reverse mortgages must also tell borrowers that they do not have to complete the transaction even though they have received disclosures and signed a loan application. Additionally, a total annual loan cost rate (TALC) must be provided. While similar in purpose to the annual percentage rate disclosure for other types of open- and closed-end loans, the TALC is computed and disclosed differently. For more information on calculating the TALC, see Alan Dombrow and Ken Shim s Disclosure Requirements for Reverse Mortgages in Consumer Compliance Outlook, first quarter 2009, a publication of the Federal Reserve Bank of Philadelphia at bank-resources/publications/consumer-compliance-outlook/2009/first-quarter/q1_01.cfm. The general prohibitions contained in the Real Estate Settlement Procedures Act also apply to reverse mortgages, so early estimates and final settlement costs must be disclosed. Referral fees and other charges must be earned for services actually performed, and lenders cannot accept or pay fees for referring reverse mortgage business. Federal fair lending laws and regulations also apply, as may relevant state fair lending laws. These laws prohibit discouraging or discriminating against consumers on prohibited bases during the credit granting process. How and where the product is marketed or advertised; how applicants are treated during the application process; how applicants are approved for or denied loans; how loan interest rates, fees, and other charges are determined; and how borrowers are treated should issues arise after loan consummation must all be considered. Potential redlining issues must also be considered generally, and specifically in those parts of a financial institution s lending areas facing dropping property values and other effects of the economic downturn. Lastly, the Flood Disaster Protection Act applies to reverse mortgage loans. A determination must be made as to whether the property is in a designated flood hazard area. If so, then appropriate disclosures must be made and flood insurance obtained. Rules related to the use of the flood hazard determination form and forced placement also apply. Safety and Soundness Concerns Certain safety and soundness concerns also arise with a financial institution s involvement with reverse mortgages. Regulatory appraisal and real estate lending standards must be followed. If a financial institution involves third parties in its lending process, then the guidance that the agencies have provided covering mortgage brokers and other third-party lenders should be reviewed and relevant aspects of that guidance followed. Unlike traditional real estate lending, which relies on the borrower s ability to repay, property value is the repayment source for reverse mortgages. As such, financial institutions will need to be more diligent in making sure the property values securing reverse mortgages are maintained. If the financial institution does not escrow for taxes and insurance, it needs to be sure that borrowers are aware of their responsibility to pay these fees and can pay them. Even though we mentioned the flood insurance requirements as a consumer protection issue, from a safety and soundness perspective, institutions must make sure that adequate coverage is obtained at loan origination and throughout the life of the loan. We also remind institutions that they cannot require the purchase of an annuity or life insurance policy, for example, to obtain a reverse mortgage loan. Another issue that will create concern is whether the institution has the technology to handle the payment streams ABA Bank Compliance MARCH APRIL

5 and value calculations needed throughout the loan servicing period. Also, policies and procedures should be in place to manage the results of declining property values that may create a situation at repayment time that more is owed than the property is worth. What about selling the property? While repayment may be a long way down the road, all of these issues need to be considered up front when deciding whether to offer this product and managed throughout the life of the loan. Risk Management Processes to Manage the Reverse Mortgage Business Institutions face clear risks related to the reverse mortgage product, but as with any product an institution offers, a good understanding of those risks and how to manage them can reduce them substantially. Now that we have a basic idea of what the reverse mortgage is and some of the regulatory requirements and safety and soundness concerns related to it, how do you manage this business? As with any new or existing product, institutions must determine the quantity of risk (inherent risk) associated with the product. Quantity of risk 3 indicators should include the following: What is the experience of the staff with this product? Can institution software and electronic systems handle the reverse mortgage product? What lending channels will the institution use to obtain loan applications? How will the product be marketed and will marketing pieces be reviewed prior to use? Will the institution provide customers with independent counseling services regarding the product? Will consumers be apprised of other lending products when applying for a reverse mortgage product and told the difference of each and what the consumer should consider before deciding? Will mortgage brokers, third-party service providers, subsidiaries, and affiliates be involved with product disclosures, marketing, origination, and servicing? Will lender compensation be based on amount and size of loans and cross-selling of other products? Will the product be available throughout the institution s lending area or only in certain areas? This provides a basic understanding of some of the risks that institutions should consider when thinking of or continuing to offer a reverse mortgage product. Whether the quantity of risk is low, high, or somewhere in between, management must next address how well that risk will be mitigated or managed. Quality of risk management indicators that institutions should consider include the following: How well does management understand all aspects of the reverse mortgage product? Does management exhibit a clear commitment to compliance with the various laws and regulations that apply? How well is this commitment communicated to the lending staff associated with the reverse mortgage product? Are authority and accountability for safety and soundness concerns and compliance implications clearly defined and enforced? Will lending compliance considerations be incorporated into product design, system development, and modification processes? Will systems and processes include the activities of third-party participants, service providers, subsidiaries, and affiliates? Are appropriate and reasonable systems in place to identify weaknesses or violations in a timely manner? Will management decision making be centralized or decentralized? Will lenders adhere to sound underwriting standards associated with reverse mortgages? Will training be provided to the appropriate personnel? Will management act quickly and reasonably to correct policies, procedures, or practices when violations or weaknesses are identified? After the quantity of risk is identified and the quality of risk management indicators are applied to those risks, we are left with an aggregate level of risk (residual risk). This aggregate risk may be minimal or substantial, which may indicate that management needs to implement more systems or procedures to ensure compliance and a safe and sound program. Management should also determine the trajectory of that risk is it increasing, decreasing, or stable? Following this model, institutions should be able to develop safe and sound risk management processes to address this emerging product. Conclusion We are sure that in this short article we have left out one or more issues that institutions should consider when deciding to offer and service reverse mortgages. A reverse mortgage product can be as easy to offer, administer, and manage as any other loan product. It can provide benefits to some borrowers but may be inappropriate for others. As we have tried to demonstrate, this product also can be complicated for consumers and create confusion as to its true benefits and pitfalls. However, if you do your homework, thoroughly understand product features, determine the risk areas, develop risk processes to mitigate and manage the risks, and provide appropriate consumer disclosures, you should have a product that benefits both your financial institution and consumers. With the aging of the population, this product most likely will continue to grow in popularity. With this increased popularity will come more regulatory and public scrutiny. Since we began this article with a quote from Comptrol- 10 MARCH APRIL 2010 ABA Bank Compliance

6 If you do your homework, thoroughly understand product features, determine the risk areas, develop risk processes to mitigate and manage the risks, and provide appropriate consumer disclosures, you should have a product that benefits both your financial institution and consumers. ler Dugan, we would like to end with another from that same speech: There is another mortgage product that (1) has not yet been widely accepted in the market, (2) has the possibility for rapid growth in the very near future, and (3) poses significant compliance risk. He was referring to the reverse mortgage. BC About the Authors Phillip R. Rick Freer, Jr., CRCM, has served since July 2000 as a national bank examiner in the Compliance Policy Division of the Office of the Comptroller of the Currency (OCC). He handles compliance regulations, including fair lending and HMDA, compliance risk management initiatives, and training activities. Mr. Freer joined the OCC in 1969 as an assistant national bank examiner. He was commissioned as a national bank examiner in From 1976 through 1978 he served as a regional training officer and regional director for the Human Resources Division. From 1978 through 1990, he held various positions in the OCC s Washington office: special project coordinator in the Chief National Bank Examiner s Office; national recruitment coordinator and associate director in the Human Resources Division; and acting deputy director in the Training and Development Division. From 1990 through 1997, he was director for compliance management and handled CRA and fair lending examination programs, consumer complaints, and compliance training and administrative programs. In 1997, Mr. Freer joined the OCC s Resource Cadre. He was a senior internal consultant and participated in such tasks as CRA and compliance appeals with the OCC s Ombudsman s Office, large bank CRA exams, and the development of examiner recruitment training, the OCC s contract examiner hires program, and examination handbooks and policy positions for the Community and Consumer Policy Unit. Reach him by telephone at (202) or via at rick.freer@occ.treas.gov. Calvin R. Hagins, CRCM, CRP, AMLP, a national bank examiner, became director for compliance policy in October 2005 at the Office of the Comptroller of the Currency (OCC). In that position, he serves as the OCC s senior manager and plans, organizes, implements, and directs activities associated with identifying risks. He also provides guidance on policy issues affecting the compliance process and consumer policy programs and issues. He reports to and serves as an expert adviser to the deputy comptroller for compliance policy and the senior deputy comptroller for bank supervision policy on all community and consumer policy matters. He interprets policies and procedures and represents the OCC externally and internally on community and consumer policy issues. From March 2003 through September 2005, he served as senior adviser to the deputy comptroller for compliance policy. In that position, he served as an expert on the formulation and implementation of a broad range of policies and procedures relating to the efficient and effective supervision of compliance risk. He also advised OCC executive management and examiners throughout the country on complex compliance supervision issues and provided recommendations on a broad range of compliance supervision, operational, and planning matters. From March 1999 through March 2003, he served as the assistant deputy comptroller (ADC)-Compliance. He provided technical expertise and guidance to the Southeast District s midsize and community banks on all aspects of consumer compliance, CRA, fair lending, and Bank Secrecy Act/anti-money laundering activities. Prior to serving as the (ADC)-Compliance, he served as an examiner in the Compliance Cadre from 1994 to During that period, Mr. Hagins was active in developing and instructing in the National Basic Consumer Compliance School, the National Fair Lending School, and the National CRA School. Mr. Hagins joined the OCC in 1987 and was commissioned a national bank examiner in He holds a bachelor s degree in finance from the University of South Florida in Tampa. Reach him at (202) or via at calvin.hagins@ occ.treas.gov. Endnotes 1 To read all of the comptroller s remarks see Consumer Protections for Reverse Mortgages in the Office of the Comptroller of the Currency News Release , occ.gov/ftp/release/ htm. 2 For additional information regarding issues related to consumer counseling, see the June 2009 U.S. Government Accountability Office Report, Reverse Mortgages: Product Complexity and Consumer Protection Issues Underscore Need for Improved Controls Over Counseling for Borrowers, 3 For a more thorough discussion of quantity of risk and quality of risk management indicators, see Appendix A in Community Bank Supervision a booklet of the Comptroller s Handbook; handbook/cbsh2003appendixes.pdf. ABA Bank Compliance MARCH APRIL