Reverse Mortgages: Paying the Piper

Among the late Senator Fred Thompson’s acting roles was spokesperson for the efficacy of a financial product called a “reverse mortgage.”

A reverse mortgage or a home equity conversion mortgage (HECM) is a home loan for homeowners 62 or older that requires no monthly mortgage payments and permits the homeowner to convert her equity in the home into cash.

The HECM is the Farmers Home Administration’s reverse mortgage program. It enables older homeowners to withdraw some of the equity in their homes, touted by the U.S. Department of Housing and Urban Development as a “safe plan that can give older Americans greater financial security.”[1] The FHA’s requirements are straightforward:

The homeowner must be at least 62 years of age;

The homeowner must either own the home outright or have a low mortgage balance that can be paid off at closing with proceeds from the reverse mortgage loan;

The homeowner must have the financial resources to pay ongoing property taxes and insurance; and

The homeowner must live in the home. The home can be a single family home or a two-to-four unit home with one unit occupied by the borrower. HUD-approved condominiums and manufactured homes that meet FHA requirements are also eligible.

When the homeowner sells the home or no longer uses the home as her primary residence, the cash, interest and other finance charges must be repaid. All proceeds beyond the amount owed to the lender (if any) will revert to the homeowner (if she is still living) or the homeowner’s estate. In other words, remaining equity in the home can theoretically be passed to the homeowner’s heirs — without any debt attached.

HUD rules provide that the amount a borrower can receive from a HECM varies and depends on the age of the youngest borrower or eligible non-borrowing spouse; the current interest rate; and the lesser of appraised value of the HECM FHA mortgage limit of $625,000 or the sales price of the home.

The advantages of securing a reverse mortgage seem obvious, but homeowners should also be wary of the negatives:

The fees and interests rates are often higher than for a traditional home equity loan. Between the fees and interest rates, borrowers are often surprised about how little money they actually get;

When a person enters into a reverse mortgage, the loan is paid off when the home is sold. If the borrower dies, the home will be sold so that the proceeds will cover the balance of the loan, including accrued interest. Unless the borrower’s heirs pay off the loan themselves, they will not get to keep the home. If the borrower’s estate pays off the loan, there will be less of the borrower’s “legacy” money to be distributed to heirs.

Death is not the only trigger for the requirement to pay off the loan. If the borrower ceases to live in the home (e.g., goes into an assisted living facility or nursing home), loan repayment is required. A person is considered to have “moved out” of the home if she doesn’t occupy the home for a year or more. At a time when money is likely to be tight because of medical expenses and less income, the borrower must repay the loan when she moves out of the home. If the lender is not paid, foreclosure proceedings will ensue and the lender will be entitled to the total amount of the debt.

The homeowner is required to pay all property taxes, insurance and maintenance costs for the home during the course of the reverse mortgage.

To help homeowners who think that they may want to enter into a reverse mortgage arrangement, there are HECM counselors who can discuss a homeowner’s personal situation before the decision is made. HUD requires borrowers to undertake this counseling before they take out a federally insured HUD reverse mortgage.

Non-borrowing Surviving Spouse

Robert Bennett of Annapolis, Maryland, found himself facing the foreclosure of his home when his wife died in 2008. Ms. Bennett was listed as the borrower on a reverse mortgage taken out on their home before her death, but Mr. Bennett was not listed as a co-borrower. HUD rules allowed banks and other lenders making reverse mortgages to force surviving spouses who are not also listed as co-borrowers to pay off reverse mortgages or face foreclosure on the underlying home. In 2013, a case brought against HUD on behalf of Mr. Bennett by AARP Foundation Litigation was decided in favor of the widower’s position. The U.S. District Court for the District of Columbia ruled for the AARP, finding that HUD’s rules contradict federal law governing reverse mortgages — law which protects surviving spouses. The court sent the matter back to HUD for a “fix.”

After a myriad of horror stories like these, HUD issued a revised rule in August 2014[2] that would allow reverse mortgage lenders to transfer some loans to HUD when a borrower dies but is survived by a non-borrowing spouse. However, the new rule left many spouses out, and HUD apparently decided to rescind the rule based on comments.[3]

Going back to the drafting board, HUD issued a new rule. Effective April 27, 2015, borrowers will have to pass a financial assessment before they can take out a reverse mortgage.[4] The new rules are meant to prevent defaults, but they will also make it more difficult to get a reverse mortgage. The new rule requires borrowers to demonstrate the ability to pay taxes and insurance premiums promptly on the property. For the first time, lenders will be required to look at the borrower’s income and credit histories to ensure they can timely meet those financial obligations. Prior regulations only considered the borrower’s age. If a borrower cannot meet the financial requirements, she has the option of setting aside money from the loan to pay the property taxes and insurance premiums. This “set aside” is based on a formula and can be large, making such a loan impractical for many borrowers. Like many agency rules designed to protect consumers, this one is also likely to drastically reduce the number of older Americans who can afford to take advantage of the HECM reverse mortgage — even if it could be shown to be a suitable product for them.

Likewise, the Consumer Financial Protection Bureau (CFPB) is concerned about reverse mortgages because they are not simple products and they target older homeowners. In a recent focus group sponsored by the CFPB, a group of older homeowners were gathered to watch a number of television commercials about reverse mortgages. After the commercials, the watchers were asked questions about the product and were given the opportunity to ask the CFPB questions. It seemed clear from these discussions that there are a lot of misconceptions about reverse mortgages. CFPB director Richard Cordray has said, “As older consumers consider reverse mortgage loans to tap into their home equity, they need to be careful of those late night TV ads that seem too good to be true,”[5] A 30-second spot suggesting to insomniacs that their post-retirement financial concerns can be alleviated with a reverse mortgage is not financial planning — even if it’s the Fonz or Fred Thompson encouraging seniors to “plan for their retirement” with a reverse mortgage. Let the mortgagor beware.

Notes

  1. “Frequently Asked Questions about HUD’s Reverse Mortgages,” HUD.gov.
  2. ML 2015-03, Rules of U.S. Department of Housing and Urban Development.
  3. FHA INFO #15-33 (April 30, 2015).
  4. HUD Mortgagee Letter 2015-06 (Feb. 26, 2015).
  5. Richard Cordray, director of the Consumer Financial Protection Bureau, in ConsumerAffairs blog written by Mark Huffman (06-04-2015).

Katie Edge KATHRYN REED EDGE is a member in the Nashville office of Butler Snow LLP with offices in Tennessee, Mississippi, Alabama, Colorado, Pennsylvania, Georgia, Louisiana, New York, New Mexico, Hong Kong, Singapore and London, England. She is a member of the firm’s Regulatory and Government Relations Group and concentrates her practice in representing regulated financial services companies. She is a past president of the Tennessee Bar Association and a former member of the editorial board for the Tennessee Bar Journal.

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