Consumer Compliance Outlook > 2008 > Third Quarter 2008

Consumer Compliance Outlook: Third Quarter 2008

Reverse Mortgages and Consumer Protection Issues

By John S. Insley Jr.
Principal Examiner, Bank Supervision and Regulation,
Federal Reserve Bank of Richmond

The growth in the number of seniors in the U.S. population in conjunction with housing market developments, notably private securitization, has stimulated broad interest and substantial growth in reverse mortgages in recent years. As a result, it is increasingly likely that many banks and others involved in the traditional mortgage business may consider originating reverse mortgages or be afforded opportunities to participate indirectly in the reverse mortgage market. Despite recent troubles in the national mortgage market, reverse mortgages are growing at a rapid rate: "Expansion of this hot spot in mortgage lending is expected to continue owing to increasingly flexible products, new sources of capital, and a growing supply of potential borrowers. As the reverse mortgage market develops, it is important that potential borrowers be educated about this complex product to protect them from taking out unsuitable loans."¹

What Is a Reverse Mortgage?

As the name suggests, reverse mortgages share similarities with traditional mortgages, but the flow of payments during the loan term is reversed. The borrower receives payments or access to funds with no obligation to repay the principal or interest until the loan is due. The U.S. Department of Housing and Urban Development (HUD) describes a reverse mortgage as "a special type of home loan that lets a homeowner convert a portion of the equity in his or her home into cash. The equity built up over years of home mortgage payments can be paid to you. But unlike a traditional home equity loan or second mortgage, no repayment is required until the borrower(s) no longer use the home as their principal residence."² According to the National Reverse Mortgage Lenders Association (NRMLA), home equity conversion mortgages (HECM), the reverse mortgage product insured by the Federal Housing Administration (FHA), a federal agency within HUD, account for 90 percent of all such loans extended.³ Under the FHA program, homeowners can select from among five payment plans:⁴

• Tenure - equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence.
• Term - equal monthly payments for a fixed period of months selected.
• Line of Credit - unscheduled payments or in installments, at times and in an amount of the borrower's choosing until the line of credit is exhausted.
• Modified Tenure - combines a line of credit and tenure monthly payments.
• Modified Term - combines a line of credit and term monthly payments.

To qualify for a HECM, borrowers must be 62 or older, have paid off their mortgages or have a small balance remaining, and currently live in the home as their primary residence.⁵ While the proceeds of a reverse mortgage can be used for any purpose, a recent study by the AARP⁶ found that the majority of borrowers surveyed were looking to meet basic needs.

What Is the Potential Market for Reverse Mortgages?

In November 2007, the Wall Street Journal noted: "It may sound hard to believe, but one part of the mortgage business is hot: reverse mortgages."⁷ Although currently a minor portion of the overall mortgage market (about 1 percent),⁸ reverse mortgage lending has been growing exponentially. HECM originations increased from 157 made in fiscal year 1990 to 107,558 in fiscal year 2007.⁹ While HECM products account for the overwhelming portion of the reverse mortgage market, an increasing number of lenders have developed proprietary reverse mortgage products that compete with HECM loans. Some of these products are designed to fund mortgages that exceed the maximum loan amount available under the HECM program and give consumers more options, including lower age requirements, more flexible rate structures, and lower fees. Recent growth in private lending programs has likely been stimulated by the prospect of securitization, following the first sale of securities backed by bundled HECM loans to private investors in 2006. While recent credit market disruptions may diminish this prospect in the near term, the initial barrier has been broken. The untapped reverse mortgage market is significant. The NRMLA estimates that as of the first quarter of 2007, seniors age 62 or older had home equity of $4.3 trillion.¹⁰ Considering shifting demographics and home appreciation, the NRMLA suggests that this figure could double within 10 years. Given the potential demand, examiners expect to see many more banks entering the reverse mortgage market as direct originators or as facilitators of broker or correspondent relationships.

Promoting Informed Decision-Making

Reverse mortgages are a particularly complex type of home loan. The borrower must select from among various products that offer different loan amounts and payment scenarios. Taking out a reverse mortgage involves tapping the equity of a house that typically is owned free and clear. In many cases, this equity represents the borrower's largest single source of net worth. The decision to obtain a reverse mortgage and the process of selecting a product and terms must consider the consumer's life-style, financial situation, and estate plans. The decision should be made in the context of the availability and suitability of other financial products, such as traditional lines of credit. For example, a reverse mortgage may not be the best option because the upfront fees associated with both the HECM and most proprietary products tend to be high. As a result, the reverse mortgage is often an expensive choice for borrowers who plan to remain in their homes for less than three years.

Consumer counseling is mandated for borrowers seeking to obtain a HECM loan. Counselors are responsible for educating borrowers about the financial implications of the transaction and the alternatives that may be available, but they cannot recommend whether a borrower should consummate such a transaction or what loan terms best suit the borrower's situation.¹¹ Ultimately, the consumer must select a financial option to pursue. For this reason, when crafting marketing strategies for reverse mortgages or working with potential reverse mortgage borrowers, lenders and brokers should not assume that the provision of counseling diminishes in any way the responsibility to provide clear and accurate information about both the benefits and costs of a reverse mortgage.

In this regard, lenders must comply with all legal and regulatory requirements. While reverse mortgages are subject to special rules in §226.33 of Regulation Z (the implementing regulation for the Truth in Lending Act), such loans remain subject to other rules and regulations that apply to mortgage loans, including (but not limited to) other sections of Regulation Z, the Real Estate Settlement Procedures Act, Regulation B (the implementing regulation for the Equal Credit Opportunity Act), and the Fair Housing Act. Lenders and brokers should ensure that marketing materials and direct contact with the consumer reinforce the legally required disclosures and present a consistent message that avoids potentially misleading consumers.

Regarding the marketing of reverse mortgage products, lenders and brokers should be especially sensitive to the prohibition against unfair or deceptive acts or practices under §5 of the Federal Trade Commission Act. Lenders and brokers should avoid presenting the product in a way that misrepresents the product's terms, either affirmatively or by omission, or that is likely to mislead consumers.

To better understand the concept of unfair or deceptive acts or practices, lenders should consult a joint publication issued in 2004 by the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation titled "Unfair or Deceptive Acts or Practices by State-Chartered Banks."¹² The statement discusses the management of risks related to unfair or deceptive acts or practices and includes guidance on best practices that state-chartered banks can use to avoid such practices. The statement urges creditors to pay particular attention to ensure that disclosures are clear and accurate with respect to reverse mortgages, as well as other products. Those promoting reverse mortgages should pay particular attention to the following best practices as presented in the agencies' joint statement.

• The need for clear and accurate disclosures that are sensitive to the sophistication of the target audience is heightened for products and services that have been associated with abusive practices. Accordingly, banks should take particular care in marketing credit and other products and services to the elderly, the financially vulnerable, and customers who are not financially sophisticated. In addition, creditors should pay particular attention to ensure that disclosures are clear and accurate with respect to: the points and other charges that will be financed as part of home-secured loans; the terms and conditions related to insurance offered in connection with loans; loans covered by HOEPA; reverse mortgages; credit cards designed to rehabilitate the credit position of the cardholder; and loans with pre-payment penalties, temporary introductory terms, or terms that are not available as advertised to all consumers.
• Tailor advertisements, promotional materials, disclosures and scripts to take into account the sophistication and experience of the target audience. Do not make claims, representations or statements that mislead members of the target audience about the cost, value, availability, cost savings, benefits, or terms of the product or service.
• Review all promotional materials, marketing scripts, and customer agreements and disclosures to ensure that they fairly and adequately describe the terms, benefits, and material limitations of the product or service being offered, including any related or optional products or services, and that they do not misrepresent such terms either affirmatively or by omission. Ensure that these materials do not use fine print, separate statements or inconspicuous disclosures to correct potentially misleading headlines, and ensure that there is a reasonable factual basis for all representations made.

A higher proportion of the elderly, compared with younger borrowers, may be dealing with health-related issues, resource constraints, or pressing financial matters that compel critical life-style choices, including decisions about the ability to live independently in one's own home. As a result, this target market may be particularly susceptible to being misled by the omission of material product information. Again, although counseling is required for HECM loans (and is recommended as a best practice by the NRMLA for private products), the function of counseling should not be to fill in significant information gaps or correct misunderstandings that may have developed through advertising or other contact with the consumer. For example, the fact that this product is a loan secured by the consumer's dwelling should not be obscured. Many seniors receive benefits from a host of federal programs (Social Security, Medicare, Veterans Administration, Medicaid, etc.). Promoting a reverse mortgage as a federally sponsored "benefit" might obscure the fact that it is a loan with significant associated cost and could mislead some borrowers about the true nature of the product.

Marketing of reverse mortgages that emphasizes the amount of money that can be borrowed or that payments need not be made during the term of the loan to the exclusion of communicating the significant costs associated with obtaining the mortgage could adversely affect the prospective borrower's capacity to make informed decisions later in the process, even after cost information has been disclosed. Web-based reverse mortgage calculators, for example, that compare only the features of different products, but not the associated or relative costs, might create a bias toward a particular product that could prove difficult to overcome, even after the consumer has received more detailed information and counseling.

Evolving Consumer Protection Issues

Over the years, both Congress and HUD have been sensitive to potential abuse in the reverse mortgage market. For example, in 1999, HUD implemented rules that effectively banned the payment of referral fees under the guise of estate planning, financial advice, and other services that are related to the mortgage but are not required to obtain a HECM loan.¹³

More recently, another potential concern has come to light. The AARP study raised the specter of unscrupulous reverse mortgage lenders' extending such loans in conjunction with ill-suited financial products. Nine percent of borrowers surveyed by the AARP said that their lenders had offered them specific financial products — including annuities and longterm care insurance — that may be unwise investments relative to loan costs.¹⁴ These concerns were the focus of testimony at a hearing held by the U.S. Senate Special Committee on Aging on December 12, 2007.¹⁵

This testimony in conjunction with findings from the AARP study suggests potential conflicts of interest that might lead to abuse in the reverse mortgage market. Reinforcing this concern is the finding in the AARP's study that most consumers do not know much about reverse mortgages and have many misconceptions.¹⁶ It is therefore important that lenders and others in the reverse mortgage market ensure that all communications regarding this product are both clear and accurate.

Consumer complaint and inquiry data collected by the Federal Reserve System reinforce this conclusion. A review of these data suggests that while reverse mortgages account for a relatively small percentage of the total, the 18 complaints and inquiries received through April 2008 already exceed the total number received for the previous two years. It is possible that this increase merely reflects the growing volume of such lending, the promotion of such loans, or heightened consumer interest in such loans, but the increased evidence could also reflect consumer confusion about a complex product.

Conclusion

Whether a direct originator, a broker, or a correspondent, those involved in the reverse mortgage business should be particularly mindful of the legal and reputational risks of engaging in, or becoming associated with, acts or practices that could be considered unfair or deceptive. Market participants should take actions that promote informed decision-making.

• ¹ Heidi Kaplan, "Reverse Mortgages-the Next Hot Spot ," Bridges, Federal Reserve Bank of St. Louis (Spring 2008).
• ² U.S. Department of Housing and Urban Development
• ³ National Reverse Mortgage Lenders Association website
• ⁴ U.S. Department of Housing and Urban Development
• ⁵ U.S. Department of Housing and Urban Development
• ⁶ Donald L. Redfoot, Ken Scholen, and S. Kathi Brown, "Reverse Mortgages: Niche Product or Mainstream Solution? " AARP (December 2007).
• ⁷ Kelly Greene and Valerie Bauerlein, "Reverse Mortgages: The Choices Expand ," Wall Street Journal, November 13, 2007.
• ⁸ National Reverse Mortgage Lenders Association website
• ⁹ National Reverse Mortgage Lenders Association website
• ¹⁰ National Reverse Mortgage Lenders Association website
• ¹¹ U.S. Department of Housing and Urban Development
• ¹² Board of Governors of the Federal Reserve System website
• ¹³ U.S. Department of Housing and Urban Development
• ¹⁴ AARP.org at pp 89-90
• ¹⁵ The U.S. Senate Special Committee on Aging
• ¹⁶ AARP.org ; see pp. 107-08