Consumer Compliance Outlook: First Quarter 2009
Disclosure Requirements for Reverse Mortgages
In a previous issue of Consumer Compliance Outlook, John S. Insley from the Federal Reserve Bank of Richmond discussed a fastgrowing credit product called a reverse mortgage and its potential compliance risks.^{1} This article will review the disclosure requirements under Regulation Z for reverse mortgage transactions and also explain the steps in computing the total annual loan cost rate, or TALC rate, required by Regulation Z using the examples found in Appendix K to Regulation Z.
WHAT IS THE TALC RATE?
The TALC rate is an annual percentage cost of a reverse mortgage. Unlike the annual percentage rate (APR), which takes into account only the finance charges in a credit transaction, the TALC rate considers all costs, which is why it is named the total annual loan cost. In addition to finance charges, the TALC rate may reflect other costs, such as annuity premiums, appraisal fees and other closing costs, and a percentage of any appreciation in the consumer's house.
The following scenario illustrates the difference between an APR and the TALC in calculating the amount financed.
APR  TALC  

Loan requested  $105,000  $105,000 
Nonfinance charges financed  3,000  3,000 
Prepaid finance charges  2,000  2,000 
Loan amount  $110,000  $110,000 
Nonfinance charges financed  $3,000  
Prepaid finance charges  $2,000  $2,000 
Amount financed  $108,000  $105,000 
The amount financed for the APR is higher because only the prepaid finance charges are subtracted from the $110,000 loan amount, whereas the amount financed for the TALC rate calculation subtracts all charges, including nonfinance charges. Typically, this difference translates to a higher TALC rate compared to the APR.
DISCLOSING REVERSE MORTGAGES
Section 226.33 of Regulation Z requires reverse mortgage creditors to disclose a good faith projection of the total cost of the credit to the consumer in a tabular format similar to the matrix disclosure currently required by the Department of Housing and Urban Development's (HUD) Home Equity Conversion Mortgage (HECM) program, a reverse mortgage insured by the Federal Housing Administration.
The regulation also requires creditors to use the term "total annual loan cost rate" to avoid any confusion with the APR and to more accurately describe the percentage cost of reverse mortgages. In projecting the total cost of credit, TALC rates must be based on three credit transaction periods: two years, a period equal to the youngest consumer's life expectancy, and a period equal to 1.4 times the youngest consumer's life expectancy. Appendix L^{2} to Regulation Z provides life expectancy figures based on U.S. Decennial Life Tables published by the Department of Health and Human Services. The regulation also adds an optional loan period that the creditor may disclose equal to onehalf of the youngest consumer's life expectancy.
In addition to the loan periods mentioned above, TALC rates must also be based on assumed annual house appreciation rates of 0 percent, 4 percent, and 8 percent. The 4 percent annual appreciation rate comes from HUD's assessment of longterm averages of historical housing appreciation. The 0 percent and 8 percent annual appreciation rates were included to help consumers understand the potential costs and benefits if the dwelling does not appreciate in value at all or if it appreciates at a rate faster than the average.
The projected total cost of credit must reflect all costs and charges to the consumer, including the costs of any annuity that the consumer purchases as part of the reverse mortgage transaction. Some creditors require or allow consumers to purchase an annuity as part of the transaction that immediately, or at some time in the future, supplements or replaces the creditor's payments. The regulation requires that the amount paid by the consumer for the annuity must be included as a cost to the consumer, regardless of whether the purchase is made through the creditor or a third party and regardless of whether the purchase is mandatory or voluntary.
All advances made for the benefit of the consumer, including annuity payments, must be reflected in the projected total cost of credit. Also, any shared appreciation or equity that the creditor is entitled to receive pursuant to the credit contract, and any limitation on the consumer's liability, such as equity conservation agreements, must be considered. An equity conservation agreement is an agreement limiting the consumer's liability to a specific percentage of the net proceeds available from the sale of the home. If a contract does not specify a percentage for net proceeds, creditors must assume 7 percent, which approximates the amount paid for typical brokerage fees and other incidental costs.
In addition to the good faith projection of the total cost of the credit as explained above, the regulation requires creditors to provide the following information in a form substantially similar to the model form found in paragraph (d) of Appendix K:^{3}
 A statement that the consumer is not obligated to complete the reverse mortgage transaction because the consumer has received the disclosures or has signed an application for a reverse mortgage loan;
 An itemization of loan terms, charges, the age of the youngest borrower, and the appraised property value;
 An explanation of the table of total annual loan cost rates.
The disclosures must be provided to the consumer at least three business days before consummation of a closedend credit transaction or before the first transaction under an openend credit plan.^{4}
CALCULATING THE TALC RATE
Before discussing an example from Appendix K, four important assumptions must be made in order to calculate the TALC rate:
 Assume that reverse mortgage transactions begin on the first day of the month in which consummation is estimated to occur. In other words, assume no odd days.
 For those reverse mortgages in which the consumer controls the timing of advances made after consummation (such as in a credit line), assume that 50 percent of the principal loan amount is advanced and that no further advances are made during the remaining term of the loan. In that regard, the transaction is treated as closedend credit for TALC rate calculation purposes.
 For variablerate reverse mortgage transactions, assume that the initial interest rate will not increase. If the initial interest rate is a discounted rate, the discounted rate must first be applied for the period that it will be in effect. For the remaining term, apply the original rate without the discount to compute the TALC rate, similar to the requirements set forth in section §226.17(c).
 Assume that all closing and other consumer costs are financed.
The last example in Appendix K [(d)(2), Sample Form] is the combination of a lumpsum advance, monthly advances, and a credit line. The borrower receives a lumpsum advance of $1,000, plus a $301.80 monthly advance at consummation. The borrower will receive a monthly payment of $301.80 for the 12year term of the loan. In addition, the borrower has a $4,000 line of credit.
Lumpsum to borrower  $1,000 
Monthly payments to borrower  $301.80 
Total loan costs financed  $5,000 
Credit line  $4,000 
Contract interest rate  9% 
Assumed annual dwelling appreciation rate  4% 
Appraised value of property  $100,000 
Age of the youngest borrower  75 
Estimated loan term  12 years 
Equity reserved  7% 
STEP 1 — CALCULATE FUTURE VALUE OF ALL ADVANCES
Future Value of All Advances
N  I  PV  PMT  FV 

144 months  0.75% (HP 12c) 9% (HP 17bII) 
$301.80  ?  
144 months  0.75% (HP 12c) 9% (HP 17bII) 
$1,000 (initial advance)  ?  
144 months  0.75% (HP 12c) 9% (HP 17bII) 
$2,000 (1/2 of credit line)^{5}  ?  
144 months  0.75% (HP 12c) 9% (HP 17bII) 
$5,000 (total loan costs)  ? 
I = 9% contract rate divided by 12 months in a year = 0.75%
When calculating the future value of monthly payments, the calculator must be set to BEG mode (payments made at the beginning of the month).
For the HP 17bII, the P/YR must be set to 12 (12 payments per year).
FV ($301.80 monthly for 12 years)  = $78,360.68 
FV ($1,000 after 12 years)  = $2,932.84 
FV ($2,000 after 12 years)  = $5,865.67 
FV ($5,000 after 12 years)  = $14,664.18 
FV of all advances  = $101,823.37 
STEP 2 — CALCULATE FUTURE VALUE OF THE DWELLING
Future Value of the Dwelling
N  I  PV  FV 

12  4%  $100,000  ? 
I = Assumed annual dwelling appreciation rate 
For the HP 17bII, the P/YR must be set to 1 (one payment per year).
FV = $160,103.22
STEP 3 — CALCULATE REPAYMENT AMOUNT
The repayment amount is the lesser of the FV of all advances ($101,823.37) or the FV of the dwelling minus the equity reserved:
($160,103.22—$11,207.23[7% of FV of dwelling]= $148,895.99).
Repayment Amount = $101,823.37
STEP 4 — CALCULATE THE TALC RATE USING THE APRWIN PROGRAM
Below are the entries for the APRWin program:
Loan Information  
Amount Financed:  $3,301.80 ($1,000 lumpsum + $301.80 first monthly advance + onehalf of $4,000 credit line) 
Disclosed APR:  11.03% (If the disclosed TALC rate is being verified, enter the disclosed rate here. If the TALC rate is being calculated, enter an estimated rate, e.g., 1.) 
Disclosed Finance Charge:  Leave blank 
Loan Type:  Installment Loan 
Payment Frequency:  Monthly 
Payment Schedule
Payment Stream #  Payment Amount  Number of Payments  Unit Periods  Odd Days 

1  301.8  143  1  0 
2  101823.37  1  144  0 
Payment Stream #1 — The payment amount must be entered as a negative value. The number of payments is the remaining number of advances left after the initial advance at consummation.
Payment Stream #2 — The payment amount is the repayment amount from Step 3.
APR = 11.03% (This is the TALC rate based on the multiple advances to the borrower [$301.80 x 144 = $43,459.20], $1,000 initial advance, $2,000 credit line outstanding, and the $101,823.37 payment.)
DISCLOSING REVERSE MORTGAGES
In the previous example, the TALC rate was calculated based on a 12year loan term with an assumed annual appreciation rate of 4 percent, but that is just one of nine TALC rates that must be disclosed. Section 226.33(c) of Regulation Z requires creditors to disclose TALC rates based on three loan terms as determined by the life expectancy of the youngest borrower in accordance with Appendix J to Regulation Z, and to assume annual appreciation rates of 0 percent, 4 percent, and 8 percent for the dwelling.
Below is the reverse mortgage disclosure for the example. (Note that the TALC rates based on a sixyear loan term, which is onehalf of the life expectancy of the youngest borrower, are optional):
TOTAL ANNUAL LOAN COST RATE  

Loan Terms  Monthly Loan Charges  
Age of youngest borrower:  75  Service fee:  None  
Appraised property value:  $100,000  
Interest rate:  9%  Other Charges  
Monthly advance:  $301.80  Mortgage insurance:  None  
Initial draw:  $1,000  Shared appreciation:  None  
Line of credit:  $4,000  Repayment Limits  
Initial Loan Charges  Net proceeds estimated at 93% of projected home sale  
Closing costs:  $5,000  
Mortgage insurance premium:  None  
Annuity cost:  None  
Assumed Annual Appreciation  2year loan term  [6year loan term]  12year loan term  17year loan term 
0%  39.00%  [14.94%]  9.86%  3.87% 
4%  39.00%  [14.94%]  11.03%  10.14% 
8%  39.00%  [14.94%]  11.03%  10.20% 
The cost of any reverse mortgage loan depends on how long you keep the loan and how much your house appreciates in value. Generally, the longer you keep a reverse mortgage, the lower the total annual loan cost rate will be. The table above shows the estimated cost of your reverse mortgage loan, expressed as an annual rate. It illustrates the cost for three [four] loan terms: two years, [half of life expectancy for someone your age], that life expectancy, and 1.4 times that life expectancy. The table also shows the cost of the loan, assuming the value of your house appreciates at three different rates: 0 percent, 4 percent, and 8 percent. The total annual loan cost rates in this table are based on the total charges associated with this loan. These charges typically include principal, interest, closing costs, mortgage insurance premiums, annuity costs, and servicing costs (but not disposition costs—costs when you sell the home). The rates in this table are estimates. Your actual cost may differ if, for example, the amount of your loan advances varies or the interest rate on your mortgage changes. SIGNING AN APPLICATION OR RECEIVING THESE DISCLOSURES DOES NOT REQUIRE YOU TO COMPLETE THIS LOAN. 
Additional Examples Are Available  

Example 2

Example 3

Example 4

CONCLUSION
Creditors who fail to comply with the requirements of §226.33 may face civil liability under the Truth in Lending Act. Regulation Z does not provide an accuracy tolerance for TALC rate disclosures, as it does for APR disclosures. As a result, the smallest deviation from the actual rate may trigger a violation.
In a successful action brought by a borrower, creditors may be assessed a penalty in an amount equal to the sum of any actual damage sustained by the borrower, in addition to attorney's fees and court costs. In the case of individual actions, the penalty can be twice the amount of the finance charge (minimum $100, maximum $1,000 for openend credit; minimum $400, maximum $4,000 for closedend credit), and in the case of a class action, up to the lesser of $500,000 or 1 percent of the creditor's net worth. Specific issues and questions should be raised with the consumer compliance contact at your Reserve Bank or with your primary regulator.
 1 John S. Insley, Jr., "Reverse Mortgages and Consumer Protection," Consumer Compliance Outlook (Third Quarter 2008).
 2 "http://edocket.access.gpo.gov/cfr_2008/janqtr/pdf/12cfr226AppL.pdf
 3 http://edocket.access.gpo.gov/cfr_2008/janqtr/pdf/12cfr226AppK.pdf
 4 12 C.F.R. 226.31(c)(2)
 5 For a credit line, the TALC must be based on the assumption that 50 percent of the line of credit is outstanding at closing. TALC rate calculations effectively treat the transaction as a closedend credit transaction after that.