Keeping reverse mortgages in compliance

A reverse mortgage is a unique type of loan for homeowners age 62 and older. This special type of loan is frequently insured by the Federal Housing Administration and allows homeowners to access the equity in their homes, without making monthly mortgage payments. Borrowers are not required to repay the reverse mortgage loan as long as they live in the home. However, the loan must be repaid when the last surviving borrower dies, moves out, or sells.

Research shows that borrowers typically use the money to pay for home renovations, medical costs, and daily living expenses. Additionally, some borrowers actually take out a reverse mortgage to pay off an existing regular mortgage, to eliminate the burden of monthly mortgage payments. The amount homeowners can borrow varies by lender but generally is based on age, home value, and the interest rate at the time of closing.

A recent study by the Consumer Financial Protection Bureau found that reverse mortgage advertisements were confusing. Some reverse mortgage recipients had the false impression that the loans were a type of a government benefit or that they guaranteed that the borrower could remain in the home for the rest of their lives. Moreover, CFPB has compiled approximately 1,200 complaints regarding reverse mortgages received from Dec. 1, 2011-Dec. 31, 2014.

Clearly, with an increasing number of Baby Boomers taking out reverse mortgages, there is a need for additional clarification on the topic.

Before you go into reverse

Communication is key! The majority of complaints stemmed from general confusion about the product and how it actually functions. Lenders should take the necessary steps to ensure that borrowers fully understand key components of the product. These include the borrowers' responsibility for property taxes, loan limits, and protections for surviving family members.

Below is a summary of the key issues that lenders should carefully explain to any potential borrowers to avoid being branded as a lender that employs misleading advertising.

1. Regarding property taxes and related expenses.

• Borrowers must remain current on their property taxes, homeowner's insurance, and any homeowner association fees. Additionally, the borrower must maintain the home according to FHA guidelines. Many borrowers are not aware of these requirements. Thus, time should be taken to explain this to potential borrowers.

• A recent CFPB report found that nearly 10% of reverse mortgage borrowers are at risk of foreclosure because they failed to pay such expenses. Therefore, lenders should examine whether potential borrowers have any retirement resources or secondary income streams to alleviate the burden of paying property taxes, insurance, and any homeowners' association fees.

2. Regarding lending limits.

• Borrowers, typically, encounter issues when they take out a large lump sum payment. It should be explained to potential borrowers that there are limits to the amount of money that one can draw from the loan in the first year.

Generally, borrowers are capped at taking out 60% of their initial principal limit during that period. This is an area of concern because substantial front end withdrawals can become a huge issue for borrowers who essentially outlive their reverse mortgages. Lenders should explain to potential borrowers that they have the option of taking out monthly payments or a line of credit, as opposed to a large lump sum.

3. Regarding protections for surviving family members.

• In the past, couples who took out reverse mortgages in the name of only one spouse encountered issues when the borrowing spouse died. Historically, when a borrower died, the surviving spouse had to pay back the loan in full or move out of the residence. A primary complaint of borrowers was the inability to add new borrowers to the existing loan, if the borrower passes away during the loan period, so that they could keep the home.

It should be explained to potential borrowers, especially married borrowers, that it may be prudent to take out the loan as a couple. If the borrowers decide not to do so, it should be explained that the surviving spouse can continue living in the home under certain conditions. However, the surviving spouse will stop receiving payments from the reverse mortgage after the borrowing spouse's death.

• Additionally, it should be explained that when the reverse mortgage loan becomes due, the borrower's heirs can choose to repay the loan and keep the home or sell the home to pay back the loan. If the home sells for more than the remaining balance on the loan, the excess funds go to the heirs. If the home sells for less than the balance owed, the estate is not required to pay more than the value of the home at the time the loan is repaid.

Consumers complained that loan servicers do not provide a clear process to allow them to settle the debt; complained about appraisal delays; and complained about a lack of response from loan servicers. Therefore, lenders and servicers should take the time to speak with any adult children of the borrowers and provide a step-by-step process of handling the loan, in the event of the borrower's death.

4. Regarding borrower education.

In order to combat some of the difficulties that certain borrowers experience with reverse mortgages, homeowners interested in obtaining a reverse mortgage must agree to receive free mandatory counseling by an independent third party, typically an agency approved by the Department of Housing and Urban Development or a national counseling agency such as AARP.

Lenders and loan servicers can assist in this public education effort by providing straightforward and easy-to-understand information. Potential borrowers should be provided information about the product, application process, fees, qualification criteria, borrower responsibilities, and the potential risks to the borrowers and their heirs.

About the author

Montoya M. Ho-Sang is a litigation attorney in Baker Donelson's Atlanta office. She defends mortgage lenders and servicers in all types of litigation, including liability defense; claims that arise out of contested foreclosures; bankruptcy; eviction; and real estate owned. [email protected].