Reverse Mortgages:
What Consumers and Lenders Should Know
T
he U.S. senior citizen population
is growing. Between 1990 and
2000, the number of individuals
at least 65 years of age increased from
31.2 million to nearly 35 million. Many
more are reaching the minimum social
security retirement age; by 2010, more
than 50 million people in this coun-
try will be at least 62 years old.
1
Life
expectancies are lengthening, creating
the need for retirement income to last
longer than in previous generations.
However, according to the U.S. Govern-
ment Accountability Office, “Efforts to
increase personal savings outside pension
arrangements seem to have had only
marginal success.”
2
As a result, older
people who need additional funds to
cover general living expenses are turning
to the reverse mortgage lending market
in greater numbers.
Historically, the largest investment of
the average American household is its
primary residence. A recent study by
the American Association of Retired
Persons (AARP) indicates that more
than 80 percent of households over the
age of 62 own their own home, with
an estimated value of $4 trillion.
3
Until
recently, equity in these homes has not
been tapped, but now it represents a
likely source of retirement income and
an opportunity for significant growth
in the reverse mortgage lending indus-
try. This article describes the features
of reverse mortgage loan products,
identifies key consumer concerns, and
provides an overview of potential safety-
and-soundness and consumer compliance
risks that lenders should be prepared to
manage when implementing a reverse
mortgage loan program.
What Is a Reverse Mortgage?
Reverse mortgage loans are designed
for people ages 62 years and older.
This product enables seniors to convert
untapped home equity into cash through
a lump sum disbursement or through a
series of payments from the lender to the
borrower, without any periodic repay-
ment of principal or interest. The arrange-
ment is attractive for some seniors who
are living on limited, fixed incomes but
want to remain in their homes. Repay-
ment is required when there is a “matu-
rity event”—that is, when the borrower
dies, sells the house, or no longer occu-
pies it as a principal residence.
Almost all reverse mortgage lending
products are nonrecourse loans: Borrow-
ers are not responsible for deficiency
balances if the collateral value is less than
the outstanding balance when the loan
is repaid. This situation, known as cross-
over risk, occurs when the amount of
debt increases beyond (crosses over) the
value of the collateral.
Reverse mortgages are fundamentally
different from traditional home equity
lines of credit (HELOCs), primar-
ily because no periodic payments are
required and funds flow from the lender
to the borrower. The servicing and
management of this loan product also
differ from those of a HELOC. (See
Table 1 for a comparison of reverse
mortgage loan products and HELOCs.)
Evolution of the Reverse
Mortgage
Reverse mortgages have been available
for more than 20 years, but consumer
1
U.S. Census Bureau, 2000 Census Population and Projections.
2
Retirement Income—Implications of Demographic Trends for Social Security and Pension Reform, United
States General Accounting Office, July 1997, p. 7.
3
Donald L. Redfoot, Ken Scholen, and S. Kathi Brown, “Reverse Mortgages: Niche Product or Mainstream Solu-
tion? Report on the 2006 AARP National Survey of Reverse Mortgage Shoppers” (AARP Public Policy Institute,
December 2007).
Supervisory Insights Winter 2008
14
Table 1
Features of Reverse Mortgage and HELOC Products
Reverse Mortgage HELOC
Collateral /security
interest
Borrower remains owner of home;
lender takes security interest.
Borrower remains owner of home;
lender takes security interest.
Flow /access to
loan funds
Several options, including periodic
payments to borrower and draws on
the total available credit.
Borrower draws funds as necessary.
Interest, fees,
and charges
All up-front and periodic fees are
added to the loan balance. Interest
continues to accrue on the outstand-
ing balance until repayment at the
end of the loan.
Depending on the program, borrower
may pay fees outside closing or by
adding them to the unpaid balance.
Interest and fees are assessed on
outstanding balance until repaid.
Repayment No periodic payments of principal or
interest. One payment is due when
borrower dies, sells the house, or no
longer occupies it as a primary
residence.
Payments vary by program.
Generally, HELOCs feature monthly
interest-only payments for a set
period of time, followed by flexible
principal and interest payments until
the maturity date.
Maximum loan
amount
Some programs allow the maximum
loan amount to grow over time (see
description later in text of Home
Equity Conversion Mortgage).
May vary by program, but most
establish the maximum amount
based on combined loan-to-value
ratio at the time of origination.
Loan suspension Unused loan proceeds may not be
suspended by
the lender.
Subject to Regulation Z require-
ments, unused lines of credit may be
suspended in response to delinquent
payments or significant decline in
collateral value.
demand has been relatively weak because
of uncertainty about how this product
works. Consumers often ask the follow-
ing questions:
n Can I retain the title to my house?
n What happens if the loan balance
exceeds my home’s value?
n Will I be able to bequeath my home to
my heirs?
Financial institutions have been slow
to enter the reverse mortgage lending
market because of the unique servicing
and risk management challenges. For
example, when the reverse mortgage
was first introduced, banks were wary
of booking potentially long-term loans
that increase over time, do not have a
predefined, scheduled repayment stream,
and for which there was no established
secondary market. Lenders also faced
uninsured crossover risk.
However, the market changed in 1988
when the Federal Housing Administra-
tion (FHA) launched the Home Equity
Conversion Mortgage Insurance Demon-
stration, a pilot project that eventually
was adopted permanently by the U.S.
Department of Housing and Urban
Development (HUD).
4
The outcome was
the Home Equity Conversion Mortgage
(HECM), a commercially viable loan
product with strong consumer protec-
tions. For example, the HECM requires
prospective borrowers to complete a pre-
loan counseling program that explains
4
Redfoot, Scholen, and Brown, 2007, p. viii.
Supervisory Insights Winter 2008
15
Reverse Mortgages
continued from pg. 15
the nature of reverse mortgages, includ-
ing the risks and costs.
5
In addition, the HECM is a nonre-
course credit that protects consumers
from crossover risk. HECMs carry FHA
insurance, which protects lenders from
this risk. HECMs have maximum loan
amounts based on the location of the
collateral (the house). (See Table 2 for
details.)
Table 2
In some cases, individuals with high
value homes desire loans that exceed
HECM maximums. This demand led to
the development of private, proprietary
programs through which consumers can
obtain alternative loan products if they
need access to higher equity amounts.
However, crossover risk is a concern
with these proprietary programs, as no
insurance is available to cover potential
collateral deficiencies. Generally, in these
Features of HECMs and Proprietary Programs
HECM
Proprietary Programs
Who grants the loan? FHA-approved lenders. Individual lenders.
What is the maximum Primarily based on the age of the youngest borrower. For all Lender’s discretion. Generally these are
loan amount? HECMs insured after November 5, 2008, the maximum loan jumbo loans designed to fill the market niche
amount is $417,000. The limit is higher in identified high cost areas for borrowers who want loans above the
in Alaska, Hawaii, Guam, and the Virgin Islands. In these areas, HECM limit.
loans may exceed the national limit up to 115 percent of the area
median price or $625,500, whichever is less.
6
How are funds Borrowers have five options:
Lender discretion—programs vary.
drawn?
1. Fixed monthly payments
2. Fixed monthly payments for a set period
3. Line of credit, drawn for any amount at any time
4. Combined fixed payments and a line of credit
5. Combined fixed payment term and a line of credit
Does overall loan cap Yes. HECM allows the loan to grow each year. For example, the
No.
grow over time? unused loan balance is increased by the same rate as the interest
charged on the loan. Therefore, for the unused portion of the loan,
the total loan amount continues to grow.
What happens if the
value of the house
becomes less than
the amount of the
loan?
FHA insures the difference. The borrower (or borrower’s heirs)
will not be responsible for shortages if the value falls below the
outstanding balance. The borrower pays FHA insurance premiums
during the term of the loan; these premiums are added to the loan
balance.
Anecdotal market data suggest that most
current programs are nonrecourse loans.
However, programs vary and may be subject
to limits under state laws. Lenders bear the
risk of collateral shortages.
What are the costs
and fees?
Origination fee: maximum of 2 percent of the first $200,000 plus
Lender discretion.
maximum of 1 percent of amounts over $200,000. The overall cap
is $6,000. The minimum is $2,500, but lenders may accept a lower
origination fee when appropriate.
Mortgage insurance (2 percent initial plus .5 percent annually).
Monthly servicing fee: $30.
Other traditional closing costs (appraisal, title, attorney, taxes,
inspections, etc.).
5
HUD partnered with the AARP Foundation’s Reverse Mortgage Education Project to develop consumer
education materials and train and accredit financial counselors. For additional resources, see
www.hecmresources.org/project/proje_project_goals.cfm.
6
“2009 FHA Maximum Mortgage Limits” (HUD Mortgagee Letter 2008-36, November 7, 2008),
https://www.hud.gov/sites/documents/DOC_20412.doc.
Supervisory Insights Winter 2008
16
Chart 1: HECM Endorsements Have Increased Dramatically Since 2004
HECM Endorsements
112,154
120,000
107,558
100,000
80,000
60,000
40,000
20,000
6,640
4,165
389
0
1990 1992 1994 1996 1998 2000 2002 2004 2006 Sep
2008
Source: U.S. Department of Housing and Urban Development (www.hud.gov).
private programs, greater risk translates
into higher costs for consumers—lenders
must price products to cover the risk of
repayment or loss. (See Table 2 for a
comparison of HECMs and proprietary
programs.)
The need for higher HECM loan limits
was addressed as part of the Housing
and Economic Recovery Act of 2008
(HERA), signed into law on July 30,
2008. The HERA effectively raised the
maximum HECM loan amount from a
range of $200,160–$362,790 to a new
nationwide ceiling of $417,000, by tying
the limit to the national conforming
limits for Freddie Mac. (Higher limits
are allowed in certain, designated high
cost areas, as noted in Table 2.) Given
that the maximum amounts were only
recently changed, the impact on the
demand for proprietary jumbo loans is
not yet known.
In addition to HECMs and proprietary
programs, Fannie Mae previously offered
the Home Keeper reverse mortgage loan
program. This product featured many
of the same consumer protections as
the HECM, including the counseling
requirement, as well as generally higher
maximum loan amounts. However, the
program did not capture a large segment
of the market, and Fannie Mae terminated
it in September 2008 subsequent to the
new loan limits allowed under the HERA.
Overall, even with the emergence of
proprietary programs, more than 90
percent of reverse mortgages are HECMs,
and the number of HECMs has increased
steadily since 2004. During HUD’s 2007
fiscal year, 107,558 HECMs were insured
by the FHA, an increase of more than
40 percent over the previous year.
7
As
of September 2008, more than 112,000
HECMs had been insured by the FHA
during the calendar year (see Chart 1).
Consumer Issues
Reverse mortgages benefit consum-
ers by providing a nontaxable source of
funds. This is particularly attractive to
seniors who have limited, fixed incomes
7
National Reverse Mortgage Lenders Association, statistics as of July 2008. See
www.nrmlaonline.org/RMS/STATISTICS/DEFAULT.ASPX?article_id=601.
Supervisory Insights Winter 2008
17
Reverse Mortgages
continued from pg. 17
but high amounts of home equity.
These loans can enable some people to
continue living in their homes, which
may not have been feasible without this
additional source of cash. However, this
loan product is not for everyone, and
potential borrowers should carefully
assess the pros and cons before taking on
a reverse mortgage.
The report Reverse Mortgages: Niche
Product or Mainstream Solution?
published by the AARP Public Policy
Institute in late 2007 presents informa-
tion about consumers who obtained
reverse mortgages, as well as those who
opted not to pursue them after complet-
ing the required pre-loan counseling.
8
Survey respondents cited many reasons
for deciding not to pursue a reverse mort-
gage. The following represent the three
most-cited reasons: the high cost (63
percent); respondents found another way
to meet financial needs (56 percent); or
respondents determined that the loan
was not necessary given the individual’s
financial position (54 percent).
9
The results of this study highlight key
consumer considerations, such as the
importance of pre-loan counseling, which
may provide information about other
programs better suited to a borrower’s
needs. For example, local lenders and
community organizations may offer
low-cost home improvement loans for
seniors. In some cases, consumers might
find they are better off financially if they
sell their property rather than refinance
an existing loan with a reverse mortgage.
Lenders also face risks associated with
the various consumer issues, including
those identified in the AARP survey.
For example, there is a potential for
reputation risk, and perhaps even legal
risks that could result from aggressive
cross-marketing of other financial prod-
ucts, such as long-term annuities. Some
financial service providers encourage
reverse mortgage borrowers to draw
funds to purchase an annuity or other
financial product. Interest begins to
accrue immediately on any funds drawn
from the reverse mortgage, and borrow-
ers may lose other valuable benefits, such
as Medicaid. For example, funds that are
drawn and placed in deposit accounts
or non-deposit investments would be
included in the calculation of the individ-
ual’s liquid assets for purposes of Medic-
aid eligibility.
Aggressive cross-selling is considered
predatory by many consumer advocates.
In fact, the HERA specifically prohibits
lenders from conditioning the extension
of a HECM loan on a requirement that
borrowers purchase insurance, annuities,
or other products, except those that are
usual and customary in mortgage lend-
ing, such as hazard or flood insurance.
These prohibitions apply to HECMs but
not to products in a proprietary lend-
ing program—a fact consumers should
consider when choosing a reverse mort-
gage product.
Another potentially predatory practice
is equity-sharing requirements, which
are contractual obligations for borrow-
ers to share a portion of any gain—or,
in some cases, equity—when the loan
is repaid. These provisions mean addi-
tional, sometimes substantial, charges
that the consumer or the consumer’s
estate is obligated to pay, thus reducing
the consumer’s share of his or her home
value. Such provisions are prohibited in
the HECM program but were a compo-
nent of early reverse mortgage programs
developed in the 1990s. A person who
chooses a proprietary program should
carefully review contracts for the exis-
tence of these provisions.
8
Redfoot, Scholen, and Brown, 2007.
9
Percentages total to more than 100 percent because survey respondents could select more than one reason for
not pursuing a reverse mortgage.
Supervisory Insights Winter 2008
18
Table 3
Safety and Soundness Concerns in Reverse Mortgage Lending
Issue Description
Property appraisals Lenders must ensure that property appraisals are conducted in accordance
with the requirements of the appraisal regulations in Part 323 of the FDIC
Rules and Regulations.
Real estate lending Lenders must comply with Part 365 of the FDIC Rules and Regulations, which
standards requires insured state nonmember banks to adopt and maintain written poli-
cies that establish appropriate limits and standards for extensions of credit
that are secured by liens on or interests in real estate, or that are made for
the purpose of financing permanent improvements to real estate.
Third-party risks
Lenders must manage potential risks associated with third-party involve-
ment.
This is particularly relevant to situations in which lenders either
conduct wholesale activities or act as brokers or agents themselves.
For additional details, refer to “Guidance for Managing Third-Party Risk”
(FDIC Financial Institution Letter FIL-44-2008, June 6, 2008),
www.fdic.gov/news/news/financial/2008/fil08044.html.
Servicing complexity Specialized loan servicing functions must be implemented, including
processes for disbursing proceeds over extended periods of time and moni-
toring maturity events that will necessitate repayment.
Securitization and Although a secondary market for reverse mortgage lending exists, it is rela-
liquidity tively new, and financial institution expertise in this area may be limited.
Collateral Lenders/servicers must ensure that collateral condition is maintained during
the term of the loan.
Regulatory and Supervisory
Considerations
Given the downturn in traditional 1–4
family mortgage lending, reverse mort-
gages may become an attractive product
line for some institutions. However, these
loans can include complex terms, condi-
tions, and options that could heighten
consumer compliance and safety and
soundness risks.
Financial institutions participate in
the delivery of reverse mortgage loans
in a variety of ways. Generally, the
lender acts either as a direct lender or
a correspondent (or broker) that refers
applications to, or participates with,
other lenders. Rather than developing
the expertise in-house, small community
banks might establish referral arrange-
ments with other specialized lenders.
Regardless of the nature or extent of
the institution’s involvement in offering
reverse mortgage products, manage-
ment should be aware of the safety and
soundness and compliance risks associ-
ated with this type of lending. Reverse
mortgage lending is subject to many of
the same underwriting requirements
and consumer compliance regulations
as traditional mortgage lending. Table
3 gives an overview of key safety-and-
soundness issues, and Table 4 summa-
rizes provisions of some of the federal
consumer protection laws and regula-
tions that apply to reverse mortgage
lending.
In general, the same safety and sound-
ness and consumer compliance regula-
tions and requirements that apply to
traditional real estate lending apply to
reverse mortgage lending. However,
reverse mortgages often present unique
challenges and issues for institutions that
plan to offer this product line for the first
time. For example, management may
need to amend operating policies and
procedures to appropriately identify and
manage the inherent risks, regardless
of whether the institution offers reverse
Supervisory Insights Winter 2008
19
Reverse Mortgages
continued from pg. 19
Table 4
Consumer Protection Laws and Regulations Applicable to Reverse Mortgage Products
Truth in Lending Act (TILA), 15 U.S.C. 1601 • Requires disclosure of overall costs of credit.
et seq. / Regulation Z, 12 CFR 226
• Contains provisions for reverse mortgages, because the traditional annual percentage rate
and total finance charge will vary depending on how the credit availability is used.
• Requires a disclosure of the “total annual cost” using three scenarios.
Real Estate Settlement Procedures Act
(RESPA), 12 U.S.C. 2601 et seq. / Regulation
X, 24 CFR 3500
• Requires disclosure of fees and charges in the real estate settlement process, including
fees not considered finance charges under Regulation Z.
• Prohibits kickbacks between settlement service providers in these transactions. These
provisions are particularly applicable to indirect lending situations in which banks make
referrals to other lenders.
• Effective October 1, 2008, only FHA-approved mortgagees may participate in and be
compensated for the origination of HECMs to be insured by FHA. Loan originations must be
performed by FHA-approved entities, including: (1) an FHA-approved loan correspondent
and sponsor; (2) an FHA-approved mortgagee through its retail channel; or (3) an FHA-
approved mortgagee working with another FHA-approved mortgagee.
10
Fair Lending
• Prohibits discrimination in all aspects of credit transactions on certain prohibited bases.
(Equal Credit Opportunity Act, 15 U.S.C. 1691
et seq. / Regulation B, 12 CFR 202, and Fair
Housing Act, 42 U.S.C. 3601 et seq.)
Flood Insurance—National Flood Insurance • Requires lenders to determine whether property is located in a designated flood hazard
Program, 42 U.S.C. 4001 et seq. area prior to making the loan.
• Requires borrower notification if property is in a flood zone.
• Requires property to be covered by flood insurance during the entire loan term.
Unfair and Deceptive Acts or Practices • Generally prohibits unfair or deceptive acts or practices in all aspects of the transaction.
(UDAP)–Section 5(a) of the Federal Trade
• Provides legal parameters for determining whether a particular act or practice is unfair or
Commission (FTC) Act, 15 U.S.C. 45(a)
deceptive.
mortgages through direct lending or as a
correspondent for other institutions.
Conclusion
As the U.S. population continues to
age and life expectancies lengthen, more
people will be living longer in retire-
ment and undoubtedly will need addi-
tional sources of long-term income. This
scenario suggests that the demand for
reverse mortgages will increase. Poten-
tial borrowers should weigh the pros
and cons of this loan product for their
particular financial situation, and lenders
should take steps to ensure they under-
stand how to identify and manage the
risks associated with this product.
David P. Lafleur
Senior Examination Specialist
Division of Supervision and
Consumer Protection
10
“Home Equity Conversion Mortgage (HECM) Program—Requirements on Mortgage
Originators" (HUD Mortgage Letter 2008-24, September 16. 2008).
Supervisory Insights Winter 2008
20
