Reverse Mortgage Loans
By
James H. Backman, Professor of Law, J. Reuben Clark Law School, Brigham Young University, Provo, Utah
And
Sandra R. Bullington, Esq., Member, Maryland bar
This chapter was originally published as part of Chapter 31 of Real Estate Financing – Text, Forms, Tax Analysis. Copyright Matthew Bender & Company. Ms. Bullington updated the chapter in 2008. Those wishing to order a copy of this publication should visit the Lexis Bookstore.
1. What Is a Reverse Mortgage Loan?
A reverse mortgage loan differs significantly from the traditional mortgage where the lender gives funds to the borrower and the borrower executes a promissory note and a mortgage or deed of trust. Under this type of mortgage, the loan proceeds are disbursed either in a lump sum or periodically, and the balance of the loan is repaid when the home that secures the property is sold, the borrower no longer lives in the home, or the borrower dies.<1>
A reverse mortgage loan, on the other hand, is a special type of loan used by older home owners to convert the equity in their homes into cash.<2> The great advantage of a reverse mortgage loan is that it enables the home owner to convert the accumulated equity in his or her home into cash without having to move or make regular loan payments. The money obtained through a reverse mortgage loan can provide older home owners with financial security in their retirement years. This mortgage loan gets its name from the fact that the payment stream is reversed: Instead of the borrower making monthly payments to a lender, as with a regular first mortgage, the lender makes payments to the borrower. While the reverse mortgage loan is outstanding, the borrower owns his or her home and does not make any monthly mortgage payments.
Dangers of Reverse Mortgages:Reverse mortgages have been described as a "potentially dangerous product" and the reverse mortgage lending field has been described as "rife with the opportunity for fraud and financial abuse."<3> There are cases where homeowners have accused mortgagees of unfairly taking advantage of them through a reverse mortgage.<4> Similar to other mortgages, a reverse mortgage can put the borrower's home at risk. In addition, reverse mortgages are often more costly than other mortgages due to high up-front fees. Therefore, it should be no surprise that the federal government and several states have statutorily regulated this type of mortgage product.
Although the concept of a reverse mortgage is simple, the calculations are not because these mortgage formulas rely upon:
1. the mortgagor's projected life expectancy,
2. the home's projected appreciation over this life expectancy, and
3. the deferred interest that accumulates over this time period.
Often these mortgages involve the mortgagee receiving a stated percentage of the value of the home when the home is subsequently sold to pay off the reverse mortgage.
Since reverse mortgages are non-recourse, the mortgagee may receive less than what is owed on the reverse mortgage since the mortgagor cannot owe more than the home is worth when the loan is repaid. Conversely, if the home has appreciated considerably or the mortgagor falls far short of his or her projected life expectancy, the mortgagee can wind up with a windfall.
Mortgagor’s Estate: Due to the mortgagor taking out much of the home's equity through the reverse mortgage, the home will not be available to pass through the mortgagor's estate. This fact may cause displeasure among the mortgagor's heirs since they typically must pay the reverse mortgage balance if they want to inherit the home as an asset of the estate.<5> And since the mortgagor usually took out the reverse mortgage due to a cash shortfall, it is unlikely that there will be sufficient cash or other liquid assets in the estate to repay the reverse mortgage balance at the time of the mortgagor's death.
Defined by Federal Law: Federal law has defined a reverse mortgage transaction as a non-recourse transaction in which a mortgage, deed of trust, or equivalent consensual security interest is created against the consumer's principal dwelling which secures one or more advances of cash, and which, with respect to the payment of any principal, interest, and shared appreciation or equity due, is payable (other than in the case of default) only after either:
1. the transfer of the dwelling;
2. the consumer ceases to occupy the dwelling as a principal dwelling; or
3. the death of the consumer.<6>
Due to the non-recourse nature of a reverse mortgage, there is no personal liability on the mortgagor's part (or the mortgagor's estate) in the event that the proceeds from the home fail to cover the loan amount.<7>
Required Disclosures: Federal consumer protection law requires that certain disclosures must be made in connection with a reverse mortgage transaction. Not less than three days prior to consummation of the transaction, the creditor must disclose to the consumer, using a conspicuous typeface, a good faith estimate of the projected total cost of the mortgage to the consumer.
The creditor must also provide a statement that the consumer is not obligated to complete the reverse mortgage transaction merely because the consumer has received the disclosure required under 15 U.S.C. Section 1648 or has signed an application for the reverse mortgage.<8>
Who Is Eligible? In order to qualify for a reverse mortgage loan, the home owner must be at least 62 and own his or her home or condominium. There are no income or medical requirements to qualify. Home owners can qualify for a reverse mortgage loan even if the home is encumbered with a first or second mortgage.
How Payments Are Made: Home owners can choose how to receive the money from a reverse mortgage. Payment options include:
The Loan Amount: The amount of the reverse mortgage loan that a home owner can obtain depends upon:
- the applicant's age at the time of the loan application,
- the type of reverse mortgage loan sought,
- the value of the home,
- current interest rates, and sometimes
- the location of the home.
General Rule: (1) The older the home owner, the more valuable the home; and (2) the less that the homeowner owes on the home, the larger the reverse mortgage loan can be.
Costs in Obtaining Loan: Costs associated with obtaining a reverse mortgage loan include the origination fee, an appraisal fee, and other charges similar to those for regular mortgage loans. The home owner may be able to finance the origination fee rather than paying it out of pocket.
Taxation of Proceeds; Impact on Eligibility for Gov’t Assistance: The proceeds received by a home owner in a reverse mortgage loan are not subject to income tax. However, the proceeds may affect the home owner's eligibility for certain kinds of government assistance. For example, a reverse mortgage may affect a homeowner's eligibility for Medicaid. A Medicaid applicant's home is generally considered an exempt asset for purposes of determining financial eligibility, but the home may lose this exempt status if the homeowner obtains a reverse mortgage.<9>
Counseling for the Home Owner: Before applying for a reverse mortgage loan, the home owner usually must meet with a reverse mortgage counselor. For an FHA-insured reverse mortgage loan, counseling is mandatory and must be received from a HUD-approved "housing agency" (a nonprofit counseling agency). For Fannie Mae Home Keeper loans, consumer education is also required. This is usually provided by a HUD-approved housing agency, or by a Fannie Mae HomePath specialist (telephone counseling). A list of approved counseling agencies nationwide is posted on the Internet by the U.S. Department of Housing and Urban Development on its Website. The counselor's job is to educate the home owner about reverse mortgage loans, to inform the home owner about other alternative options given the home owner's situation, and to assist the home owner in determining which particular reverse mortgage loan product would best fit his or her needs if the home owner decides to get a reverse mortgage loan. Counseling sessions usually must be done face-to-face. However, home owners seeking a Fannie Mae reverse mortgage loan can do so by telephone.
When Is the Creditor Paid Back? No payments are due to the creditor on a reverse mortgage loan while it is outstanding. The loan becomes due and payable when the borrowers cease to occupy their home as their principal residence. Typically, this occurs when the home owner:
1. dies (in cases where the reverse mortgage was made to a couple, the loan becomes due at the death of the last surviving spouse),
2. sells the home, or
3. permanently moves out of the home.<10>
Note that the home does not have to be sold to pay off the loan. The borrower (or the borrower's heirs) can pay off the reverse mortgage loan and keep the home. Regardless, the amount owed on the reverse mortgage loan cannot exceed the value of the home at the time that the loan must be repaid. Moreover, if the home is sold and the sale proceeds exceed the amount owed on the reverse mortgage loan, the excess proceeds go to the borrower or the borrower's estate.
Who Offers Reverse Mortgages? Reverse mortgage loans are offered by banks, thrifts, and other financial institutions. As of 2000, four reverse mortgage products are available to consumers in the United States. One of the most popular reverse mortgages is the federally-insured reverse mortgage, available through the FHA Home Equity Conversion Mortgage Program (HECM). The other major product is the Home Keeper reverse mortgage loan, which was developed in the mid-1990s by Fannie Mae. A companion product is the Home Keeper for Home Purchase mortgage, which is intended for home purchases. Two "jumbo" private reverse mortgage products are offered by Financial Freedom Senior Funding Corporation, of Irvine, California.<11> The HECM and Home Keeper products are available in every state, while Financial Freedom's products are offered in a limited number of states.
State Law Regulation of Reverse Mortgages: State law should also be consulted for laws and regulations affecting reverse mortgages. For example, in 2005, Texas voters amended the Texas Constitution, thereby making it possible for senior homeowners to draw advances at unscheduled intervals, if and when needed, and only in the amounts needed, during the loan term. This amendment also:
1. prohibits requiring the use of a credit card, debit card or similar device to obtain an advance;
2. prohibits the charge or collection of a transaction fee solely in connection with any debit or advance after the time the extension of credit is established; and
3. prohibits the lender or holder from unilaterally amending the extension of credit.<12>
California also has statutes which address reverse mortgages. This is significant because it is estimated that California represents 40 percent of all reverse mortgage transactions.<13> Important safeguards for the protection of California reverse mortgagors include the following:
1. Prepayments are permitted without penalty at any time during the term of the reverse mortgage loan.<14>
2. A lender who fails to make loan advances as required in the loan documents and fails to cure a default after notice as specified in the loan documents shall forfeit to the borrower treble (three times) the amount wrongfully withheld, plus interest at the legal rate.<15>
3. Temporary absences from the home not exceeding 60 consecutive days shall not cause the mortgage to become due and payable. Extended absences from the home exceeding 60 consecutive days, but less than one year, shall not cause the mortgage to become due and payable if the borrower has taken prior action which secures and protects the home in a manner satisfactory to the lender, as specified in the loan documents.<16>
4. The lender's right to collect reverse mortgage loan proceeds is subject to the applicable statute of limitations for written loan contracts. The statute of limitations commences on the date that the reverse mortgage loan becomes due and payable as provided in the loan agreement.<17>
5. A lender cannot require an applicant for a reverse mortgage to purchase an annuity as a condition of obtaining a reverse mortgage loan.<18>
6. The loan applicant must receive from the lender a statutorily-required plain language statement in conspicuous 16-point type or larger, advising the prospective borrower about counseling prior to obtaining the reverse mortgage loan.<19>
7. A court has the power to refuse to enforce an unconscionable reverse mortgage. The court may also enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result.<20>
8. If certain contracts are orally negotiated primarily in Spanish, Chinese, Tagalog, Vietnamese, or Korean, then prior to the execution thereof, a translation of the contract or agreement in the language in which the contract or agreement was negotiated must be delivered to the other party. This document must include a translation of every term and condition in that contract or agreement.<21>
California has also enacted an Elder Abuse and Dependent Adult Civil Protection Act<22> which addresses financial abuse of an elder or dependent adult.<23> When financial abuse has been proven by a preponderance of the evidence, the court can award the plaintiff reasonable attorney's fees and costs in addition to other remedies allowed by law.<24> If the financial abuse involves the defendant being guilty of recklessness, oppression, fraud or malice in the commission of the abuse, the plaintiff can also recover punitive damages.<25>
Some state housing agencies have reverse mortgage programs available.<26> Seniors considering a reverse mortgage should consider such an agency as a potential lender if this option is available in their state.
2. Fannie Mae Offers Two Reverse Mortgage Loan Products
Fannie Mae offers two types of reverse mortgages loans:
The Home Keeper Mortgage is an adjustable-rate, conventional reverse mortgage loan that allows homeowners 62 and above to borrow against the value of their homes and receive the proceeds according to the payment option they select. The amount available is based on three factors:
Anyone 62 years or older who either owns his or her home “free and clear” or has very low mortgage debt is eligible for a Home Keeper mortgage loan. Eligible properties include one-unit, single-family dwellings, condominiums, units in planned-unit developments, and properties held in trust and leasehold properties that meet Fannie Mae's standard guidelines.
Repayment of the Home Keeper Mortgage is deferred until the borrower no longer occupies the property as his or her principal residence. A borrower cannot be forced to sell or vacate the property to pay off the loan (provided the borrower maintains the property and pays property taxes and insurance), even if the total of the mortgage payments plus interest exceeds the home's value. Prospective borrowers must receive home buyer education to help them select the right choice for their situations.
Fannie Mae's second reverse mortgage product, Home Keeper for Home Purchase, allows older home owners to purchase a new home without using all of their personal resources to fund the purchase. The borrower will have no monthly mortgage payments. Eligible properties include one-unit, single-family dwellings, condominiums, and units in planned-unit developments that meet Fannie Mae's standard guidelines. One advantage of this loan program is that only one transaction (rather than two separate transactions) is required to purchase and receive the reverse mortgage loan financing. This should reduce the closing costs.
Fannie Mae will also purchase HUD-FHA insured reverse mortgages.
3. HUD/FHA Has a Reverse Mortgage Loan Program
HUD has a reverse mortgage loan program. The Federal Housing Administration, which is part of HUD, collects an insurance premium from all borrowers to provide this coverage.<27>
The size of reverse mortgage loans is determined by the borrower's age, the interest rate, and the home's value. The older a borrower, the larger the percentage of the home's value that can be borrowed. For example, based on an interest rate of 9 percent, a 65-year-old could borrow up to 26 percent of the home's value, a 75-year-old could borrow up to 39 percent of the home's value, and an 85-year-old could borrow up to 56 percent of the home's value.<28>
There are no asset or income limitations on borrowers receiving HUD's reverse mortgage loans. There are also no limits on the value of homes qualifying for a HUD reverse mortgage loan. However, the amount that may be borrowed is capped by the maximum FHA mortgage limit for the area, which varies depending on local housing costs. Consequently, owners of higher-priced homes can't borrow any more than owners of homes valued at the FHA limit.
HUD's reverse mortgage loan program collects funds from insurance premiums charged to borrowers. Senior citizens are charged 2 percent of the home's value as an up-front payment plus one-half percent on the loan balance each year.<29> These amounts are usually paid by the lender and charged to the borrower's principal balance. FHA's mortgage insurance makes HUD's program less expensive to borrowers than the smaller reverse mortgage programs run by private lenders without FHA insurance.
HUD's reverse mortgage loan product is called the Home Equity Conversion Mortgage (HECM).<30> Borrowers must be at least 62 years old<31> and either own their home free and clear or have a very low outstanding mortgage balance. Borrowers must agree to accept mortgage counseling from a HUD-approved counseling agency.<32> Family members are strongly encouraged to attend these counseling sessions. The counseling will cover the concept of reverse mortgage loans and alternatives to this mortgage loan product.
Properties eligible for HECM include one-unit dwellings, including condominiums, manufactured housing (mobile homes), and 2-4-unit properties in which the borrower occupies one of the units meeting HUD Title II requirements.<33>
The program's purpose is to allow older homeowners to convert their equity into cash while living in their homes as long as they want to. Borrowers retain ownership of their property and may sell and move at any time. A borrower cannot be forced to sell his home to pay off the loan even if the loan balance grows to exceed the property's value. When the loan comes due, the lender's recovery from the borrower's estate is limited to the home's value.
The three basic payment options under the HECM program are:
-
Tenure Payment – The borrower receives monthly payments from the lender for as long as the borrower occupies the home as a principal residence.<34>
-
Term Payment – The borrower receives monthly payments for a fixed time period, selected by the borrower.<35>
-
Line of Credit Payment – The borrower can make draws up to a maximum amount at any time and in amounts of the borrower's choosing.<36>
Unlike ordinary home equity loans, a HUD reverse mortgage loan does not require repayment as long as the borrower lives in the home. Lenders recover their principal, plus interest, when the home is sold. The remaining value of the home goes to the homeowner or to his or her survivors. If the sales proceeds are insufficient to pay the amount owed, HUD will pay the lender the deficiency.
Regulations regarding HUD's reverse mortgage program are found at 24 C.F.R. Part 206.
4. Sources of Information on Reverse Mortgage Loans
Practitioners needing more information about reverse mortgages can refer to the following organizations and documents:
The National Reverse Mortgage Lenders Association
1400 16th Street, N.W., Suite 420
Washington, D.C. 20035
Telephone: 202-939-1760
Fax: 202-265-4435
The National Reverse Mortgage Lenders Association (NRMLA) is a national trade association for financial services companies that originate, service, and invest in reverse mortgages. NRMLA members originate and service more than 90 percent of all reverse mortgages in the U.S.
AARP Home Equity Information Center
601 E. Street NW
Washington D.C. 20004
Telephone: 202-638-2863
The American Association of Retired Persons (AARP) is a nonprofit membership organization of persons 50 and older. The AARP web pages regarding reverse mortgages include information on alternatives to a reverse mortgage.
The American Bar Association
Commission on Law and Aging
740 15th Street, N.W.
Washington, D.C. 20005-1022
Telephone: 202-662-8690
Fax: 202-662-8698
Finally, the U.S. Department of Housing and Urban Development publishes Home Equity Conversion Mortgages: Handbook 4235.1 REV-1 (Washington, D.C. 1994).
END NOTES:
1. Due to this mortgage repayment structure, a default on the loan while the mortgagor is living and residing in the home typically occurs only if the mortgagor fails to pay real estate taxes or homeowners insurance or commits waste with respect to the home.
2. See Celeste M Hammond, Reverse Mortgages: A Financial Planning Device for the Elderly (1993) 1 Elder LJ 75, 76 (1993) (describing a reverse mortgage as a financial planning device for the elderly who are "house rich, but cash poor"); Jacqueline Queener, Note, Finding the Gold to Finance the "Golden Years": Options for Financing Long-Term Care in Arizona, 45 Ariz L Rev 857, 888 (2003) (referring to a reverse mortgage as a way to give "asset-poor, house-rich" elders the opportunity to remain in their homes).
3. Deanne Loonin & Eliabeth Renuart, The Growing Debt Burdens of Older Consumers and Related Policy Recommendations, 44 Harv J on Legis 167, 198 (2007). See also Donna S Harkness, Predatory Lending Prevention Project: Prescribing a Cure for the Home Equity Loss Ailing the Elderly, 10 BU Pub Int LJ 1, 40 (2000) (discussing abuses of reverse mortgage lenders).
4. See Senior Income Reverse Mortgage Corp v Olson, 1999 US Dist LEXIS 8193 (ND Ill May 19, 1999); Flores v Transamerica Homefirst, Inc, 93 Cal App 4th 846, 113 Cal Rptr 2d 376 (2001), review den’d, 2002 Cal LEXIS 298 (Jan 16, 2002); Black v Financial Freedom Senior Funding Corp, 92 Cal App 4th 917, 112 Cal Rptr 2d 445 (2001), review den’d, 2002 Cal LEXIS 479 (Jan 23, 2002); John Hancock Mutual Life Ins Corp v Setser, 42 Cal App 4th 1524, 50 Cal Rptr 2d 413 (Cal Ct App 1996).
5. See Financial Freedom v Kirgis, 377 Ill App 3d 107, 315 Ill Dec 537, 877 NE2d 24 (2007), app den’d, 2008 Ill LEXIS 149 (Jan 30, 2008), for a case where the mortgagor's son was displeased that the reverse mortgage lender was essentially entitled to his mother's home.
6. 15 USC § 1602(bb); 12 CFR § 226.33(a). See Black v Financial Freedom Senior Funding Corp, 92 Cal App 4th 917, 922, 112 Cal Rptr 2d 445, 449 (2001), review den’d, 2002 Cal LEXIS 479 (Jan 23, 2002).
7. See William J Delaney, Reverse Mortgages: Rainbow or Mirage for One's Golden Years?, 48 RI Bar J 11, 13 (June 2000).
8. 15 USC § 1648(a); 12 CFR § 226.33(b).
9. 42 USC § 1396p. Subsection (f)(1)(A) provides in part that "in determining eligibility of an individual for medical assistance with respect to nursing facility services or other long-term care services, the individual shall not be eligible for such assistance if the individual's equity interest in the individual's home exceeds $500,000." Subsection (f)(3) states: "Nothing in this subsection shall be construed as preventing an individual from using a reverse mortgage or home equity loan to reduce the individual's total equity interest in the home." See also Gregory C Larson & Melissa Hauer. Planning for Nursing Home Care in North Dakota, 74 N Dak L Rev 191, 197 (1998) ("The cash from a reverse mortgage could push a recipient over the asset and income limits in means-tested public benefit programs, thereby reducing or terminating the benefit.").
10. See Flores v Transamerica Homefirst, 93 Cal App 4th 846, 849 n 1, 113 Cal Rptr 2d 376, 378 n. 1 (2001), review den’d, 2002 Cal LEXIS 298 (Jan 16, 2002).
11. Financial Freedom Senior Funding Corporation, 1 Banting, Irvine, CA 92618, phone: (800) 500-5150, Website: http://www.ffsenior.com.
12. See Tex Const Art XVI, § 50 (p) and (v). See gen’ly J Alton Alsup, Texas' New and Improved Reverse Mortgage, 68 Tex BJ 1076 (2005).
13. See Leslie R Ramos, California Provides Further Protection for Seniors Contemplating Reverse Mortgage Loans, 38 McGeorge L Rev 45, 50 (2007), citing Senator Joseph Simitian, Cal State Senate, Fact Sheet on SB 1609, at 1 (2006).
14. See Cal Civ Code § 1923.2 (a).
15. See Cal Civ Code § 1923.2 (e).
16. See Cal Civ Code § 1923.2 (g)(1) and (2).
17. See Cal Civ Code § 1923.2 (g)(3).
18. See Cal Civ Code § 1923.2 (i).
19. See Cal Civ Code § 1923.5.
20. See Cal Civ Code § 1670.5; Flores v Transamerica Homefirst, Inc, 93 Cal App 4th 846, 852-855, 113 Cal Rptr 2d 376, 381-383 (1st Dist 2001), review den’d, 2002 Cal LEXIS 298 (Jan 16, 2002).
21. See Cal Civ Code § 1632.
22. See Cal Welfare & Inst Code § 15600, et seq.
23. See Cal Welfare & Inst Code § 15610.30.
24. See Cal Welfare & Inst. Code § 15657.5(a).
25. See Cal. Welfare & Inst Code § 15657.5(b).
26. See William J Delaney, Reverse Mortgages: Rainbow or Mirage for One's Golden Years?, 48 RI Bar J 11 (June 2000) (discussing in part the reverse mortgage program of the Rhode Island Housing & Mortgage Finance Corporation).
27. See 24 CFR § 206.105. According to HUD's webpage titled, "How HUD's Reverse Mortgage Program Works," senior citizens are charged 2 percent of the home's value as an up-front payment plus one-half percent on the loan balance each year. These amounts are usually paid by the lender and charged to the borrower's principal balance. See http://www.hud.gov/buying/reverse.cfm (site visited Mar 3, 2008).
29. 24 CFR § 206.105.
30. 24 CFR § 206.1.
31. 24 CFR § 206.33.
32. 24 CFR § 206.41.
33. 24 CFR § 206.45. See also the HUD webpage titled, "About Reverse Mortgages for Seniors – Section 255 – Home Equity Conversion Mortgages (HECM)," which states that a 1-4 unit home with one unit occupied by the borrower is an eligible property for the reverse mortgage program. This webpage is found at: http://www.hud.gov/offices/hsg/sfh/hecm/hecmabou.cfm (site visited Mar. 3, 2008).
34. 24 CFR § 206.19(b).
35. 24 CFR § 206.19(a).
36. 24 CFR § 206.19(c).