SUBPRIME REVISITED How Reverse Mortgage Lenders Put Older Homeowners’ Equity at Risk October 2009 NATIONAL CONSUMER LAW CENTER® National Consumer Law Center® 7 Winthrop Square, 4th Floor Boston, MA 02110 (617) 542-8010 www.consumerlaw.org Subprime Revisited: Written by How Reverse Mortgage Tara Twomey Lenders Put Older Of Counsel Homeowners’ Equity National Consumer Law Center at Risk Rick Jurgens Contributing Author ACKNOWLEDGMENTS The authors would like to thank Odette Williamson for overseeing the writing and editing and coordinating the release of this report; Carolyn Carter and Willard Ogburn for their valuable guidance and input to early drafts; Julie Gallagher for designing and formatting the report and its graphics; Denise Lisio for editorial assistance; and Eric Fletcher for assistance with footnoting. This report was enriched by the support, insight and expertise of attorneys Daniel Claggett, Prescott Cole, Frank Kautz, Dan Murphy, Mark Redmond, David Mandel, Daniel Mulligan, Megan Tighe and Bill Brennan as well as advocates Len Raymond, Bronwyn Belling, Ken Scholen and Roberta Levitan. Among the many seniors and family members who shared their experiences with the authors were Margaret Keast, Janet Altenbaugh, Brenda Holder, Miguel Posada, Marvin Kidwiler and Eugene Burson. Others provided information and opinions about the reverse mortgage market, including Neil Granger, George Lopez, Jeffrey Nash, W.L. Pulsipher and Jeffrey Taylor. TABLE OF CONTENTS I. Introduction 1 II. Reverse Mortgage Basics 2 HECM Loans 3 III. Origins and Evolution of Reverse Mortgages 4 IV. “The Senior Market is a Goldmine” 5 V. A Multi-Billion Dollar Opportunity 6 The Lenders 6 The Brokers 8 Wall Street and the Securitization Spigot 9 VI. The Marketing Machine 11 Pushing Reverse Mortgages 11 VII. More Payouts 12 Yield Spread Premiums 12 The Annuity Trap 14 VIII. Private Equity Conversion Products 14 Proprietary Reverse Mortgages 15 Equity Sharing Deals 15 IX.Disclosure and Counseling: The Bulwark Against Abuse? 16 Total Annual Loan Cost 16 HECM Counseling Requirement 17 X. Recommendations: Making the Reverse Mortgage Market Safe 18 CONCLUSION 20 Notes 21 SUBPRIME REVISITED How Reverse Mortgage Lenders Put Older Homeowners’ Equity at Risk October 2009 I. Introduction fees. Predators who once reaped profits from ex- otic loans have now focused on wresting more The U.S. Office of the Comptroller of the Cur- wealth from vulnerable seniors. And securitiza- rency and other federal regulators that oversee tion, which allowed subprime loan originators to banks were slow to recognize the threat posed by disassociate themselves from the downside risks the recent boom in subprime mortgage lending, of abusive lending, is becoming commonplace in and slow to act. So it was noteworthy when, in the reverse mortgage industry. June 2009, Comptroller John C. Dugan, went be- Reverse mortgages are complicated. The op- fore a gathering of bankers and warned of a danger portunities for abuse abound. Seniors, many of growing in a market designed to serve the na- whom lack experience with complex financial tion’s seniors: “While reverse mortgages can pro- products, often depend upon lenders and bro- vide real benefit, they also have some of the same kers for expertise and guidance. Reverse mort- characteristics as the riskiest types of subprime gage lenders, like subprime lenders, emphasize mortgages—and that should set off alarm bells.”1 the benefits that they provide to borrowers and During 2008 more than 100,000 seniors used often tout their commitment to responsible reverse mortgages to tap more than $17 billion in lending principles. However, such claims are un- home equity.2 Within the mortgage industry, re- dermined by a growing public record of how sub- verse mortgages continue to grow despite the prime lenders—including some now active in the economic downturn, with volume more than reverse mortgage market—profited from acting doubling between 2005 and 2008.3 Despite a irresponsibly during the recent mortgage boom. summer slowdown in originations, 2009 still ap- In addition, reverse mortgage lenders have fol- pears to be on pace for a record year. lowed in the footsteps of their subprime counter- Certainly, the continuing availability of reverse parts by using financial incentives to reward mortgages is good news for seniors who need to brokers for arranging deals that boost lenders’ cash out some of their housing wealth to supple- profits and raise the costs paid by borrowers. By ment Social Security, to meet unexpected med- adjusting reverse mortgage loan terms, such as ical costs, or to make needed home repairs. But interest rates, servicing fees, rate adjustment in- growth in the reverse mortgage market has un- tervals and distributions, brokers and lenders can leashed other, more malign forces. maximize their profits at the expense of senior Many of the same players that fueled the sub- homeowners. prime mortgage boom—ultimately with disas- Seniors are also vulnerable to other abuses as- trous consequences—have turned their attention sociated with reverse mortgages. Some seniors to the reverse market. Lenders, including some of have been persuaded to sink proceeds from reverse the nation’s largest banks, view that market as a mortgages into complicated annuity contracts or source of profits that have dried up elsewhere. expensive long-term care insurance products. Mortgage brokers see it as a new source of rich These products generate large commissions for 1 2 SUBPRIME REVISITED sellers, but frequently prove financially toxic for borrower pays off the balance of the loan with senior homeowners. monthly payments. Under a reverse mortgage, While counseling is required for all borrowers the lender advances funds to a borrower as a of federally insured reverse mortgages, only a hand- lump sum, in monthly payments, through a line ful of states require counseling for all types of re- of credit, or a combination of these options. The verse mortgages. And while quality counseling borrower does not make monthly payments on can be helpful to seniors, counseling remains in- this loan. Instead, over time, the reverse mort- consistent and underfunded. gage balance rises as a result of additional ad- There is now an urgent need for more safe- vances, accruing interest, and fees. Seniors guards at the federal and state level to protect generally use reverse mortgages to tap home eq- consumers from reverse mortgage abuse, to help uity while remaining in their homes, but some seniors preserve their home equity, and to ensure programs allow borrowers to purchase homes that reasonably priced and fairly structured re- with a reverse mortgage. verse mortgages are available for those who truly Reverse mortgage borrowers must be at least need them. To strengthen protections, states and 62 years of age and must generally own their own the federal government should: homes free and clear or with a minimal amount ᔣ Create suitability standards for reverse mort- of outstanding liens. Because reverse mortgages gages and other equity conversion products re- are essentially equity-based transactions, there quiring lenders and brokers to only arrange are no income or credit qualifications. deals that do not harm the financial well-being The entire balance for a reverse mortgage loan of seniors; is due at maturity. When the loan matures de- pends on whether the loan is a “tenure loan” or a ᔣ Strengthen borrower counseling, which to “term loan.” For tenure loans maturity occurs date remains inconsistent and underfunded; when the borrower dies, sells, or fails to continue to ᔣ Ban yield spread premiums, which incent bro- occupy the home for at least a year. Term reverse kers to make loans more profitable for lenders mortgages mature after a fixed term of years. and investors at the expense of borrowers; There are two principal types of reverse mort- gages: Home Equity Conversion Mortgages ᔣ Regulate proprietary reverse mortgages and (HECMs) and proprietary reverse mortgages. other equity conversion products, which are HECM loans, which are discussed below, are fed- not federally insured and not subject to exist- erally insured and make up the vast majority of ing federal reverse mortgage regulations; and the reverse mortgage market. HUD promulgates ᔣ Improve data collection on reverse mortgages regulations with respect to HECM loans, some of and other equity conversion products that are which are intended to curb abusive lending. Pro- not currently reportable under the Home prietary reverse mortgages, which are discussed Mortgage Disclosure Act. in section VIII, are equity conversion products that are developed and backed solely by private fi- nancial institutions. Proprietary reverse mort- gages lack even the basic federal consumer II. Reverse Mortgage Basics protections that apply to HECM loans. Reverse mortgages enable senior homeowners to HECM Loans convert equity in their homes into cash without having to move out. Under a traditional “for- The Home Equity Conversion Mortgage (HECM) ward” mortgage, the lender advances the princi- program was designed to meet the needs of sen- pal at the origination of the loan, and the ior homeowners by reducing economic hardship SUBPRIME REVISITED 3 that results from increasing costs of health, charged for document preparation, appraisals, housing, and subsistence needs at a time of re- title and tax searches, flood zone searches, inspec- duced income.4 The program is one of many single- tion fees, tax reporting services, attorney’s fees, family mortgage