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California Senior Legal Hotline/Legal Services of Northern Calif.
444 North 3rd Street, Suite 312, Sacramento, CA 95811
Telephone: (916) 551-2145 Fax: (916) 551-2197
www.seniorlegalhotline.org
Reverse mortgages, as originally conceived by HUD, AARP and the home loan industry
in the 1980s, were not meant to be used for loss mitigation. Home equity conversion
mortgages (HECMs, the most ubiquitous form of reverse mortgage, highly regulated
and insured by FHA), were designed for elders (minimum age is 62) with houses that
are paid off or nearly so, and who are both determined and likely able to remain
in the house for years to come – but who need extra income to make it possible.
The loans enable such borrowers to draw on this home equity, converting it to monthly
payments calculated according to actuarial formulas and market factors. A lump sum
option, to be used as an alternative or in combination with monthly income, was
included to enable borrowers to meet certain immediate needs, such as repairs or
modifications, and in some cases, to pay off relatively small balances on existing
home loans. And some of the available proceeds from a HECM may be held back as a
line of credit for future use.
Nevertheless, even long before the current crisis, HECMs were used at times as a
last resort to prevent foreclosure. I well remember a case we opened in 1998 for
Ms. J, then 84, who had been victimized four years earlier by a predatory, adjustable
rate loan. A forbearance agreement had bought some time, but as it neared an end,
the loan servicer refused to respond to our rescission notice or discuss a permanent
modification – and all we sought was a fixed rate at then-market levels.
We looked into a HECM, as several objective and subjective factors were favorable:
Ms. J had no children, was physically well for her age, and remaining at home was
a high priority for her. But the debt was too high compared to value, and extensive
repairs were needed ... so the idea was quickly dropped.
Soon after, we had no choice but to arrange to put Ms. J in a Chapter 13 bankruptcy
plan, which lasted for years while we helped her manage her budget, avoid the scams
to which she was prone by having her voluntarily hire a fiduciary to manage her
finances – and with help from legal aid attorneys in three other states, eventually
cleared title on a small lot she had inherited in Georgia and arranged to have it
sold.
By 2004, Ms. J was stressed but still going strong. Ironically, the sharp increase
in market values then was the key to making a HECM viable. The bankruptcy court
approved it as part of a revised plan; the old loan was paid off and the house was
fixed up. She died peacefully at home last year, at 94, having enjoyed her final
four years, secure, comfortable and quite happy.
But imagine if Ms. J could have obtained, in 2000, a HECM to pay off part of her
debt, together with a small, subordinate loan for the rest and the repairs. While
not possible in every situation, it would have been eminently affordable in hers.
And it would have spared her four years of stress, determined to remain in her home
of half a century, but worried over losing it and meanwhile, unable to afford badly
needed repairs.
Fast forward to 2009. Millions of “homeowners” owe more than their home’s current
market value, in some cases, far more. We have seen case after case in which longtime
senior homeowners, many of them minorities, were clearly targeted for unaffordable,
predatory loans precisely because 2 they had built up significant equity over the
decades. Moreover, their vulnerability to such schemes – and their outcomes – was
often tied to some of the harsh realities of aging: Suddenly reduced income due
to unexpected job loss, disability or death of a spouse, coupled with much lower
likelihood, compared to younger folks, of finding additional income. At the same
time, many of the same people faced rising expenses for health care, home help,
needed repair of older houses, maxed-out credit cards, etc. They succumbed again
and again and again to refinancing pitches as home prices rose, each time catching
up temporarily only to fall further behind. Brokers and lenders were more than willing
to feed the habit, often breaking promises of “lower payments” but collecting huge
fees and kickbacks along the way.
The latest in a series of government and some servicer plans meant to reduce the
foreclosure rate seems more likely to succeed than its 2008 predecessors. But its
main variations – refinance and modification – are both sharply focused on achieving
manageable housing cost to income (HTI) ratios. Interest rate reduction, extension
of terms and in some cases, principal reduction are the tools, with low starting
payments gradually rising designed to help those who are suffering from job loss
or other temporary, recession-linked hardship.
For borrowers whose debt is too high and income too low, however, the plan offers
only minimal help to facilitate a short sale or other scenarios, including foreclosure.
And many seniors’ hardship is anything but temporary, but rather manifested in “fixed”
or diminishing incomes and rising expenses, plus in many instances, credit scores
that have been badly tarnished by the circumstances that led to the situation. Elders
who face home loan debt that approaches or even exceeds value are far more likely
to fall short of the income they would need to pay on the best refinances or modifications
now available.
But homeowners over 62 are eligible for what could be a much happier ending – by
means of a HECM that could go a long way toward paying off debt that is close to
– or reduced to – current value.
In a handful of such cases, we and other advocates for low-income seniors have persuaded
servicers to accept the maximum net proceeds of a HECM as satisfaction of the loan
– a “short refi” to a reverse mortgage. This is most likely to occur when predatory
attributes of the original loan that could lead to a lawsuit are a motivator. In
one well-timed case we handled, a nearly 6-month-old (the HECM limit) appraisal
amid sharply falling property values meant that accepting the HECM proceeds netted
the lender about as much as it would have obtained in foreclosure, so there was
no reason to decline the offer.
Those are exceptions, though. In far more cases, a HECM could provide the bulk of
a solution, but only alongside a subordinate loan to make up the difference between
the net HECM proceeds and what the servicer would net in a foreclosure. Otherwise,
foreclosure remains the preferred option.
Aside from the fact that it would save seniors’ homes, this would have a number
of advantages for lenders and borrowers alike:
- The subordinate loan, even amortized at market rates, would be small enough to make
it eminently affordable to huge numbers of seniors for whom payments under other
modification models would be a risky stretch, at best.
- Lenders would avoid the messy process, not to mention costs, of foreclosure and
eviction, not to mention the risk of bad PR from ejecting an elderly, longtime homeowner.
- Lenders would receive the bulk of the remaining value immediately, from the HECM
proceeds, as opposed to a standard modification or in-house refinance, many of which
are likely to result in re-default to boot.
- Borrowers would be highly motivated not to default on the subordinate loan, whose
payments would almost invariably be lower than for any comparable rental or purchase
opportunity.
The main risk is clear: If the HECM becomes due before the subordinate loan is paid
off, there insufficient proceeds may remain for the latter. But that risk could
be minimized by having the subordinate loan amortized for a relatively short term,
say 10 years or less. Then, if the HECM terminates even sooner, its built-in margin
of safety would make it likely that sufficient proceeds would remain, while if the
HECM lasts long enough to risk an excess of debt over value, the subordinate loan
would probably have been paid off. Moreover, keeping a home occupied is more likely
to preserve its market value than if it were to be foreclosed and revert to REO.
The relatively short term of such a subordinate loan could undermine its affordability
for borrowers in some marginal cases, but not, I think, in the vast majority.
As of now, the only way such a scenario can succeed without running afoul of FHA
is if an existing loan is “modified” – more accurately described as an extreme makeover
– into a loan that would be subordinated to a new HECM. This would not be an “outstanding
or unpaid obligation incurred by the mortgagor in connection with the mortgage transaction,”
disallowed under 24 CFR 206.32(a) “after the initial payment of loan proceeds,”
since it would have pre-existed the HECM. Nor would it “arise or be connected with
obtaining a HECM loan,” as expressed in ML 06-20, which refers to the regulation
and specifically permits the survival of a pre-existing lien, as long as it is subordinated
to the HECM liens. In contrast, a new, subordinate loan, whether provided by the
HECM or another lender, would appear to be ruled out by these clauses – though we
have heard of such scenarios occurring.
We have now also heard that FHA may, in a new mortgagee letter, specifically disallow
even the recasting of an existing loan – the unaffordable one causing the risk of
foreclosure – into a benign, subordinate loan that together with a HECM, could serve
to keep many thousands of seniors in homes they would otherwise lose.
This whole matter deserves further scrutiny.
First, as far as I can tell, there is nothing in the enabling statutes that requires
the restriction imposed in ML 06-20’s interpretation of the regulation.
Second, 24 CFR 206.32(a) seems intended more for a different purpose in a different
era. Coupled as it is with 206.32(b): “The initial payment will not be used for
any payment to or on behalf of an estate planning service firm,” the target appears
to be the abusive HECM marketing practices that mushroomed in the decade preceding
the current downturn, in which some brokers and lenders pushed reverse mortgages
in order to then induce borrowers to spend the proceeds on a panoply of questionable
investments, annuities, insurance policies, etc. Interestingly, the regulation itself
doesn’t even contain the word “subordinate.” The phrase “outstanding or unpaid obligation”
could mean many things besides a subordinate lien.
Perhaps, therefore, the framers of 24 CFR 206.32 didn’t mean at all to go where
ML 06-20 takes it. And perhaps, therefore, it is time to rethink the restrictions
imposed on subordinate liens by ML 06-20, and the even more draconian restrictions
that may now be under consideration. In today’s crisis, why not facilitate instead
of bar the use of HECMs in certain situations to prevent the foreclosure of tens
of thousands of homes occupied for decades by now older Americans?
A similar case can be made regarding the new “HECM for purchase” program that took
effect January 1, 2009. Like the original HECM program, its design contemplates
only those situations in which the buyer/borrower has sufficient equity from a prior
home (or other assets) to pay the difference between the HECM net proceeds and the
sales price. And ML 08-33, which outlines the program, is even more strict about
barring subordinate obligations than is ML 06-20 with regard to traditional HECMs.
Not even “gifts” may be used to provide the required investment.
Even as originally envisioned, such strict rules limit the use of HECMs for purchase
to 4 relatively well-off elders, mostly owners of prior homes. With today’s collapse
of the housing market, however, large numbers of seniors who would have qualified
until recently have lost the home equity they thought they had. Why not allow them,
along with some first-time buyers with limited savings, to use HECMs to purchase
modest homes they could not afford otherwise, as long as they have sufficient income
to service a small, subordinate lien and meet other needs?
Additionally, envision perhaps programs to help older, low- to moderate-income first-time
homebuyers sponsored by state housing finance agencies or local housing authorities.
They could be the providers of such subordinate loans, and some, instead of being
amortized, might be “silent,” even forgivable after a certain number of years. A
plethora of programs along these lines already exists.
Amid today’s crisis, HECMs for purchase could also be a useful tool in the settlement
of predatory lending/improper foreclosure cases. A lender might be induced to agree,
post-foreclosure, to “sell” the property back to the victim, effectively gift the
gap amount to the “buyer.” Legally and procedurally, it would be far simpler than
a settlement involving a rescission of the trustee sale and reinstatement of the
prior loan, only to then drastically modify it, as described above.
Finally, if subordinate loans are more widely permitted with HECMs, what’s to prevent
abuses in this new field?
Of course, additional obligations could be abusive and predatory. But so can any
other financial product, including HECMs themselves, as has been widely seen. Generally,
though, the worst abuses are nurtured by desperation, manifested in actions that
desperate people will be driven to take when reasonable solutions are disallowed
or at least made extremely difficult. The current fashion involves inducing homeowners
to pay thousands of dollars to “foreclosure rescue” scammers. Some of the victims
are elders who might have been legitimately “rescued” with the help of certified
HECM counselors, but couldn’t qualify for a reverse mortgage solely because the
addition of a small subordinate loan was not permitted.
Abuses need to be attacked head on. There needs to be more legitimate counseling
available, and better quality control, especially for the mandatory HECM counseling.
Alternatives to reverse mortgages should always be carefully considered, whatever
the motivation and goals. Meaningful anti-predatory lending laws would help – adoption
of a suitability standard for HECMs, for instance (currently proposed in a bill
in the California Legislature), and perhaps for all loans secured by the borrower’s
residence, for that matter. FHA could set specific standards for any subordinate
loans that accompany HECMs, as it does for HECMs themselves, by insuring them to
a limited degree.
David L. Mandel (dmandel@lsnc.net)
March 26, 2009
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