On March 8, 2011, AARP filed a lawsuit against the U.S. Department of Housing and Urban Development (HUD). The lawsuit, filed on behalf of three surviving spouses of HECM borrowers, alleges that HUD inaccurately and illegally interpreted the definition of “non-recourse” and “homeowner” in establishing HECM policies. AARP suggests that the result of the lawsuit could have national implications because it will determine if non-borrowing spouses can avoid foreclosure and have the right to stay in homes that are underwater.
This is something, they state, that borrowers had paid insurance premiums to avoid. HUD was granted the authority to create an FHA insurance program for reverse mortgages by Section 255 of the Housing and Community Development of 1987, signed by President Ronald Regan on February 5, 1988. The subject of the debate that has resulted in the AARP lawsuit involves these definitions that are drawn from two subsequent regulations that laid out the framework of the Home Equity Conversion Mortgages (HECMs) to be insured by the FHA. The first is the statute within United States Code that defines HUD’s authorization to create an insurance program, U.S.C. Title 12, Chapter 13, Subchapter II, Section 1715z-20. In this case, AARP has focused specifically on Subjection (j), which serves to protect a homeowner from displacement, and creates the definition of “homeowner” in the dispute.
The second regulation in the debate is the HUD Handbook 4235.1 released in August 1989 and revised through Handbook 4235.1 REV-1 in September 1994. Again, the subject of contention is narrowed down to a single subsection, Chapter 1, Section 3, Subsection C, wherein the definition of “non-recourse,” as it relates to FHA insurable HECM loans, is established.
AARP conducted a study on the FHA-insured HECM program in 2006 and released their report, “Reverse Mortgages: Niche Product or Mainstream Solution,” in December 2007. In the report, AARP first publically raised their concerns about how HUD was applying these definitions in implementing their policies. It appears that in creating their recommendations, AARP was giving HUD a “friendly warning” about these policies with the goal of encouraging them to correct the problematic discrepancies.
The resulting lawsuit could then be seen as the culmination of AARP’s frustration that HUD’s policies continued to run afoul of their interpretation of the statute. In order to protect their constituency, and seek to have the appropriate application of the language clarified, they may have felt that litigation would provide the clearest possible remedy.
In light of hundreds of pages of regulatory language, it may be hard to imagine, but this case, with major implications for the program and the industry, is essentially a debate over the specific language in two sentences. AARP suggests that HUD’s policies and practices related to “non-recourse” and “homeowner” may have effectively created administrative law that overstepped the authority given to them in the statute. The allegations claim that the statute is unambiguous and clear in establishing the definition of these terms, and that HUD abandoned long-standing rules in establishing arbitrary changes to the policies and practices that run contrary to the statute.
In Section 1-3(C) of the HUD Handbook, “non-recourse” as it relates to HECM is stated to mean: “the HECM borrower (or his or her estate) will never owe more than the loan balance or the value of the property, whichever is less; and no assets other than the home must be used to repay the debt.” AARP, along with industry participants, have long believed that this protection to homeowners is an unconditional benefit afforded to borrowers when they execute the HECM. It is essentially the basis of the FHA mortgage insurance for which borrowers have paid significant premiums for this protection.
There is debate as to when HUD began interpreting this provision as only applying to when the estate sells the home, not when they desire to retain it, which then requires repayment of the full outstanding balance regardless of home value. HUD has indicated that they believe this has always been their interpretation of the statute, but the practice began to come to light sometime in 2006 or 2007. The AARP report published in December 2007 indicated that HUD had never announced that its non-recourse practice varied from the policy in the HECM Handbook. It called on HUD in “Recommendation 5” (page 111) to “clarify that the HECM non-recourse limit means that borrowers or their estates will never owe more than the value of the home.”
HUD did not respond to the AARP recommendation until Mortgagee Letter 2008-38 was issued in December 2008. The stated goal was to issue “clarification regarding borrower’s recourse for repayment of HECM loan debt and termination of a HECM mortgage.” The letter stated that program participants had mistakenly inferred that the language in the handbook included situations when the estate desired to retain the home. It then states that the intended meaning of the provision is “simply that if the borrower (or estate) does not pay the balance when due, the mortgagee’s remedy is limited to foreclosure and the borrower will not be personally liable for any deficiency resulting from the foreclosure.”
Therefore, in cases where the home is sold, the non-recourse provision only applies to “arm’s length” transactions when the home is sold for less than the balance of the reverse mortgage. HUD made it clear issuing ML 08-38 did not amount to a change in policy; only a clarification wherein the heirs were not unduly afforded the ability to purchase the property as a method to avoid paying the full balance of the HECM. A reason for this definition, some have suggested, is that in a “non-arm’s length” transaction, heirs or estates may actually seek to artificially reduce the value of a home for the sole purpose of taking advantage of the non-recourse provision, or at least receive the unfair dual benefit of retaining the home and paying the lesser balance of the HECM.
The second component of AARP’s lawsuit focused on this sentence defining “homeowner” in the U.S. Code. Subsection (j), titled, ”Safeguard to prevent displacement of homeowner,” states that in order to insure a HECM, it must defer repayment of the loan until “the homeowner’s death, the sale of the home, or the occurrence of other events specified in regulations of the Secretary. For purposes of this subsection, the term ‘homeowner’ includes the spouse of a homeowner.”
At issue is whether the non-borrowing spouse of a HECM borrower is afforded the protections of this provision even if they are not a signatory to the HECM loan. HUD has long insured transactions where a borrower’s spouse was either excluded from title and the HECM loan, or removed via a Quit Claim Deed (QCD) in the processing of a HECM loan. This scenario typically occurs in cases where a spouse is either below the age of 62 and cannot qualify for the HECM, or one borrower is younger and qualifying based upon their age would provide insufficient funds to accomplish their borrowing needs. Persons in these cases, in addition to the QCDs (if applicable), were also typically required to sign disclosures acknowledging their position as a non-borrower, even resulting in a “Non-Borrowing Resident” form that had to be signed by any non-borrowing person residing in the home, whether they were a spouse or not.
HUD essentially interpreted “homeowner” to be interchangeable with “mortgagor” and “borrower.” Accordingly, any of the three terms would only include the spouse when they remained on title to the home and were a party to a transaction. This practice allowed for loans to be insured in cases where a spouse was not a party to the transaction.
The goal of the recommendation in AARP’s 2007 report was to encourage HUD to return the application of “non-recourse” to be unconditional, where a homeowner can never owe more than a home is worth without further interpretation. The result being, no matter how the HECM loan was resolved, the amount paid to the lender would be the lesser of the HECM loan balance or the appraised value (or sales price approved by the lender and HUD).
AARP’s lawsuit involves three plaintiffs that were non-borrowing spouses to HECM borrowers. In all three cases, the borrowing spouse has passed away and the plaintiffs are subsequently defending foreclosure actions under the “due and payable” provisions of the HECM. One plaintiff claims he was removed from title without his knowledge when the HECM was executed. By revising the definition of “non-recourse,” the suit alleges that the plaintiffs will have suffered substantial hardship if they are forced to pay the full balance of the reverse mortgage in order to retain their home. The lawsuit also claims that the “Safeguard to Prevent Displacement of Homeowner” section of the U.S. Code precludes a spouse from being displaced via foreclosure, even if they were not named on the mortgage. The lawsuit attests that HUD has never recognized this important provision.
The lawsuit seeks to gain an injunction against ML 08-38, restoring the original language and establishing the legal definition of the terms according to the statute, and also seeks damages for the plaintiffs.
AARP has stated that they believe the clarification amounts to a breach of contract between borrowers and lenders and a breach of insurance contract between HUD and borrowers, the second of which negates a primary reason for the insurance premiums that are paid through the loan.
Additionally, should the court affirm the claim that HUD inappropriately interpreted the definition of “homeowner” in the statute, it could lead to a determination that non-borrowing spouses had their property rights improperly terminated through QCDs that were executed in the processing of HECM loans. Ultimately, the QCDs that the plaintiffs executed could be deemed void, thereby reaffirming their rights to the properties and bringing into question the validity of the HECM liens against the properties.
At the NRMLA West conference in mid-March, President Peter Bell discussed NRMLA’s position on the claims in the lawsuit, as well as their actions, as the situation unfolded since even before the release of ML 08-38. He noted that the first mention of including the “non-arm’s length” requirements in the definition of “non-recourse” first appeared in a 2006 counseling training session that included a Statement of Policy from HUD. In August of that year, NRMLA took a position to protect the unconditional definition of “non-recourse.” NRMLA counsel James Brodsky noted that NRMLA began a period of heavy engagement with regulators to restore the original definition. NRMLA suggested that the potential for limited abuses could be mitigated in valuation process requirements, and it was an unfair practice to treat heirs differently than others when it came to applying the non-recourse provisions.
In issuing ML 08-38, HUD reaffirmed its position of narrowing the definition and NRMLA continued to advocate for restoring the original. NRMLA believes that this can be simply resolved by replacing ML 08-38 to make “non-recourse” unconditional, but include appropriate safeguards to ensure a fair and reasonable process of property valuation in “non-arm’s length” transactions.
In regard to the definition of “homeowner,” Bell indicates a more problematic issue that essentially is the result of “poor drafting language” in the statute that didn’t accurately reflect the legislators’ intent. NRMLA has taken the position that it is reasonable to infer that the meaning of “homeowner,” “mortgagor” and “borrower” can be considered interchangeable. Accordingly, NRMLA supports HUD’s interpretation that their definition reflects the true intentions of the statute, thereby making the non-borrowing spouse allowable in insurance contract.
The problem, Bell points out, is that due to the nature of a statutory definition versus an administrative interpretation, this is an issue that most likely cannot be resolved through negotiation and will need to be adjudicated by the court. Should the claim prevail, Bell suggests that a potential outcome would be for HUD to amend rules no longer allowing for a spouse to be excluded from title in a HECM transaction. He acknowledges that this creates potential for lost volume and some borrowers with greater need being limited by this application, but this is unavoidable if the term “homeowner” is determined to be as broadly applied as the lawsuit portends.
NRMLA has offered to be a broker in this lawsuit, helping HUD and AARP reach a consensus on addressing the issues. NRMLA believes that the best course of action would be for the organizations to focus on legislative efforts that seek to amend and clarify the statutory language, rather than leaving it up to the courts.
Since AARP believes that this case could have national implications, in addition to clearly changing the application of these rules, their initial objective could be to create precedence on which future cases are able to base their claims. Even though AARP had made their opinions known in 2007, it has come to the point of litigation due to perceived lack of clarity in the statutory language. When it comes to interpreting legislative intent, it usually can only be resolved by either legal or legislative action.
In the first likely action in the case, the court may issue injunctions ceasing foreclosure proceedings against the plaintiffs until the case is litigated. Due to potential precedent created by the case, HUD could then consider imposing a broader moratorium on similar actions pending resolution of the lawsuit.
The ramifications could fundamentally change the HECM program. This amounts to the first major lawsuit against the HECM program. If the lawsuit prevails and becomes a precedent for additional lawsuits, lenders and HUD could be forced to pay damages to borrowers and estates that were negatively impacted by HUD’s interpretation. Additionally, they could be required to amend the existing HECM loans to comply with the clarified rules. Depending on perceived risks to the HECM insurance fund, HUD could also consider additional limitations to the program.
Even with the potential direct impacts of the litigation, a major concern for the industry is the resulting media coverage and the potential negative impact on the reputation of the product among the public. Each step in the litigation process will be covered in varying light by the media. Media outlets will likely turn to legal and financial analysts, who may or may not fully understand the HECM program and the lawsuit, to discuss the merits of the issues at hand. Detractors, such as the Consumer Union, may use this lawsuit as a way to substantiate the dangers of the program they have previously portrayed. The litigation may seek to clarify the law, but industry participants could be portrayed as complicit in HUD’s actions.
This lawsuit has pointed at cracks in the foundation of the HECM program, but it may very well lead to a process of strengthening the program and how it helps seniors finance their retirement. Although the process of resolving this situation may create a period of instability or uncertainty for the reverse mortgage industry, the clarifications should help strengthen the foundation of the program for the future. A period of pain for the industry may be necessary to avoid problems as the program matures. At the end of the day, it is better to have an industry that continues to grow on a solid foundation of clear rules rather than on a shaky foundation of poor regulation and supervision.