Ever since the virtual disappearance of the structured finance market after the financial crisis of 2008, reverse mortgage industry participants have waited and wondered when the secondary market for so-called “proprietary” (or non-FHA-insured) conventional reverse mortgages would return. With all of the changes that FHA has made to the HECM program over the past couple of years, including five successive PLF cuts, the imposition of initial disbursement limits, and the designation all fixed-rate HECMs as single-disbursement loans, one would think that the interest of originators in proprietary (or non-FHA-insured conventional) reverse mortgages would be keen and heightened at this time. Must a secondary market for such loans redevelop first, or will lenders have to take a risk and originate loans in the hopes that investment interest will follow? Perhaps it will be a bit like the quote from Field of Dreams: If you build it, they will come!
This article addresses the perceived (and real) impediments to reintroducing a proprietary reverse mortgage into the market at this time, and reviews some (but not all) of the legal and regulatory issues that should be considered in designing, marketing and offering such loans.
Federal Regulatory Issues – Is It a Reverse Mortgage?
Non-FHA-insured conventional reverse mortgages are by definition not FHA-insured. Therefore, FHA HECM rules do not apply to non-FHA-insured conventional reverse mortgages. However, other federal rules do apply to non-FHA-insured conventional reverse mortgages.
Under Regulation Z, a reverse mortgage transaction is defined as a non-recourse consumer credit obligation in which a security interest securing one or more advances is created in the consumer’s principal dwelling, and any principal and interest, is due and payable (other than in the case of default) only after: (i) the consumer dies, (ii) the dwelling is transferred, or (iii) the consumer ceases to occupy the dwelling as a principal dwelling.
A couple of things stand out in this Regulation Z definition of reverse mortgages. First, the loan must be secured by the consumer’s principal dwelling. Similar to the HECM regulations, under Regulation Z, a consumer can have only one principal dwelling at a time. Thus, a vacation or other second home would not be a principal dwelling. So, a question arises as to whether a non-FHA-insured conventional reverse mortgage could be secured by a second home. From this definition, it appears the answer would be “no.” This is not to say that a lender could not make a non-recourse loan with no required monthly payments secured by a second home. It would appear however, that such a loan would not qualify as a reverse mortgage under Regulation Z. And if such “non-reverse” mortgage loans were structured as closed-end credit, they would be subject to the CFPB’s new Ability to Repay and Qualified Mortgage rules, which adds additional complications if no monthly payments on the loan were required. Lenders would nonetheless have to demonstrate that the borrower has the ability to repay such non-reverse mortgage loans.
Further, reverse mortgages are exempt from the high-cost home loan rules under HOEPA. If a loan failed the definition of a “reverse mortgage” under Regulation Z, regardless of whether it was closed-end or open-end credit, it would be subject to the APR and points and fees tests under the recently revised provisions of HOEPA. Generally, a loan is covered under HOEPA if the APR on a first lien loan exceeds by more than 6.5 percentage points the average prime offer rate on a loan with a comparable term, or the points and fees exceed 5 percent of the loan amount.
Another question is whether a lender could require the borrower to make interest-only payments under a loan, in order to increase the amount of loan proceeds that can be advanced to the borrower under the loan. As outlined above, a reverse mortgage as defined under Regulation Z provides that the borrower is not required to make any repayment of principal or interest until there is a maturity event (or default). Requiring the borrower to make interest-only payments under a loan would cause the loan to fail the definition of a reverse mortgage as provided under Regulation Z, with similar consequences as those outlined above for second homes.
As with HECMs, TALC (and other Regulation Z) disclosures must be provided to a borrower in connection with a reverse mortgage. However, a TALC disclosure is not required, and thus should not be used, with a loan that is not a reverse mortgage.
State Law Issues – The Balkanized Landscape
Approximately 33 states have laws on reverse mortgages. These laws can be broken down into those that have a comprehensive regulatory scheme for reverse mortgages, and those that only impose regulatory or lesser requirements.
Those states with a comprehensive reverse mortgage regulatory scheme include states such as New York, North Carolina and Tennessee. In these three states, unless a lender is a federally chartered bank, it will need a separate entity-level approval to make reverse mortgages, in addition to its standard or general mortgage lending license issued by each of these states.
In New York, a proprietary reverse mortgage lender must have a stand-by letter of credit to fund 12 months’ worth of loan production, or $3 million, whichever is greater, unless the lender has a Dun & Bradstreet rating of either 4A1 or 5A1 for three consecutive years. Proprietary reverse mortgage lenders also must maintain a minimum net worth of $10 million, or have a parent company with a net worth of $100 million with a written commitment to make $10 million available to the reverse mortgage lender subsidiary. These financial responsibility requirements do not apply to a proprietary reverse mortgage lender that only originates reverse mortgage loans when the proceeds are fully disbursed at closing. Washington has similar financial responsibility requirements for proprietary reverse mortgage lenders, with similar exemptions.
In addition to entity-level approval, in order to make proprietary reverse mortgages in New York, there are detailed loan level requirements. In New York, there are so-called 280 and 280-a reverse mortgages (named for the code sections of the New York Real Property where the statutory requirements are published). In summary, a lender must make as many 280-a loans as it does 280 loans in New York, or demonstrate why it cannot or does not plan to do so. Section 280-a loans generally must have private mortgage insurance and carry escrow accounts for taxes and insurance. If mortgage insurance is not available, a lender must submit proof to the mortgage banking regulator to that effect. Trying to prove the nonexistence of private mortgage insurance is a little like trying to prove a negative, and some lenders have had trouble in the past obtaining approval to do business in New York due to an inability to satisfy New York’s Kafkaesque requests in this regard.
In addition, in Massachusetts, a lender cannot offer a reverse mortgage program until it submits its program specifications and loan documents to the Massachusetts Division of Banks for approval. Approval can take several months, and a lender cannot offer a reverse mortgage program in Massachusetts until the Massachusetts Division of Banks approves the program. The same holds true in Iowa.
California has a separate chapter in its civil code that governs reverse mortgages. Among other things, these laws require special disclosures and limit items such as prepayment penalties and the “cross selling” of reverse mortgages with other financial services products (except for things such as title insurance). (Cross selling is also prohibited in a number of other states, including Arizona, Louisiana, Maryland, Minnesota, New Hampshire, Rhode Island and Washington.) California laws on reverse mortgages were recently amended to provide for a seven-day cooling-off period between counseling and the taking of an application, and the required disclosures have also been updated.
Louisiana, Massachusetts and Minnesota also have seven -day cooling-off period that runs from the date a loan commitment is issued by the lender. Proprietary reverse mortgages are not allowed in Vermont, and are difficult to offer (and thus uncommon) in Tennessee. Some states have different borrower vacancy timing periods for a maturity event. Further, in Illinois and Oregon, lenders must disclose to the borrower that obtaining a reverse mortgage may affect the borrower’s eligibility to obtain a tax deferral programs in those states.
In Arizona, a reverse mortgage must contain restrictions that ensure the borrower does not fund any unnecessary costs for obtaining the reverse mortgage, including costs of estate planning, financial advice or other related services. Louisiana also requires special disclosures for proprietary reverse mortgages.
In Maryland, all reverse mortgages must meet the program requirements of the FHA-insured HECM program, except for the limit on origination fees, the maximum claim amount or the requirement for mortgage insurance.
In Arkansas, reverse mortgages are subject to that state’s high-cost home loan law (which has APR, points and fees triggers similar to federal HOEPA, discussed above) unless the loan is sold to Fannie Mae or insured by FHA within 60 days of origination. This may not be possible with proprietary reverse mortgages.
In Pennsylvania, among other guidelines, a lender should take steps to determine if an applicant has the ability to understand the transaction. A reverse mortgage loan should not be offered or made if it is concluded that the customer is unable to understand the transaction. And a lender should consider the appropriateness, and fully disclose the possible consequences, of a reverse mortgage loan for a non-borrowing spouse living in the mortgaged property.
Several states’ reverse mortgage laws provide that if the lender does not make advances to the borrower as specified under the loan documents, the lender may be subject to penalties, or the loan will be void, or the lender may not be able to collect interest, principal, or both. Such states include California, Nebraska, North Carolina, Texas and Tennessee.
Counseling
Approximately 25 states require counseling in connection with reverse mortgages, and many states require that the counselor be HUD-approved. Many states also require that the lender give the borrower a list of counselors to choose from (much like the FHA HECM program) and require counseling independence. This can be problematic for lenders that want to send their proprietary reverse mortgage applicants to a counselor that understands their particular proprietary loan program, or for those lenders that wish to pay for counseling.
Conclusion
With all of the changes that FHA has made to the HECM program over the past couple of years, it seems logical the interest and appetite for proprietary reverse mortgages will increase. There certainly seems to be interest from certain segments of the secondary market. Whether the reintroduction of proprietary reverse mortgages will be like Field of Dreams remains to be seen. In designing and reintroducing non-FHA insured reverse mortgages, lenders should be aware that although FHA rules do not apply to such loans, many laws and regulations at both the federal and state levels do apply. Such laws and regulations include Regulation Z, and state laws requiring approval either at the entity level or the reverse mortgage program level, as well as counseling requirements, and other regulations on terms and conditions of the loans and disclosure requirements.
