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SUBPRIME REVISITED How Reverse Mortgage Lenders Put Older Homeowners’ Equity at Risk October2009 National Consumer Law Center 7 Winthrop Square, 4th Floor Boston, MA 02110 www.consumerlaw.org Subprime Revisited: Writtenby How Reverse Mortgage TaraTwomey Lenders Put Older Of Counsel Homeowners’ Equity National Consumer Law Center at Risk RickJurgens 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. NATIONAL CONSUM ER LAW CENTER INC —————————————— ▲ 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 October2009 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- tion, which allowed subprime loan originators to rency and other federal regulators that oversee 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.” 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- 2 home equity. 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 reversearts 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 federallyinsuredreverse 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 are essentially equity-based transactions, there gages and other equity conversion products re- are no income or credit qualiﬁcations. quiring lenders and brokers to only arrange 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- ᔣ Regulate proprietary reverse mortgages and gages: Home Equity Conversion Mortgages other equity conversion products, which are (HECMs) and proprietary reverse mortgages. 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. The program is one of many single- tion fees, tax reporting services, attorney’s fees, family mortgage insurance programs admin- and origination fees. Origination fees are limited istered by the Department of Housing and Urban to the greater of 1) $2,500 or 2) two percent of Development. As with all HUD-insurance pro- the maximum claim amount up to $200,000, grams, borrowers pay premiums for the insur- plus one percent of any portion of the maximum 15 ance and HUD guarantees that the lender will be claim amount that is greater than $200,000. repaid, up to speciﬁed limits, for extending credit Notwithstanding this formula, origination fees to the homeowner. 6 Under the HECM program, are capped at $6,000. 16For example, the maxi- the senior homeowner is also protected by HUD mum origination fee for a $300,000 HECM loan in the event the lender is unable to fulﬁll its pay- would be $5,000 ($200,000 ǂ.02 + $100,000 ǂ 7 ment obligation. The HECM loan is only avail- .01). In addition, HECM borrowers must pay able through HUD-approved lenders. mortgage insurance premiums (MIP) and a Under the HECM program borrowers have a monthly servicing fee. The upfront MIP for an choice of receiving mortgage payments through HECM loan is equal to 2% of the maximum claim ﬁve basic payment plans: tenure, term, line-of- amount. The upfront MIP on a $300,000 HECM credit, modiﬁed tenure, and modiﬁed term. The8 loan is $6,000. The initial mortgage insurance amount that can be borrowed is based on the premium and other costs commonly are ﬁnanced maximum claim amount, the age of the youngest with the proceeds of the loan itself. borrower, and expected average mortgage interest After the closing, a monthly MIP accrues daily rates. The maximum claim amount is the lesser on the mortgage balance at a rate of 0.5% a year of the appraised value of the home or the maxi- and is paid by the lender to HUD. Borrowers also mum amount that HUD will insure. The Hous- are typically charged a ﬁxed monthly servicing ing and Economic Recovery Act of 2008 set the fee, ranging from $25 to $35. MIP amounts and maximum claim amount for HECM loans at servicing fees are added monthly to the bor- $417,000. The limit has been temporarily in- rower’s mortgage balance. 10 creased for 2009 to $625,500. HECM loans have been the workhorse of the Because interest is generally the largest single reverse mortgage industry since they were cre- cost of any reverse mortgage, the expected interest ated. The enabling statute and subsequent rate is an important factor in calculating the funds amendments have attempted to stem abusive available to senior homeowners. While some ﬁxed- practices by providing borrowers with some basic rate HECM loans have been available, most come consumer protections. For example, Congress 11 with adjustable rates, as allowed by statute. has mandated that HECM borrowers obtain “ad- HECMs were designed to be “non-recourse” equate counseling” by an independent third loans, which means that the borrower (or his or party before entering into a reverse mortgage 17 her estate) is never supposed to owe more than transaction. Congress has capped the origina- the loan balance or the value of the property, tion fee that lenders can charge to borrowers. whichever is less.12HECM loans may be prepaid, More recently, Congress has banned the selling 13 in whole or in part, without penalty. Borrowers of other ﬁnancial and insurance products, such are generally required to keep the property in as annuities, in conjunction with HECM loans. good repair and pay property taxes and hazard While these statutory requirements provide im- 14 insurance premiums in a timely manner. portant protections to borrowers, they are un- HECM loans have a number of costs and fees likely to counteract the market forces that drive that are borne by the borrower. Borrowers may be inappropriate or abusive lending. 4 SUBPRIME REVISITED way to reduce the impact of poverty upon elderly III. Origins and Evolution of Reverse Mortgages homeowners. Advocates pushed policymakers to create a standard equity conversion product that Equity conversion products such as reverse mort- would be widely accepted by the lending industry gages have been around since the early 1960s. Ini- and that would provide basic consumer protections tially offered on a very limited basis by private for potentially vulnerable senior homeowners. ﬁnancial institutions, equity conversion loans Congress responded in 1988 by authorizing a varied widely and were largely unregulated. Early demonstration program through which the Federal products included shared appreciation mort- Housing Administration would provide reverse gages, reverse annuity mortgages, deferred pay- mortgage insurance. Originally limited to 2,500 ment loans, and sale/leaseback arrangements. mortgages, the total number of insured mort- Through the early 1980s, ﬁnancial institu- gages under the government’s Home Equity Con- tions, eager to take advantage of home equity version Mortgage (HECM) program now exceeds growth among seniors, attempted to expand the 425,000. 23The annual volume of HECM loans reverse mortgage market. In 1980, a group of Cal- has climbed rapidly over the past ten years. 24 In ifornia banks created a nonproﬁt reverse mort- ﬁscal year 2001, 7,781 HECM loans were origi- gage joint venture. 18In 1983, the nation’s ﬁrst nated. By the end of ﬁscal year 2008, the annual for-proﬁt reverse mortgage company, American volume of HECM loans topped 112,000, repre- 19 Homestead Mortgage Co., was launched. De- senting an incredible 1,300% increase in loan vol- spite the potential for reverse mortgages to open ume in just six years. The monthly HECM up a new source of income for millions of Ameri- volume reached a record high in April 2009, with 25 cans, these early efforts faltered. By mid-1988, 11,660 HECM loans originated. American Homestead had underwritten only The HECM program has dominated the re- 1,200 loans. 20 The California venture collapsed verse mortgage market since its inception, but 21 within a decade. there have been alternatives. In 1996, Fannie Mae While private lenders were interested in exploit- developed its own reverse mortgage—the Home ing new business opportunities, senior advocates Keeper—to serve borrowers with higher property and academics championed reverse mortgages as a values, condominium owners, and seniors wish- A DEARTH OF DATA Currently, there is a dearth of publicly available ireﬁnancing. However, the deﬁnition of reﬁnancing formation on proprietary reverse mortgages. While is limited to “a new obligation that satisﬁes and HUD provides monthly reports describing basic loan replaces an existing obligation by the same bor- and borrower characteristics for HECM loans, no rower.”28 As a result, lenders would not need to comparable information is available for non-HECM report reverse mortgage transactions where borrow- loans. The Home Mortgage Disclosure Act (HMDA), 27 ers’ homes are owned free and clear prior to the which provides extensive information on home transaction. Additionally, reporting is optional if the mortgage applications, including approval rate, so- reverse mortgage includes a lin29of credit for home cioeconomic characteristics of applicants, and some improvement or home purchase. These two excep- mortgage pricing information, covers few, if any, retions eliminate required reporting of most reverse verse mortgage transactions. mortgages. Even in cases where reverse mortgages Under HMDA, reverse mortgages are subject to are required to be reported, HMDA currently pro- the general rule that lenders must report appli- vides no way to distinguish them from traditional cations or loans that meet the deﬁnition of a home forward mortgages. purchase loan, a home improvement loan, or a SUBPRIME REVISITED 5 HECM volume as of 2008 120,000 100,000 Number 17 of Loans Originated 80,000 Total Principal Commited by Lenders 60,000 ($ million) 10 Number of Loans Dollars (billions) 40,000 5 20,000 2 0 1990199119921993199419951996199719981999200020012002200320042005200620072008 Fiscal Year (Oct. 1 to Sept. 30) Source: U.S. Department of Housing and Urban Development, "HECM cases endorsed for insurance by ﬁscal year," posted on-line at www.hud.gov/ofﬁces/hsg/comp/rpts/hecm/hecm0908.xls ing to use a reverse mortgage to purchase a new However, economic recovery over the next few home. The Home Keeper reverse mortgage was years is likely to reinvigorate proprietary reverse discontinued as of December 31, 2008. mortgage products, which to date remain almost Private ﬁnancial institutions also have offered entirely unregulated. a variety of equity conversion products, such as shared appreciation mortgages and proprietary reverse mortgages. A widely held view is that propri- etary reverse mortgages make up approximately IV. “[T]he Senior Market is 26 5–10% of all reverse mortgages originated. With a Goldmine” 30 today’s sagging housing prices, frozen capital markets, and new higher loan limits for the The senior population of the United States is ex- HECM program, the percentage of proprietary re- pected to grow rapidly, from 35 million in 2000 to verse mortgages is probably signiﬁcantly smaller. 64 million by 2025. Seniors are also expected to 6 SUBPRIME REVISITED account for a growing share of the population— with annual incomes below $5,000 owned their about 18 percent in 2025, up from 12 percent in houses free and clear, while another 2.4 million 2000. 32 with annual incomes below $15,000 had no 39 At ﬁrst glance, seniors may not seem to consti- mortgages. All told, more than 7 million sen- tute a rich market. In 2007, the median annual iors with annual incomes below $30,000 owned income of those aged 65 and older was $17,382, their homes outright. 40 33 or just under $1,500 per month. But a closer That treasure trove of home equity has not es- look reveals that seniors do, in fact, possess con- caped the notice of lenders, brokers, and Wall siderable wealth. As one study noted, “Residen- Street investors. tial real estate has grown to become the largest single asset class held by households with heads aged 65 or older.” 34 Data from the most recent American Housing Survey reveals that over 18 V. A Multi-Billion Dollar million seniors (65 and over) own their homes. 35 Opportunity Approximately 15 million of those homeowners are potential reverse mortgage borrowers, includ- “ThepotentialoriginationfeesforReverseMortgages ing more than 12.4 million with no mortgage today are in excess of $42-Billion. How will you get 41 debt and 2.6 million with mortgage debt of less yourshare?” than 40 percent of the value of their house.36 Reverse mortgage lenders have estimated that While reverse mortgage lending remains a niche in the multi-trillion dollar banking industry, it seniors hold as much as $4 trillion in home eq- has begun to attract the interest of banks, insur- uity. Data from the American Housing Survey supports a more conservative ﬁgure, $2.8 tril- ance companies, mortgage brokers, and Wall 38 Street investors looking for new proﬁt centers in lion. Regardless of where in the range the true the wake of the subprime mortgage meltdown. value lies, there is no question that seniors—even The growing presence of these players in this many of the poorest—have signiﬁcant home eq- once overlooked submarket highlights the need uity available to be tapped by the reverse mort- gage industry. In 2007, the American Housing for safeguards to protect vulnerable seniors and to prevent a recurrence of abuses that were wide- Survey found that more than 700,000 seniors spread during the subprime frenzy. Senior Homeowners with No Mortgage (thousands) The Lenders 2,000 In today’s mortgage markets, lenders’ proﬁts are 1,800 driven by loan volume, loan amounts, and inter- 1,600 est rates. Reverse mortgage lenders are no excep- 1,400 1,200 tion. As in the forward mortgage business, most reverse mortgage loans have been sold to Fannie 1,000 800 Mae or into the secondary market rather than 600 held by lenders for investment purposes. 42The 400 sale of the loans allows lenders to replenish their Nu200r of Households 0 capital so that they can make more loans. Each loan generates transaction fees, based in large $1– part on the size of the loan. Loans with higher in- $4,99$5,000–9$14,999$19,999$24,999$30,000 $10,000$15,000–20,000–25,000–terest rates garner a higher sales price in the sec- Family Income Range ondary market. Larger loan amounts generally SUBPRIME REVISITED 7 Leading Reverse Mortgage Lenders Financial Freedom Wells Fargo Bank NA Bank of America NA James B. Nutter and Co. World Alliance Financial Metlife Bank Generation Mortgage Urban Financial Group Genworth Financial Home Equity Wholesale One Reverse Mortgage Retail 0 5,000 10,000 15,000 20,000 25,000 Note:Figures are for 12-month period that ended May 31, 2009. Source: Reverse Mortgage Insight produce larger fees, and greater loan volume with so much money to be made in the reverse translates into greater proﬁts. mortgage market, policymakers and future re- The subprime debacle showed that loan origi- verse mortgage borrowers need to weigh lenders’ nators too frequently sacriﬁced responsible lend- claims against their past lending practices. ing in the name of greater volume, higher fees, Some major lenders in the subprime market higher interest rates, and more proﬁts. Many in- have emerged as signiﬁcant players in the reverse dustry analysts agree that the subprime bust re- mortgage niche. For example, in 2006 Wells sulted from “lenders chasing volume by relaxing Fargo was a leading subprime lender, according underwriting standards.” 43 And, the so-called to industry publications. 46 Today they are a “vigorous competition” among subprime origina- leader in the reverse mortgage market, originat- tors was, in fact, a race to the bottom—a race that ing nearly 20,000 HECM loans in 2008. 47Wells led to improvident lending on a massive scale. Fargo espouses its responsible mortgage lending The same forces once at work in the subprime principles such as only making loans that market are now growing in the reverse mortgage demonstrate beneﬁt to the borrower and a com- market. Competition in the reverse market is mitment to provide consumers with information heating up, with more than 2,700 lenders offer- necessary to make fully informed decisions about ing HECMs. 44According to a recent GAO report, the loan terms.48 more than 1,500 lenders originated their ﬁrst Yet Wells Fargo failed to adhere to those re- HECM loans in 2008. 45The combination of in- sponsible lending practices in the subprime mar- creased competition, volume-generated proﬁts, ket, according to a lawsuit ﬁled by the City of and the vast number of potential reverse mort- Baltimore. The lawsuit claims that Wells Fargo gage borrowers is a recipe for inappropriate and had a systemic practice of steering subprime bor- abusive reverse mortgage lending. rowers into bad loans. 49An afﬁdavit from a for- Leading reverse mortgage lenders often tout mer loan ofﬁcer and sales manager describes a their commitments to responsible lending. But system in which commissions and referrals were 8 SUBPRIME REVISITED “set up in a way that made it more proﬁtable for a and was done over the telephone. Five months loan ofﬁcer to refer a prime customer for a sub- after taking out the loan, Collins was declared in- 55 prime loan than make the prime loan directly to competent by local adult protective authorities. the customer.” 50Similarly, the Illinois Attorney Lopez said in June 2009 that he had not heard General recently ﬁled a complaint against Wells about the Collins family lawsuit, and that he Fargo alleging that the company “provided sig- stood by his Senate testimony, although he had niﬁcant incentives for its employees to steer bor- later heard of some instances where reverse mort- rowers into subprime mortgages” and that its gage loans were used to buy annuities. “That sort 51 fair lending policies “were only on paper.” of stuff makes us really angry,” he said. “One Other reverse mortgage lenders have also put thing we don’t want to see is loan ofﬁcers work- themselves forward as responsible lenders. James ing in cahoots with ﬁnancial planners.” 56 B. Nutter, the second 52rgest wholesale originator Claims by lenders that they will protect the in- of reverse mortgages, claims a pristine record of terest of consumers in the lending process responsible lending. In December 2007, George should be approached with caution. Without ef- Lopez, a Nutter executive, told the U.S. Senate fective regulation, abuses are likely to occur in Special Committee on Aging that in the previous the lending process. year his ﬁrm “received no complaints of any kind related to unscrupulous third parties taking ad- 53 The Brokers vantage of our seniors.” Because of sound lend- ing principles, Lopez claimed that “the evils of Historically, mortgage brokers served as interme- mortgage fraud and deceptive advertising prac- diaries who brought mortgage borrowers and tices have not yet crept into the mainstream of lenders together. Over time, brokers’ roles have the reverse mortgage industry.” Finally, Lopez as- become more complicated. Today their compen- sured the panel that “‘ﬂy-by-night’ brokers are ef- sation and ﬁnancial incentives are often hidden fectively prevented from entering the market” behind a smokescreen of confusing and obtuse because they must be FHA-approved. 54 disclosures. Just weeks before Lopez’ testimony, however, During the subprime mortgage boom, a small his company underwrote a reverse mortgage that army of mortgage brokers pushed inappropriate was used to siphon multiple high fees from the mortgage loans on borrowers without regard for equity of a vulnerable senior, according to a lawsuit whether borrowers needed the loans or could af- ﬁled by the victim’s family. The lawsuit describes ford the payments. The subprime bust has sent how the loan was used by 87-year-old Creighton many of these mortgage brokers ﬂocking to the Collins, a retired truck driver with an eighth reverse mortgage business where many seniors grade education, to cash out $274,000 of home depend upon them for guidance through a mar- equity, and how Collins paid the high costs typi- ket that offers a welter of “educational” resources cal of reverse mortgages, including a $7,225 fee and presents complex product and ﬁnancial to the broker who arranged the loan, a $7,225 in- choices. surance premium to the federal government, and Seniors often assume that brokers have a duty $1,600 in charges to verify the title of the house to look out for the borrower’s best interest. But he had owned for decades. As part of the deal, that is not true. Because mortgage loans are con- Collins was convinced to invest the loan pro- sidered business transactions where each party ceeds, which he had borrowed at 5.74%, in an an- ostensibly protects its own economic interest, in nuity contract that was guaranteed to pay 3%. many states brokers and lenders owe no ﬁduciary Collins embarked on this costly series of transac- duty to borrowers. Brokers and lenders typically tions after receiving counseling that, according disavow the existence of any relationship of trust to his loan documents, lasted only 47 minutes and conﬁdence between them and borrowers. SUBPRIME REVISITED 9 However, their marketing material is designed to Schultz, who was over 80 years old, took out a re- build trust and often uses impressive-sounding verse mortgage against her Belleville, Mich., credentials to imply special knowledge and home and received a check for $61,325. Un- expertise. known to Schultz, James had directed the closing For example, American Reverse Mortgage agent to issue a second check payable to Schultz Corp. proclaims on its website that it has “thirty- in the amount of $42,667. James took the second one (31) Certiﬁed Senior Advisors (CSA) on our check, forged the endorsement on it, and de- staff.”57 As of December 2007, Wells Fargo posited it into his bank account. 62 claimed to have 750 “certiﬁed reverse mortgage Outright criminal conduct represents the ex- consultants” to assist borrowers with reverse treme example of bad broker behavior. More mortgage products. 58 These designations reﬂect often, however, brokers take advantage of seniors expertise with respect to59enior ﬁnancial matters in less obvious ways, such as by selling them re- and reverse mortgages. They inspire trust and verse mortgages that they do not need or getting conﬁdence from seniors who may later be sur- them into more costly loans that increase the prised to ﬁnd out that the certiﬁed advisor or brokers’ own compensation. consultant, in fact, was not obligated to look out As in the subprime mortgage market, brokers for their best interest. in the reverse mortgage market have a ﬁnancial While brokers’ marketing materials are geared incentive to originate as many loans as possible. toward building trust and inspiring conﬁdence, Brokers do not get paid if they do not close deals. the agenda for a recent gathering of reverse mort- The same origination fees that drive lenders to gage lenders warned that “it will not be long be- sacriﬁce responsible lending to proﬁts also inﬂu- fore fraudsters develop schemes to exploit ence brokers. In addition, brokers earn more seniors and lenders” in the reverse mortgage mar- money, often through yield spread premiums, ket. But there have always been thieves willing when they sell reverse mortgages that will garner to take advantage of vulnerable seniors. For ex- more proﬁts for lenders and investors. In un- ample, in November 2003, Detroit broker An- guarded moments, even brokers themselves thony James showed up on the doorstep of sometimes acknowledge that their ﬁnancial in- Shirley Schultz after she called Financial Free- centives can work against the interests of the sen- dom Senior Funding Corp., seeking information iors that they are “guiding.” “Needless to say, about a reverse mortgage. In January 2004, there are some products that will pay you more, and pay your customers less, while increasing 63 overall costs.” When brokers sell seniors more A SENIOR’S “NEW BEST FRIEND” costly and less favorable reverse mortgages in order to increase their own compensation, the At a hearing before the Senate Special Committee of Aging, Carol Anthony summed up the promises value of the senior’s lost equity can end up in the made to persuade her 80-year-old mother to take pockets of brokers and lenders. out a reverse mortgage: “There would be no risk of losing her home. But there wWall Street and the She would receive independent counseling. But she didn’t. All loan options available to her would be reviewed. Theycuritization Spigot weren’t. She would never be rushed into signing anythinRocket fuel for the recent mortgage lending she did not fully understand or was not ready to sign. But boom came from the deals in which Wall Street she was. She would not be incurring a mortgage. But sheinvestment banks assembled thousands of home did. All loan terms would be carefully explained. But tmortgage loans into portfolios, and sold in- weren’t. When mom signed on the dotted line, she felt the salesman was her new best friend. But he wasn’t.” vestors securities backed by promised returns from those portfolios. The investment banks 10 SUBPRIME REVISITED raked in billions of dollars of fees assembling and surprisingly, the securitization of HECM loans is administering these portfolios. Wall Street’s insa- becoming more common. tiable appetite for more loans to securitize Historically, most HECM mortgages were pur- prompted lenders to offer incentives to brokers chased by Fannie Mae, the giant government and other intermediaries to make more loans sponsored mortgage ﬁnance company, which and load them up with terms that made those kept those reverse mortgages in its own invest- loans more proﬁtable to investors and more ment portfolio. 66 The ﬁrst securitization of 67 costly to borrowers. HECM loans came in August 2006. From that Reverse mortgage lenders are also looking to point through the end of 2007, private ﬁnancial securitization to supply a steady stream of capi- institutions issued about $2.2 billion in securi- 68 tal to meet the growing demand for reverse mort- ties backed by HECMs. gage products. The idea is one that has been In 2006, the Government National Mortgage nurtured by policy makers and academics. In Association, also known as Ginnie Mae, announced 1998, economist Dr. Nandinee K. Kutty wrote plans to create a securitization program for that “[a] healthy secondary market for reverse HECM loans. In November 2007, Ginnie Mae mortgages would greatly reduce risk premiums guaranteed its ﬁrst issuance of securities collateral- and result in higher payments to borrowers, ized by HECMs. Since then Ginnie Mae has securi- which in turn, would increase market accept- tizedmore than $1.7 billion in HECM loans. 69 64 ance.” The following year Lehman Brothers un- The growth of reverse mortgage securitization derwrote the ﬁrst securitization of reverse is potentially a boon for an increasing number of mortgages in a $317 million deal that used pro- seniors who may need to cash out some of their prietary reverse mortgages originated by Finan- housing wealth to supplement Social Security, to cial Freedom as assets. More recently, HUD meet unexpected medical costs, or to make needed policy analysts noted that, “the long-term success home repairs. But it is also, conceivably, a curse. of HECM as a more mainstream loan product Seniors, especially those with low incomes, are may require the eventual development of a more hard-pressed to ﬁnd knowledgeable and trust- efﬁcient secondary market for these loans.” 65Not worthy advisors. On the other hand, they can ex- UNNEEDED REVERSE MORTGAGES Miguel and Laura Posada were both over 80 when, in dollars on fees taking out a loan they did not need. 2005, they were convinced to take out a $100,000 re- The salesman also persuaded the couple to pay verse mortgage secured by the home that they had $20,500 to a local attorney that they never met bought with cash two years earlier, according to a to purportedly “pre-qualify” them for Medi-Cal, lawsuit they ﬁled. As retirees who had each worked California’s medical insurance program for low-in- in blue-collar jobs for over 40 years, the Posadas come people. The salesman also sold them a 15-year both had pensions and were living comfortably. deferred annuity paying interest at 3.5%. The interest They had no need to cash out their equity. But rate on the reverse mortgage started at 6%. So the Miguel Posada saw an advertisement for a reverse couple borrowed money at 6% and invested it (in the mortgage and sent away a post card seeking more deferred annuity) to earn interest at 3.5%. They paid information. He forgot about it until a month later over $20,000 to be pre-qualiﬁed for an insurance when a man showed up at his door holding the post program that has no prequaliﬁcations. When the card. After the salesman “sat down and explained Posadas realized they had a bad deal, the lawyer everything,” the Posadas decided to take it. Now refused to return their money. The Posadas have a they’re sorry they did. lawsuit pending against the salesman and the 70 The Posadas believe they wasted thousands of lawyer. SUBPRIME REVISITED 11 pect to receive lots of encouragement to take out a tool to increase consumption on items that reverse mortgage loans. Unfortunately, much of are not necessities.72A list of 25 ways to use loan that encouragement comes from a cast of charac- proceeds recently posted on a reverse mortgage ters eerily familiar from the subprime mortgage promotion web site includes “Take a dream vaca- boom and bust: aggressive brokers eager to rake tion,” “Go on a cruise,” or “Travel around the in large fees and giant ﬁnancial institutions hun- world.” Also on the list at number 19 is: gry for proﬁts that come from maximizing loan Lifestyle enhancement—If you always dreamed of volume. In an effort to generate a steady stream of borrowers, seniors are likely to be pushed into living a rich and famous life, but your ﬁnances did not give room to it, you can use the money from a re- reverse mortgages that they do not need. With- verse mortgage to enhance your living style. You will out adequate borrower protections, the securiti- zation of reverse mortgages and the push for have more money which you can spend on luxury items to decorate your home and for personal luxury greater loan volume could lead to abusive lend- itemslikeRolexwatches,etc.74 ing that will sap the equity of senior homeowners. According to the National Reverse Mortgage Lenders Association, “the only limit on how you 75 use a reverse mortgage is your imagination.” VI. The Marketing Machine One borrower proﬁled on the NRMLA website took out a reverse mortgage against his Florida The growth of the reverse mortgage industry has home and used the procee76 to build a single-en- been spurred by broad marketing efforts aimed gine, two-seat airplane. at generating a steady supply of prospective bor- The reality is that reverse mortgages are proba- rowers, thus boosting loan volume and proﬁts. It bly not the most cost effective way for well-off is well known that “push” marketing was a staple seniors to purchase airplanes or other big-ticket of the subprime market. 71Using high-pressure items. But at least seniors able to make such expen- sales tactics, lenders and brokers pushed more sive purchases can probably absorb the expense of home-secured debt on homeowners than they sub-optimal ﬁnancing without jeopardizing their needed or desired. Today reverse mortgage access to basic necessities such as shelter, food, lenders and brokers continue that push market- and medicine. The same is not true of low-in- ing tradition. come seniors. Urging these seniors to cash out home equity to go on a “Shopping Spree” or pur- chase a “Dream Car” exposes them to the danger Pushing Reverse Mortgages of having nowhere to turn to raise money for fu- Advertising for reverse mortgages can be found ture ﬁnancial emergencies. on TV and on the Internet. Seniors looking in While reverse mortgages are often pitched as their mailboxes or picking up their phones may “free money” to use as the borrower pleases, sellers be plied with the virtues of a reverse mortgage. also have sought to exploit seniors’ unfamiliarity Also common are old-fashioned marketing tech- with reverse mortgages by implying that the niques such as advertisements in senior newslet- money comes from the federal government. Re- ters and “educational” programs at senior centers. cently, Massachusetts authorities stepped in to Sellers have enlisted celebrities as spokesmen prohibit American Advisors Group of Irvine, CA to reassure seniors about these complicated and from mailing reverse mortgage solicitations unfamiliar loans and to emphasize the pleasures under the heading “notice of 2008 government 77 that can be had with cashed out equity. Market- beneﬁts.” Undeterred by the Consent Order en- ing strategies promote reverse mortgages, not as tered into with the Massachusetts Division of a lifeline for retirees with low incomes, but as Banks in 2008, American Advisors Group sent 12 SUBPRIME REVISITED American Advisors Group Solicitation SUBPRIME REVISITED 13 the solicitation on page 12 to consumers in 2009 thing unhelpfully labeled a “yield spread pre- which again referenced government beneﬁts. 78 mium.” The premiums were paid to brokers as an Aggressive marketing by subprime lenders incentive to increase the interest rates or add pre- landed many borrowers in inappropriate loans payment penalties to mortgage loans thereby that they could not afford. Those marketing ef- making those loans more proﬁtable for lenders forts have moved to the reverse mortgage market and investors. where many seniors may be drawn into reverse Although rarely discussed with borrowers, mortgages that they do not need. payments of yield spread premiums were common in the subprime mortgage market. While federal law required an obscure disclosure of these pre- miums on the HUD-1 settlement statement, few VII. MorePayouts borrowers understood that these payments re- warded brokers for originating loans that gener- ated maximum yields to lenders and investors. 79 Yield Spread Premiums Nor did borrowers realize that those higher The subprime mortgage crisis remains a stark re- yields resulted from higher fees and interest rates minder of the damage that can be done when the that they themselves would have to pay. promise of easy money harnesses brokers to the In an effort to curb proﬁteering in the reverse interest of distant Wall Street. In the subprime mortgage market, HUD has established caps on boom, that promise often took the form of some- origination fees.80Brokers are not permitted to Pricing Memo 14 SUBPRIME REVISITED collect any additional origination fees of any In 2006, reverse mortgage sellers got their hooks kind from borrowers. However, the regulations into 80-year-old Betty Adcock. According to a law- do not prohibit lenders from paying additional fees—yield spread premiums to brokers. suit ﬁled by her daughter, Adcock had enough money to pay her bills, owned various investments, The industry has taken advantage of this loop- and had an existing home equity line of credit that hole to increase its proﬁts. For example, reverse she had tapped for $19,000. Despite her ﬁnancial mortgage wholesaler Urban Financial Group, stability, she was persuaded to take out a reverse mortgage and to purchase a 20-year, $125,000 de- which operates under the ReverseIt.org brand, re- ferred annuity contract. The annuity contract pro- cently sent out a “pricing memo” that describes the rebates paid to brokers based on the margin hibited Mrs. Adcock from withdrawing the money without penalty for 10 years. And, while the annuity and monthly service fees of a loan. Not surpris- had a guaranteed rate of 4.15% for the ﬁrst ten ingly, the higher the margin and higher the years, the starting adjustable rate on her reverse monthly service fee, the higher the rebate paid mortgage was 6%. In essence, Mrs. Adcock was from the lender to the broker. 81 convinced to borrow money at a 6% interest rate and invest the money in an annuity that paid just Urban Financial Group is not alone in its use of yield spread premiums. W.L. Pulsipher, Presi- over 4%. She paid $16,800 in closing costs for a dent of American Reverse Mortgage, said with loan that had a higher principal balance than her existing home equity line of credit, that had a respect to reverse mortgage wholesalers, “every- higher interest rate than her existing HELOC, and body is offering that.”82 that limited access to her money for ten years. Yield Spread Premiums in the reverse mort- gage market pose a serious threat to consumers. Deft brokers can use “pricing memos,” and simi- front-end expenses of the reverse mortgage loan lar incentives as a guide for juggling multiple and the annuity contract create a hybrid deal that variables in a reverse mortgage transaction to would have to yield astronomical returns to ben- take bigger and bigger bites out of consumers’ eﬁt the borrower. In addition, the complexity of equity. Senior borrowers are unlikely to under- both products makes seniors especially vulnera- stand the dizzying cost menu that brokers and ble to the misrepresentations of unscrupulous loan originators use to generate the greatest ben- brokers and lenders. eﬁts to themselves and potential investors. The chance to sell annuity contracts is a po- tent attraction to intermediaries in a position to urge seniors into reverse mortgages. The Housing The Annuity Trap and Economic Recovery Act of 2008 included a One of the greatest abuses of reverse mortgages prohibition on lenders’ ties to sellers of other ﬁnan- comes when loans are used to cash out seniors’ cial products. HUD has yet to issue a ﬁnal rule home equity and that cash is used to buy expen- with respect to the cross-selling ban. However, sive and complicated insurance policies, annu- cross-selling restrictions are likely to prove inef- ities, or other ﬁnancial products. Many of these fectual when weighed against the hefty commis- products provide insurance agents with hefty sions that await those who circumvent such 83 commissions, sometimes as high as 12 percent. prohibitions and ﬁnd ways to use reverse mort- While the terms, ﬁnancial restrictions, timing, gages to tap home equity to fund annuity sales. As and special features of contracts vary widely, they one insurance agent put it, “All that’s going to do is 86 usually involve payments to an insurance com- ferret out the stupid players.” Lax enforcement by pany that then promises to make future pay- HUD and state insurance regulators 87combined ments to the borrower. with the absence of a private right of action for in- A link to an annuity sale signals danger in any jured borrowers reduce the chances of getting reverse mortgage transaction. The combined caught and limit the effectiveness of the ban. SUBPRIME REVISITED 15 VIII. ProprietaryEquity Growth in Financial Freedom’s proprietary product was driven in part by securitization of Conversion Products these loans by Lehman Brothers. The mortgage Proprietary equity conversion products have crisis precipitated the collapse of Financial Free- been around for decades. They come in a myriad dom’s parent company, IndyMac Corp. (now of forms including proprietary reverse mortgages OneWest Bank), which was taken over by the and shared appreciation mortgages. The reach of Federal Deposit Insurance Corp. in July 2008. these products has been greatest in geographic Subsequently, the failure of Lehman Brothers areas with high property values or rapid property brought the securitization of proprietary mort- gages to an abrupt halt. As a result, few propri- appreciation. As in the past, proprietary equity conversion etary reverse mortgages are being offered today. products continue to be largely unregulated at One product that remains available is Bank of the federal level. Among states, nearly half have America’s Senior Equity Reverse Mortgage. That product is aimed at borrowers with houses valued laws related to reverse mortgages though these state statutes vary dramatically. Some states over the FHA limit (now $625,500) and up to $10 merely deﬁne reverse mortgages, while others million, according to Bank of America’s web site.0 provide more substantive protections. For exam- Despite the low numbers of proprietary re- ple, many states with reverse mortgage laws man- verse mortgages being made today, there is good date certain disclosures and ban prepayment reason to anticipate growth in the future. The penalties. Some impose a waiting period, require growing senior population and its need for in- come will likely reinvigorate these loan products mandatory counseling, or limit the fees that may 91 be charged to the borrowers. in the not too distant future. While most of these products do not vary signiﬁcantly from HECMs, borrowers have none of the basic con- sumer protections that are guaranteed to HECM Proprietary Reverse Mortgages borrowers. Moving forward efforts should be Proprietary reverse mortgages are developed and made to provide at least the same level of protec- backed solely by private ﬁnancial institutions. tion to all reverse mortgage borrowers. Prior to the recent credit crunch many of these loans—also known as jumbo reverse mortgages— were made to property owners whose property Equity Sharing Deals values exceeded the HECM loan limits. Financial Freedom Senior Funding Corp. with Like reverse mortgages, the equity conversion its Cash Account Plan dominated the proprietary products known as “shared equity agreements” reverse mortgage market for many years. Intro- have been around for a while. Such deals entitle duced in July 2006, Financial Freedom’s Cash Ac- lenders to a certain share of any appreciation in a count Advantage Plan was targeted at consumers home’s value between the time a loan is made whose home value exceeded HECM’s limits or and the time it reaches maturity. While the ﬁnan- whose type of property was excluded from the cial crisis has left sales of these products in the HECM program. 88Some of the key features of doldrums, lenders say they plan to revive them the plan were: its higher loan limits as compared when conditions in the capital and real estate to other reverse mortgages; lump sum, line of markets permit. credit, or combination payment options; adjustable REX & Co., a San Francisco-based lender backed rate; and origination fee of 2% of the maximum by controversial insurance giant American Inter- amount that was available to the borro89r on the national Group (AIG), at one point offered own- loan or $2,500, whichever was greater. ers in at least 14 states cash in exchange for 16 SUBPRIME REVISITED stakes in rising house prices but announced in IX. Disclosure and Counseling: October 2008 that it would stop making new 92 The Bulwark Against deals. “We’re hoping that that’s not a perma- Abuse? nent situation,” a company spokesman said. 93 Another outﬁt called EquityKey offered simi- Existing federal laws and rules rely on loan cost lar deals to senior homeowners in at least 10 disclosures and homeowner counseling as the states, and re
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