AARP lawsuit: Reverse mortgages cause foreclosures

March 11, 2011

Realtor Mac McCollum stands in front of a foreclosed home in Bullhead City, Arizona, November 4, 2009.  REUTERS/Lucy NicholsonReverse mortgage ads often portray contented silver-haired couples enjoying the comfort of home, confident that their decision to tap home equity will bring lifelong financial security.

But the AARP Foundation painted a different picture when it filed a lawsuit this week challenging federal rules said to be forcing borrowers into foreclosure.

At issue is declining home values in the wake of the housing crash — and lending rules affecting married couples where only one spouse signs the loan documents.

The U.S. Department of Housing and Urban Development (HUD) administers the most popular type of reverse mortgage, the Home Equity Conversion Mortgages (HECM). For years, HUD and lender marketing materials have described HECM as non-recourse loans, in which borrowers could never owe more than the value of their homes, even though the loan balances rise over time. The intent was to assure elderly borrowers that HECMs were safe.

But AARP charges that HUD illegally implemented two important rule changes in 2008. The first stated that the non-recourse provision would apply only when properties are sold. That means that a surviving non-signing spouse would have to re-pay the full outstanding HECM balance, even if the home’s value had dropped.

Second, HUD changed a rule stating that a borrower could sell a secured property for 95 percent to 100 percent of its appraised value. The new rule stated that only “arm’s length transactions” would be allowed under that range of prices. That effectively meant that a non-signing surviving spouse could retire a HECM only by repaying the full loan balance, but that a third party buyer could purchase the property for as little as 95 percent of appraised market value.

“For years, there was never any question that you couldn’t owe any more than your home value,” said Jean Constantine-Davis, senior AARP Foundation Litigation attorney. “The HUD handbook on HECMs, and countless industry publications all said so. The idea was that you want people to feel secure in their homes.”

Lenders are siding with AARP.

“We believe an equitable resolution would allow that a sale to a family member be on the same terms as a sale to a third party,” said Peter Bell, President of the National Reverse Mortgage Lenders Association. “We believe we can even the playing field for families and, at the same time, implement safeguards to ensure a fair market value transaction.

“As we have worked with HUD on improving so many features of the reverse mortgage program, we are eager to work with them and AARP to make sure families are not penalized for being related to borrowers.”

The AARP suit comes on the heels of recent efforts by HUD and lenders to address loan defaults among strapped homeowners who fail to keep up on required tax and insurance payments. HUD launched a new initiative aimed at beefing up counseling services that reverse mortgage borrowers are required to undergo as part of the loan process.

AARP’s plaintiffs are the surviving spouses of three homeowners who bought HECMs, but didn’t sign on as co-borrowers. As such, they represent a very large portion of all HECM borrowers; only 39 percent of outstanding HECM loans last year had multiple signers, HUD data shows.

HECM borrowers must be 62 years of age, so in some cases, one spouse is too young to qualify. In other cases, one spouse isn’t listed on the title; one of AARP’s plaintiffs wasn’t listed because her husband owned the house prior to their marriage in 2001.

But there also can be financial motivation for just the older spouse to sign the loan. That’s because the amount you can borrow is driven, in part, by an age-driven actuarial formula that includes the age of the youngest borrower, interest rate, home value and insurance costs; solo older borrowers will receive higher monthly payments since they aren’t expected to collect as long as younger borrowers.

“It’s way too common for a mortgage broker to convince clients that only the older spouse should sign the loan, or even to set it up that way without telling them,” says Barbara Stucki, vice president of home equity initiatives at the National Council on Aging.

Non-borrowing spouses are required to go through HECM counseling only if their names are on the property title, but Stucki says most counseling organizations require that both spouse attend, anyway. But she says the AARP lawsuit points to the need for further improvements in the counseling process.

“A home is the most valuable asset, and many people will tap it one way or the other,” she says. “This option comes with a non-recourse feature, consumer counseling and significant HUD oversight, so there’s a lot of value to this program. But we need to make sure it is done right and spouses are treated properly.”

The rising number of non-performing loans has raised concerns about the prospect of seniors losing their homes, and also about the risk of losses for the Federal Housing Administration Insurance Fund, which insures the loans. A report last year by by HUD’s Office of Inspector General estimated that the fund’s liability from potential foreclosures could cause a $1.47 billion loss for the fund. The fund collects hefty fees from HECM loans to finance its insurance  — two percent of the home value, plus 1.25 percent of the ongoing balance. The latter fee was increased last year from 0.5 percent.

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