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Reverse mortgages were designed to meet a specific credit need. A reverse mortgage is a means of tapping into the equity of a person's home without having to sell or move. HUD's Federal Housing Administration has a reverse mortgage product called the Home Equity Conversion Mortgage. Reverse mortgages present an opportunity for both homeowners and lenders. But they also present opportunities for abuse. In the past several years, too many mortgage lenders have looked only at the equity and it at the borrower, causing the borrower to lose equity for very little gain. Here are some issues for you to consider if your bank is offering, or considering offering, some variation on the concept of reverse mortgages: 1. unfair or deceptive acts or practices, 2. fair lending, 3. Community Reinvestment Act, 4. Truth in Lending/Regulation Z, 5. RESPA/Regulation X, 6. General Regulatory Guidance for Non-Traditional Mortgages, 7. risk assessment, and 8. contract provisions.

It isn't news that the mortgage market is having problems. It isn't news that we know what those problems are. But what is news is what the next mortgage challenge will be: Reverse Mortgages.

Reverse mortgages were designed to meet a specific credit need. A reverse mortgage is a means of tapping into the equity of a person's home without having to sell or move. HUD's Federal Housing Administration (FHA) has a reverse mortgage product called the Home Equity Conversion Mortgage (HECM). In addition to the FHA HECM product, there are other, proprietary reverse mortgage products that are not federally insured.

For most Americans, their home is their biggest investment. It is also likely to be their largest asset. The problem is how to make use of that asset. As the baby boomer generation moves into its 60s, they are creating a rapidly expanding pool of borrowers who may be eligible for and interested in reverse mortgages.

Essentials of reverse mortgages

Enter the HECM, which provides a method for converting the home's equity into a cash flow or cash resource. Like other mortgage programs, HECMs can take many forms. But they share the common element of tapping the customer's home equity. HECMs can be designed to provide monthly payments to the borrower; to allow for draws as needed; or to provide a lump sum at closing. Each method involves a draw, or series of draws, based on the borrower's equity in their home.

Because of their reverse nature, HECMs have both a frontend element and a back-end element. In a traditional mortgage, the balance is paid off one way or another. In a HECM, the relationship of the loan to the equity works the other way, so that at the end of the mortgage, there must be a method of determining debt, ownership, and value-sharing between the parties.

HECMs must provide for disposition of the home and any remaining equity at the termination of the loan. Usually, a reverse mortgage terminates upon either the sale of the property or the death of the borrowers. In either event, the mortgage agreement must provide for how the property will be valued and how the remaining value will be allocated between lender and borrower. Typically, this involves an independent appraisal to establish the market value of the home. The home's value then becomes the base for measuring the amount borrowed and remaining equity.

Emerging regulatory concerns aired

Reverse mortgages present an opportunity for both homeowners and lenders. But they also present opportunities for abuse. In the past several years, too many mortgage lenders have looked only at the equity and not at the borrower, causing the borrower to lose equity for very little gain. When it comes to HECMs, the borrower is tapping into the home's equity to meet financial needs. In fact, most reverse mortgages function as an annuity for elderly borrowers. Because the home is at risk and the borrower may be dependent on the mortgage payments, the needs and capabilities of the borrower should be the paramount consideration.

Protecting the consumer's equity in their home has always been a highly combustible issue, even outside of the reverse mortgage discussion. Concern about protecting homeowner equity has been the driving force behind a series of regulatory developments, including rules on rate caps; ARM disclosures; high-priced mortgages; and home equity line of credit programs. HECMs will join this lineup as they increase in use.

When a customer is using their home as a source of income, the home is likely to be their primary or only asset. Loss of this asset would be devastating. Regulators are therefore concerned about how reverse mortgages are designed, marketed, and explained.

A critical factor in making HECMs is taking steps to be certain that the borrower understands the advantages and disadvantages of the product. There is clear risk involved for the borrower who may be contracting to consume their last remaining asset. The timing, design, and content of disclosures will be a central issue for regulators and for consumer advocates. There is general agreement that the design of disclosures under both the Truth in Lending Act and the Real Estate Settlement Procedures Act has not been effective.

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John Dugan, Comptroller of the Currency, made reverse mortgages the topic of his presentation at ABA's 2009 National Regulatory Compliance Conference and stressed the importance of the regulators and the industry acting early, before problems escalate. He flagged the risk issues prevalent in reverse mortgages and called for closer regulatory attention. In fact, Dugan threw down a gauntlet, charging that the Federal Reserve's actions in Regulation Z were insufficient to protect consumers and that his agency would take additiona steps to ensure that customers of national banks are adequately protected.

Deputy Comptroller for Compliance Policy Ann Jaedicke continued OCCs advocacy for reverse mortgage reform in June 29 Senate committee testimony. OCC is particularly concerned that proprietary reverse mortgages that are not FHA insured have few regulatory protections. Banks can expect regulatory guidance or regulations to close this gap in the near future.

What you can do now

The risks are real. The target population is comprised of vulnerable customers. The products are complex, with many interactive and difficult features. Loan officers incented to make loans may push HECMs that are not in the customer's best interest. These were all elements that contributed to the predatory lending that went on in some quarters in the real estate boom.

Perhaps the most difficult aspect of reverse mortgages is showing the customer the true cost. A reverse mortgage borrower is ikely to focus their attention on the money to which they will have access, rather than on the costs of the loan. Regulators are necessarily concerned with how to balance information given to customers with the motivations of both customer and lender.

Here are some issues for you to consider if you bank is offering, or considering offering, some variation on the concept of reverse mortgages:

1. Unfair or Deceptive Acts or Practices

Deal with concerns about predatory marketing -Don't oversell these loans. Even if all requirements have been met, a bank will lose in the "court of public opinion" when pitted against an elderly couple that has lived in their house for 40 years.

Do clearly disclose. Take extra steps to be sure that the customer (and family members, if applicable) understand all of the terms and conditions of the mortgage.

Don't let your customers assume the product is safe for them just because a HECM is a government product. Take steps to be sure the borrower understands the risks and realities

2. Fair lending

Remember this is in "protected territory"- By definition, HECM borrowers are "elderly" as defined by Regulation B. Elderly borrowers are a "protected group" which can trigger concerns about fair or equal treatment.

Consider HECMs in the context of Regulation B's special-purpose aedit program provisions, which allows creditors to offer credit programs targeted to disadvantaged borrower groups. However, the reverse mortgage is not automatically a special-purpose credit program. A special- purpose credit program must be set up under a written plan and have established standards and procedures.

Know that Regulation B prohibits using statistics for life expectancy. Lending decisions and loan terms should be based on sound underwriting, considering both property value and the borrower's financial position.

Design marketing to avoid age discrimination while targeting the appropriate customer group.

Review lending product and patterns for redlining- The issue is refusal to lend in areas perceived as higher risk because of neighborhood composition. Give attention to both the demographics of the neighborhood and the type of housing available.

3. Community Reinvestment Act

Identify reverse ?nortgages as a a'edit need for CRA consideration. Determine qualified population in your market and the extent to which potential borrowers are low-to-moderate income.

Document the lending activity for presentation to examiners at the next CRA examination.

4. Ttuth in Lending/Regulation Z

Consider clarity of disclosures- The standard of "clear and conspicuous" disclosures applies, as always. Use the "grandmother" test: "Would my grandmother understand these disclosures?"

Completeness of disclosures- Be sure that the information you provide to the borrower not only meets the requirements of Regulation Z but provides all the information the consumer needs to make a safe and sound decision.

Consider special disclosures - Additional disclosures apply to reverse mortgages, including the "Total Annual Loan Cost Rate" and the "Projected Total Cost of Credit." Be sure that one or more people on staff are fully trained on making and disclosing reverse mortgages.

Check software support before making a decision on whether to offer these loans. Calculating and disclosing reverse mortgages requires special features.

5. RESPA/Regulation X

Payment for taxes and insurance should be considered- using a mandatory escrow account, savings account, or other method.

Issue correct disclosures of closing costs and other fees on the Good Faith Estimate and HUD-I Settlement Statement.

6. General Regulatory Guidance for Non-Traditional Mortgages

Adapt this concept as a best practice. Regulatory guidance on non-traditional mortgages generally applies to closed-end residential mortgage loan products that allow borrowers to defer repayment of principal or interest. While the guidance directly addresses amortizing and interest-only loans, makers of reverse mortgages should follow the spirit of the guidance and adapt model disclosure formats for reverse loans. Supervisory agencies urge lenders to use a clear disclosure format, such as boxes and large type, careful explanations in disclosures, scripting, and training for loan officers, and disclosure of risks, as well as benefits.

Build in some independent advice. Homeowner counseling should be provided before the customer makes a final decision and before you agree on loan terms.

7. Risk Assessment

Consider the impact of such loans. Before making the decision to offer reverse mortgages, a bank should conduct a formal risk assessment that includes both compliance and reputational risks. Not only is the assessment necessary for the decision to offer the product, but also with respect to how various aspects of the program will work (escrow or not? Fees to charge, etc.). Include consideration of the loan at termination, whether by sale or death of the owner.

Consider all issues with respect to future property value.

8. Contract Provisions

Don't rush the documents-Study available programs and supporting documents before deciding to offer reverse mortgages.

Don't put square pegs in round holesDon't merely adapt existing notes- use documentation designed for reverse mortgages.

Think like both a banking lawyer and an estate lawyer- The mortgage agreement should be clear enough to resolve estate disputes.

One size may not fit all- Check out the mortgage program with state law experts.

Plan carefully, or suffer reverses

Banks and all creditors must carefully plan for all of the compliance risks in relation to reverse mortgages. In these times, it pays to take extra steps to consider the spirit, as well as the letter, of the law.

The risks can be enormous. The current drop in property values should serve as a warning against excessive optimism. Property values historically increase over time, but assuming increases based on a boom economy may leave you short if the loan terminates during a bust. Borrowers may agree now to the loan terms but when the time comes to sell the property they may have different ideas and different needs. Clear and complete information-disclosures-about the loan are essential for a peaceful resolution of the loan. Also consider their heirs who may have an eye on the property and their inheritance. This comes down to what we know today and what we are assuming about the future.

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