Reverse mortgage professionals are well aware of the reputational hurdles that their industry faces in terms of connecting with seniors and the wider public. Still, even the most well-meaning reverse mortgage loan officer can have their own, long-held notions about product and industry guidelines shaped by a series of misconceptions, making it necessary to try and quash those askew ideas in order to better present reverse mortgages as a viable financial product category for seniors.
This was exactly the mission of Dan Hultquist, VP of organizational development and Jim McMinn, lead sales trainer of learning and development at Finance of America Reverse (FAR) in a presentation at the National Reverse Mortgage Lenders Association (NRMLA) Annual Meeting in Nashville, Tenn. Donning referee shirts onstage to call “penalties” on potential issues, the pair made clear that the presentation was not specifically oriented around the letter of the law. Instead, it is focused on relevant regulations and guidelines, and calling out potential infractions that may arise from misconceptions surrounding them.
“We want you to think about the messages we put out to our borrowers,” McMinn says. “Because, there may be something in [a loan officer’s long-held notions] that is not accurate. So when it comes to your own situation, we encourage you to talk to your legal or compliance departments.”
Line of credit growth
The first discussed issue relates to the Home Equity Conversion Mortgage (HECM) line of credit (LOC) growth, with Hultquist citing a hypothetical scenario where a loan officer describes the growth itself as several things that it is not: it is not income; interest; earnings; or a “return on a home equity investment.”
“Really what [the LOC offers] is the ability to borrow more,” McMinn adds. “It’s accurately described as ‘greater capacity to borrow more money in the future, regardless of home value.’”
In the Department of Housing and Urban Development’s (HUD’s) Housing Counseling Program Handbook 7610, chapter 4 part 5(c) reads, “Counselors must not tell clients that HECM credit lines ‘earn interest,’ because credit line growth is simply increased access to borrowing power, comparable to an increase in a credit limit on a credit card.”
Further solidifying this is that if the borrower was earning interest on a HECM LOC, then those funds would be taxable.
“We know they’re not taxable,” Hultquist says. “Some borrowers and loan originators have said that doesn’t seem fair. You need to put it in perspective. The growth and LOC goes away when the last borrower dies. But to bring the point home, imagine this scenario: when you die, do all your credit cards max themselves out and leave a stack of cash on your front porch?”
‘Guaranteed’ LOC growth
The second misconception comes from someone relating that a HECM line of credit is always “guaranteed” to grow, which is not a statement that can be substantiated when looking at the full picture of the credit line itself.
“We say [that there’s guaranteed LOC growth] a lot, and this may seem petty, but there are exceptions,” Hultquist says. “One simple way that the line of credit decreases is when the borrower draws funds, but if the reverse mortgage is not in good standing then that can create another situation in which it’s not growing. If [a borrower] hasn’t paid their taxes and insurance, the lender has the ability to take it out of their line of credit.”
Additionally, if there is a repair set aside that was estimated at too low a level, that money comes from the line of credit. Other instances in which the LOC will not grow can include during the initial disbursement limit in the first year of the loan; if there are negative interest rates; or if the Life Expectancy Set Aside (LESA) is depleted.
Reverse mortgage proceeds as ‘tax-free cash’
While sometimes coming in various forms, the reverse mortgage is often marketed as tax-free cash and tax-free money, Hultquist and McMinn say.
“It’s always been marketed as that, I see it all the time,” McMinn says. “When you’re getting a reverse mortgage, there could be taxes associated with that. We’ve got property taxes, recording taxes, intangible taxes, the list goes on. So, when we look at that, we have to specify which portion of the loan is actually tax-free.”
That portion is, of course, the proceeds. But to get the loan, taxes can and do interact with a reverse mortgage transaction, making it generally incorrect to say to a potential borrower that a reverse mortgage on its face is completely “tax-free.” This was highlighted by the Consumer Financial Protection Bureau (CFPB), when it released a study titled “A closer look at reverse mortgage advertisements and consumer risks” in 2015.
“Many consumers we spoke with did not understand that reverse mortgages are loans with fees, compounding interest, and repayment terms,” the CFPB report reads in part. “This confusion is understandable where ads tout that reverse mortgages provide ‘tax-free’ money.”
Borrowers also, of course, need to keep up on their property tax payments to keep the loan in good standing, McMinn says.
Partial prepayments, reduction of loan balance
If a borrower elects to make partial prepayments in an effort to reduce his or her overall loan balance, the mortgage note specifies in what order those payments are to be applied, Hultquist says. This is what’s called the “servicing waterfall,” and when a partial prepayment is made, it’s applied to other aspects of the loan before it reaches and reduces the principal balance: mortgage insurance; servicing fees; and accrued interest, respectively.
For borrowers who make partial prepayments of a certain size within a particular calendar year, they will then receive tax documentation that shows to which segment of the loan that payment was applied, Hultquist says.
“If you make a payment of $600 or more in a calendar year, you’re going to get a [tax form] 1098 in January showing what was actually paid when that [partial prepayment] was made,” he says. “The unpaid principal balance (UPB) needs to drop before your line of credit can increase. So, we need to make sure that we’re consistent in our application of this.”