Well-intentioned consumer groups have done an admirable job of curbing the abuses of mortgage lenders, but recent legislation passed in Washington state will inadvertently curtail the number of lenders able to offer reverse mortgages. Lenders in other states are watching with interest.
In a nutshell, Washington state consumers pushed their representatives to increase lender licensing requirements and scrutinize all negative-amortization loans. Negative amortization occurs when the monthly loan payment is less than the principal and interest needed to pay off the loan in a specific period of time. The difference is added to the loan amount, so that the borrower owes more than the amount initially borrowed.
Since negative amortization is a key component of all reverse mortgages currently in the marketplace, the number of lenders offering reverse mortgages will be reduced.
Reverse mortgages allow senior homeowners, with a minimum age of 62, to receive proceeds from a lender — either in a lump sum, regular monthly payments, a line of credit, or in a combination of those options. Interest is charged on the amount drawn, adding to the original amount and, thus, "negative amortization." When the house is sold, or the last remaining borrower dies or moves out of the home, the loan amount plus the accrued interest is due and repaid. The borrower makes no monthly payments and cannot owe more than the value of the home.
The legislation, SB 6471, requires that all "non-exempt lenders" doing business in Washington be licensed by the Department of Financial Institutions under the Consumer Loan Act (CLA) by June 12, 2008. Lender entities generally exempt from this change are those operating under Washington or federal law as banks, trust companies, thrifts, and credit unions — but not necessarily their subsidiaries, affiliates or correspondents.
Deb Bortner, director of consumer services for the Washington State Department of Financial Institutions, said the intent of the bill was not to limit or curtail reverse mortgages but that any resolution would have to surface from the state legislature.
"This was not our bill," Bortner said. "It is our job to implement the bill. We did have people testify who had expertise in the Consumer Loan Act, but none testified as to the ramifications for reverse mortgages.
"This is an example of unintended circumstances resulting from a particular bill. It is not something I would have wanted to have happen. The solution, however, would have to come from the legislature."
The most popular reverse mortgage has been the Federal Housing Administration-insured Home Equity Conversion Mortgage (HECM). FHA is a component of the Department of Housing and Urban Development.
"There are some lenders who have been HUD-approved for years who will no longer be able to offer reverse mortgages in the state of Washington," said Don Burton, founder and CEO of Evergreen Home Loans and president of the Washington Mortgage Lenders Association. "HUD has gotten stricter and conducts regular audits. Given those safeguards and HUD’s requirements, I would hope federal law might trump state law in this case."
The National Reverse Mortgage Lenders Association wrote to its members that it is concerned that implementation of the law would adversely impact reverse-mortgage lending.
"We believe this is a result neither the legislature intended nor one that serves the best interest of Washington’s expanding senior population" according to NRMLA advisory.
Negative amortization was also a key component of optional adjustable-rate mortgages, or option ARMs, which allowed for several different repayment options, including a minimum monthly payment plan that did not cover the entire amount needed.
Why, you ask, would you ever take out a loan where you owed more than you borrowed after a few years? In a perfect world, when you had all the money you needed when you needed it, you would never subscribe to such a deal.
But think about it. Will you have to refinance the house — or at least consider a home equity loan — to send the kids to college? Or put mom in a nursing home? Or attend that mandatory family reunion? The option ARM is a vehicle that could shortcut that extra financing step by giving you more immediate control over cash flow.
The challenge for the borrower is having the discipline to flip back to a full payment after using the minimum payment to get through tough financial times. If you don’t flip back to the full payment, the loan quickly becomes greater than the amount originally borrowed. The challenge for the lender is explaining the consequences if that flip does not take place.
Some lenders did not want to do any explaining for fear of losing the customer. Others decided to sugarcoat the message in a half-hearted attempt to provide a sort of disclosure. Some buyers took the loans knowing full well the ramifications of minimum payments. All led to legislation which, unfortunately, is causing confusion for another helpful financing vehicle.
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