The 1995 evaluation noted that one of the challenges for mortgage lenders in handling HECMs was to meet the Truth-in-Lending Act disclosure requirements for open-end credit. Traditional forward mortgages are considered closed-end credit where the amount initially borrowed and then repaid, cannot then be re-borrowed. Under an open-end loan, such as a revolving credit card, borrowers can repay and then re-borrow funds. The 1995 evaluation noted that because of differences in reporting requirements for open-end credit, mortgage lenders needed to learn and comply with an entirely different set of requirements from those they were used to in order to participate in the program. This unfamiliarity with open-end credit requirements was seen as a barrier to participation by lenders.
Originators interviewed for this study indicated that there was little confusion concerning the open- end credit disclosure requirements. For the most part, the process of originating HECM loans had been systematized enough that this issue was not a significant stumbling block for lenders seeking to originate HECMs. On the other hand, servicers noted that the disclosure requirements could be quite onerous. For example, several servicers noted the requirement of disclosing any changes in interest rate as a particular nuisance since monthly adjustable loans have changes virtually every month. The 1995 evaluation noted that the Department was preparing a proposed rule to eliminate borrower’s access to funds that have been repaid over the life of the loan. This change was expected to make all HECMs closed-end credit and eliminate additional reporting requirements. However, the Department decided not to implement this change because it believed the ability to reborrow amounts repaid could be an attractive feature for some borrowers.
The other significant disclosure issue for HECMs is the requirement that borrowers be informed prior to closing of the expected total annual loan cost (TALC) of the loan measured as an effective interest rate.45 The current TALC requirements were specified in amendments to Regulation Z issued by the Federal Reserve Board in 1995 to enact changes required by the Home Equity Protection Act of 1994. This regulation applies to all reverse mortgages, not just HECMs.
The calculation of an effective interest rate for reverse mortgages is quite different than for forward mortgages since the effective interest rate will vary quite a bit depending upon both the length of the time the loan is held and the rate of housing price appreciation – neither of which have much of an impact on the cost of forward mortgages. For forward mortgages, the rate of house price
appreciation is not a factor in estimating loan costs as the amount repaid does not depend on the house value at loan termination. In contrast, for reverse mortgages, even those without explicit equity sharing arrangement, the amount repaid may be a function of changes in the house value. For example, if the house values fail to grow at the rate assumed in the HECM program so that the loan amount exceeds the value of the house, borrowers are not liable for the debt in excess of the house value. As a result, borrowers will end up with a much lower cost loan. With regard to the life of the loan, because origination costs make up a sizeable share of the amount borrowed at origination, the effective interest rate starts out very high for reverse mortgages, but declines fairly significantly as the loan ages. In contrast, for forward mortgages, the effective interest rate declines only slightly over the life of the loan as closing costs become a smaller share of the amount paid.
Recognizing the unique nature of reverse mortgages, the TALC requirements for reverse mortgages call for disclosure of effective interest rate costs under nine different scenarios involving three
45
The NCHEC web site (www.reverse.org/info.update.tila.html) was an important source of information on the development of the TALC calculation for reverse mortgages and a discussion of concerns about the current requirements.
different house price appreciation assumptions and three different holding periods. The three house price appreciation rates are 0 percent, 4 percent, and 8 percent. The appreciation rates chosen provide a fairly generous range around a mid-range estimate of 4 percent that is similar to that assumed in the HECM pricing model. The three required time periods are two years after closing, at the life expectancy for the borrower, and at 140 percent of the borrower’s life expectancy. As will be discussed below, the choice of time periods for disclosure may have more important implications for the usefulness of the TALC.
The TALC is designed to provide a comprehensive measure of loan costs that will allow borrowers to fully assess and compare the costs of various reverse mortgage options. For the most part, the TALC has proven to be a useful tool for this purpose. The TALC is also readily calculated using HUD, NCHEC or other software available to lenders. So the reporting of this information is not difficult for lenders.
There are, however, several concerns about possible deficiencies in the TALC disclosure. The principal concern has to do with the chosen time periods for the disclosure of effective interest rates relative to the beginning of equity sharing arrangements. This issue affects Fannie Mae
HomeKeeper loans with equity sharing, but not HECMs. When borrowers choose the equity sharing option, they pledge up to 10 percent of the home’s value at termination. But this equity sharing only begins after two years have passed since origination. Since the TALC disclosure is required for exactly two years from the day of origination, this equity sharing arrangement is not included in the effective interest rate for the loan at two years. Since the next disclosure period is at life expectancy which will often be several years further in the future, the jump in loan costs in year 3, which may double the effective interest at that time, will not be evident from the TALC which declines fairly steadily with loan age.
Another concern with the TALC is that the assumptions made about draws upon a line of credit do not take into account the HECM feature that allows unused borrowing capacity to grow over time. The TALC calculation assumes that half of the line of credit is drawn at closing and the rest is never used. As a result, a comparison of a HECM with a HomeKeeper, which does not provide for increases in the unused line of credit, will not take this difference into account. In both the issue of the two year holding period and the limited line of credit, the concern is that HECM loans do not compare favorably with HomeKeeper loans due to the particular assumptions embedded in the TALC regulations.
NCHEC has raised other, more minor concerns about the TALC. But at present the Board of Governors of the Federal Reserve does not have any plans to modify Regulation Z to address these concerns.