Risk Management In Untested Waters: Many See Reverse Mortgages As The Next Big Loan Product. That Means The Fraud Artists Can’t Be Far Behind

With America's 78 million baby boomers just around the corner from retirement, the reverse-mortgage market is poised for explosive growth. But so is the market for risk management, because risk--particularly in the form of fraud--always "follows the money." [??] Because seniors are frequently targeted for financial scams of all kinds, lenders hoping to tap into this lucrative market must begin to incorporate effective risk-management strategies now in order to stay one step ahead of the "perps." This article briefly examines market demographics and program limitations, and then focuses on identifying and managing fraud risk.

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How the program works

The primary advantage of a reverse mortgage is that it allows an owner to access accumulated home equity without having to sell the property or make monthly payments while living on a fixed income. With a longer lifespan, upheaval on Wall Street and the near-certainty of increasing medical costs making them uneasy, many soon-to-be-seniors are justifiably worried that they have not saved enough to live comfortably in their twilight years. Seniors will increasingly see reverse mortgages as a viable way to tap their home equity--currently estimated at $4 trillion, according to Washington, D.C.-based AARP--to close the retirement savings gap.

Most reverse-mortgage programs generally conform to the requirements of the Federal Housing Administration's (FHA's) Home Equity Conversion Mortgage (HECM), which, according to New York-based Fitch Ratings, accounts for more than 90 percent of all reverse originations. FHA's program requires that all owners of the collateralized property be 62 or older, and that the borrower(s) occupy the property as their primary residence. Borrowers must receive counseling from a source independent of the lender prior to closing the loan. Loan proceeds may be received as a lump sum, as a home equity line of credit (HELOC) or in monthly advances. The loan doesn't have to be repaid until the last surviving borrower permanently moves, sells the home or dies.

The maximum HECM loan amount is $362,790, according to the Department of Housing and Urban Development (HUD), but the total amount that may be borrowed is controlled by the borrower's age, geographic location, equity in the home and the applicable interest rate. Maximum loan amounts are further limited to 50 percent to 75 percent of the home's value (allowed amount varies by lender). New proprietary products provide higher loan limits and permit borrowers as young as 60.

Current reverse-mortgage originations, in terms of number of loans and total dollar value, are very small in comparison with traditional mortgages--but they are growing rapidly. While fewer than 350,000 such loans have been written in the 20-year history of the program, according to AARP, the National Reverse Mortgage Lenders Association (NRMLA), Washington, D.C., reports that 107,000 reverse mortgages were written in 2007, with an additional 46,000 reverse mortgages written in the first two months of 2008 alone. With nearly 10,000 citizens turning 62 every day by 2011, according to the Alliance for Aging Research, Washington, D.C., reverse mortgage originations will undoubtedly continue to increase exponentially.

The program is most beneficial for borrowers in their 70s with substantial equity in their homes, because reverse mortgages are "rising-debt" loans (the balance of the loan increases with time). According to AARP, while the majority of loans to date have gone to this type of borrower, the number of younger borrowers--who are more likely to use loan proceeds to pay off other debt or make home repairs than to meet basic necessities--is increasing.

A growing market

The reverse-mortgage market has been slow to take hold for two primary reasons--a lack of originators and consumer resistance. Both of those factors are poised to change over the next few years.

Federal regulations originally restricted the number of lenders authorized to make reverse mortgages. As Congress became more comfortable with the performance of this product, it made the program permanent and increased the number of loans that could be made. When a HUD program review in 2000 showed that the number of lenders offering reverse mortgages had decreased, HUD began to retool the program to rebuild the number of lenders. This included increasing the limit on origination fees from a flat $1,800 to 2 percent of the home's value or the county-based home value limit. The lack of a secondary market also may have hampered growth. According to a Ginnie Mae press release, Fannie Mae was the only purchaser or securitizer of HECM-backed securities until 2007, when Ginnie Mae entered the market.

Consumer resistance to reverse mortgages occurs for a variety of reasons, ranging from a desire to pass the home's equity on to heirs to a desire to avoid debt altogether. But according to AARP, the major impediment is the high cost associated with the product.

An AARP survey shows that origination fees, which can top 10 percent of the value of the home, are the primary reason cited by people who completed reverse-mortgage counseling but ultimately decided not to close the loan.

Another negative economic factor affecting demand is the requirement for mandatory mortgage insurance. As the market for reverse mortgages grows, competitive pressures, along with a move to make mortgage insurance pricing consistent with actuarial soundness, should further reduce costs. Lower costs will ultimately make reverse mortgages more attractive to consumers.

Fraud against borrowers/elder abuse

As everyone knows, the elderly are frequently targeted by scam artists, and there is a very high probability that incidents of fraud against seniors will increase along with reverse mortgage origination volumes. Seniors are extremely susceptible to high-pressure sales techniques and fraud. In fact, according to a May 2005 study, Why Older Adults Are More Vulnerable to Scams, published by the Washington, D.C.-based American Psychological Association's Journal of Experimental Psychology: General, they're 10 times more likely than younger people to remember false information and to believe that it's true.

The newspapers are full of reports of seniors succumbing to estate-planning, investment and home-repair scams, so it's not surprising that problems reported to date with reverse-mortgage programs show many elderly borrowers being victimized. And as is the case with traditional mortgage products, the frauds frequently involve a mortgage professional. Here are a few examples:

* In Detroit, an 84-year-old woman responded to an ad she saw on television. She arranged for a loan of $62,000 over the phone and eventually went to closing. Unbeknownst to her, the loan was actually for nearly $104,000 and the loan officer had arranged for the funds to be disbursed in two checks--with one check for $42,000 made payable to himself. The loan officer was arrested and charged in the scam, which authorities believe may have netted the loan officer nearly $1 million from as many as 40 victims, according to HUD and as reported by The Detroit News.

* In another scheme, the loan officer, again capitalizing on the borrower's lack of understanding of the loan process, told the borrower that standard HECM procedures required the borrower to sign over the proceeds check to the loan officer for future disbursements. According to HUD, the loan officer made a few payments, but kept the balance of the funds for himself.

HUD was sufficiently concerned about reports like these that it issued a mortgagee letter shortly after these incidents. The letter instructed HECM counselors to adequately explain to borrowers how to access their proceeds and to warn borrowers against signing their checks over to loan officers or other third parties involved in the transaction.

Sometimes several scams are combined into one, as in the following examples.

* In California, a 75-year-old woman was approached by someone claiming to be a financial adviser who was seeking to originate a reverse mortgage on her behalf. The victim was convinced that she would have to make certain repairs to her home before the loan could be approved. The "financial adviser" introduced her to a co-conspirator handyman who allegedly overcharged her for the repairs done by a third party, pocketing the difference. The "financial adviser" is accused of forging the victim's signature on the check for the loan proceeds, obtaining more than $40,000, according to MortgageFraudBlog.com.

* In a similar case, a reverse-mortgage "broker" solicited a Texas man just before the man died. The "broker" said that major repairs would have to be undertaken in order to qualify for the loan, and he recommended a company to use. The surviving family alleges that the perpetrators forged a power of attorney and had the repairs completed without the borrower's authorization. When the reverse mortgage did not materialize, liens were placed against the property, and the estate was sued. The family is counter-claiming in an effort to save their father's home, reports Austin, Texas-based cable news News8 Austin.

* In Indiana, an elderly couple met a loan originator who also owned his own mortgage company. The originator persuaded the couple to apply for a reverse mortgage in order to obtain funds to invest in his mortgage company, promising that their funds would be placed in an interest-bearing account that would be available on request. After the loan and the investment were made, the couple requested, but did not receive, their funds. After the originator failed to meet the mortgage obligations, foreclosure proceedings were initiated against the couple's home. The originator was convicted of fraud and securities violations charges, and is awaiting sentencing, reports MortgageFraudBlog.com.

In many fraud cases, the perpetrator is a fellow church member or social acquaintance of the victims--or worse, a family member--as in the following examples:

* In another California case, a couple in their late 60s met the alleged fraudster at their church. After some discussion, they agreed to obtain a reverse mortgage from him. During the closing, which was described as "casual," the couple and the alleged fraudster discussed "church and social matters" as they signed the documents, which were not explained to them. A month after the closing, the couple learned that they no longer owned their home, and they filed a police complaint after the alleged fraudster refused to return title to their name. Police conducting a search warrant at the defendant's office said it appeared that several businesses and individuals collaborated to perpetrate the scheme. Police reports note that there were more victims, and more arrests are expected, according to the Tracy Press, Tracy, California.

* A Connecticut man was arrested and charged with larceny and forgery after he allegedly used a power of attorney to obtain a reverse mortgage on his elderly father's home. The son is accused of diverting $93,000 in loan proceeds to his own use. The father, who is unable to manage his own affairs, is a resident of a nursing home, reports MortgageFraudBlog.com.

Fraud against reverse-mortgage borrowers should be of great concern to lenders. Apart from the direct damage to the borrower, lenders risk their reputations when elderly scam victims face foreclosure. Also of concern is the fact that negative publicity surrounding these cases may cause seniors who could benefit from reverse mortgages to steer clear of the product.

As in traditional mortgage fraud cases, a lender's best defense is prevention. While lenders are not permitted to provide the initial counseling to borrowers, implementation of an internal pre-funding program could prevent these types of fraud. It could include contacting borrowers to confirm the details of the loan, including the purpose of the loan, the loan amount, fees charged and the borrower's disbursement preferences. Closing instructions to settlement agents should prohibit the disbursement of proceeds to anyone other than the borrower and bona fide lenders and/or lien holders.

Program risks and fraud against lenders

The most obvious risks to reverse-mortgage lenders involve collateral value and estimated borrower lifespan. A borrower's property may not appreciate as much as expected, and, in the case of the oldest borrowers, the value may even decline if the loan proceeds are used for living and medical expenses instead of necessary repairs and maintenance. These problems may be compounded if the borrower lives longer than expected, delaying maturity events and causing the accruing loan balance to exceed the property's value. If the loan is non-recourse, as is usually the case, the lender will suffer a loss.

Dishonest operators will always follow the money. The growth opportunities in this market are surely known to them, and it will not be long before perpetrators learn to exploit program vulnerabilities and begin to target lenders directly. Fraud against lenders in reverse-mortgage products can be accomplished in a number of ways, including the following:

* Misrepresentation of the borrower's primary residence;

* Misrepresentation of the borrower's age;

* Identity theft;

* Inflation of collateral value;

* Land-record fraud/deed forgery;

* Forged payoffs of pre-existing liens and mortgages;

* Loans arranged by children or other third parties without the consent or knowledge of the borrower;

* Loans closed with forged powers of attorney or powers of attorney signed by incompetent borrowers; and

* Settlement-agent fraud (misappropriation of proceeds).

There are a number of ways to combat these potential areas of vulnerability, including the following:

* Underwriters need to carefully compare credit reports and deed records to ensure that the collateral property is indeed the primary residence. Servicing procedures should be established to monitor for any change of residence, and the borrower's Social Security number should be regularly compared to the Social Security Administration's Master Death Index.

* Phone records, credit reports, tax returns and Social Security records should be checked to verify the borrower's age and identity.

* Establishing collateral value at origination is critically important because of the possibility that the borrower will live longer than expected or fail to maintain the property. As is the case for traditional mortgages, values can be manipulated. Quality automated valuation models (AVMs) should be used pre-funding to verify the accuracy of the appraised value.

* Interthinx investigations have identified a number of traditional mortgage fraud cases where the perpetrators forged deeds transferring title to co-conspirators and then mortgaged the property without the true owner's knowledge. Seniors whose property is owned free and clear are especially susceptible to this scam because they are unlikely to monitor deed records and may not notice that they're no longer receiving tax bills. Underwriters should be instructed to compare title insurance binders and other supporting loan documentation to detect inconsistencies indicative of unauthorized transfers of title. Automated technology that provides sales histories should be used as an additional source for verification and identification of variances in title.

* Underwriters should check the credit report for open mortgages and compare that information with the borrower's application and title binder. If there are any questions, the lender shown on the credit report should be contacted to confirm whether the mortgage is still open or whether it has been satisfied. If the lender shown on the credit report has sold the loan, the Mortgage Electronic Registration System (MERS[R]) database of current ownership and servicing rights may help indentify whom to contact for verification.

* Underwriters should be especially careful if third parties are arranging the mortgage or if a power of attorney is received as part of the application--even if the third party is, or the power of attorney is given to, the borrower's child. The borrower should be contacted to confirm that he or she is mentally competent, was competent when the power of attorney was executed, has authorized the third party to act on his or her behalf, has granted a power of attorney and is aware that the loan is being made.

* Fraud perpetrated by closing/settlement agents who intend to convert loan proceeds to their own use is very difficult to detect pre-funding. Routine borrower contact to confirm loan details, disbursement preferences and bank account information can spot problems before proceeds are released. Such frauds may be spotted post-funding by comparing application data with post-closing documentation.

The bottom line

The expected growth in reverse-mortgage lending presents a tremendous opportunity for lenders. In order to capitalize on the potential of this market, lenders must anticipate potential problems and construct risk-management programs now--while the volume of originations is still low. Effective and ongoing training for underwriters, clearly defined escalation procedures, and the use of automated technology will set the stage for a successful program going forward.

Ann Fulmer is vice president of Interthinx, Agoura Hills. California. She can be reached at [email protected].