Reverse Mortgages on the Rise
Chris Burti, Vice President and Legal Counsel

As Baby Boomers are beginning to enter their 60’s, they are looking at ways to free up the equity in what is in most cases their single largest investment…their home. For many years this was often done through a Home Equity Line of Credit (HELOC). As retirement approaches and income limitations appear on the horizon, this segment of the mortgage market is increasingly looking at reverse mortgages as a mechanism to access that equity without an adverse effect on the budget. Reverse mortgages have not been frequently used until recently any many are not familiar with the way they are underwritten for title insurance. Lenders will be requiring issuance of an ALTA Endorsement – Form 14.3-06 (Future Advance – Reverse Mortgage). A little background information may be useful before going into the requirements for issuing such an endorsement.

A reverse mortgage is used for a loan that is typically made to an elderly couple over the age of 62 with substantial equity in their home. Because reverse mortgages have no fixed monthly payments and they are repaid from the estates of the borrowers after death or upon sale of the property (or upon failure to maintain the property or pay taxes and insurance), they are a useful financial tool for homeowners to obtain the desired benefits from the equity in their home without incurring the burden of a payment during retirement years.

Many homeowners are becoming interested in reverse mortgages so they can create the desired liquidity or generate an income stream and yet stay in their own homes. Selling their homes and moving elsewhere are rarely appealing alternatives to older people. Some writers have expressed concerns as to whether this is a prudent vehicle for the graying population. With the greater longevity being experienced by this generation, there is a risk that the equity may run out before the homeowner is ready to leave. If the homeowner is dependent on the income stream from the reverse mortgage a crisis is likely to ensue and at that point a sale of the home may no longer provide a solution.

An excellent way to evaluate a reverse mortgage is to compare it to what may be the homeowner’s only real alternative: selling the home and using the proceeds to buy or rent a new home. The homeowner will need to determine:

• How much cash selling the home will net.
• The cost to buy and maintain or rent a new home.
• The income that would be earned on any money left over if invested prudently.
• The availability and acceptability of alternative housing.

Until the homeowners have explored other housing options, they will not know whether other housing choice may be better than a reverse mortgage. The homeowners will likely come to one of two conclusions. Either they will find another housing option that is a lot more attractive than expected or they will decide that where they now live is the preferable place for them to continue living. In any event this comparison will make it easier to evaluate the costs and benefits of a reverse mortgage.

To qualify for most loans, the lender checks the borrowers’ income to see how much they can afford to pay back each month. But with a reverse mortgage, there is no requirement to make monthly repayments. Therefore, the homeowners do not need any minimum amount of income to qualify for a reverse mortgage. With most home loans, the homeowner’s may lose their home if they don't make the monthly payments. But with a reverse mortgage, there aren't any monthly repayments to make. So there is no risk of losing the home by not making them. Most reverse mortgages require no repayment for as long as the homeowner — or any co-owner(s) — lives in the home.

Traditionally, when a home is purchased the homeowners often make a small down payment and borrow the rest of the purchase price. They typically pay back mortgage loan in monthly installments over many years. During that time, the debt typically decreases and home equity increases from the repayment of principal and appreciation in value. Reverse mortgages, as discussed, have a different purpose than regular home mortgages do. With a home mortgage, the borrowers use their income to repay debt and this builds up equity in the home. It's just the opposite with a reverse mortgage.

The Home Equity Conversion Mortgage (HECM) is the oldest and most popular reverse mortgage, amounting to an estimated 90 percent of the market. Available since 1989, HECMs are insured by the federal government through the Federal Housing Administration (FHA), a part of the U.S. Department of Housing and Urban Development. These loans can be used by senior homeowners age 62 and older to convert the equity in their home into monthly streams of income and/or a line of credit to be repaid when they no longer occupy the home. This loan will include a second deed of trust payable to Secretary of Housing and Urban Development, to be shown on Schedule B, Part II, of the policy.  Typically the "first" mortgage will reflect the loan amount (for example, $100,000) and that it secures an amount "up to a maximum principal amount of .  .  ." (for example, $150,000). Therefore, the policy itself should provide in Schedule A description of the deed of trust and in Schedule B-II for the "second" deed of trust. Both should reflect the amount of the loan and the maximum principle amount (in this example $100000 and $150,000 respectively).

 In 1996, Fannie Mae developed the Home Keeper® reverse mortgage as a conventional market alternative to the HECM. The borrower may choose to receive the funds from these loans in fixed monthly payments for life, or as a line of credit, or in a combination of monthly payments and line of credit. The deeds of trust secure the repayment of the debt, which is continually increasing including accruing interest, up to a stated maximum principal amount; but repayment is limited to the fair market value of the property, if less.

With a reverse mortgage, the lender lends money with no repayments. Therefore, the debt increases as the borrower gets more cash and as more interest is added to the loan balance. As the debt continues to grow, equity shrinks, unless the home's value is appreciating at a higher rate. When reverse mortgages become due and payable, homeowners may owe a lot of money with little or no equity. Yet, that is exactly what informed borrowers intend. Their goal is to "spend down" their home equity while they live in their homes, without having to make monthly loan repayments.

There are exceptions to the case of reverse mortgages having rising debt and falling equity. If a home's value appreciates rapidly, the equity will actually increase over time. Or, if there is only one loan advance and no interest is charged on it, the debt would never change and the equity would increase as the home appreciates. This is not the expected case and will not be likely to be experienced often.

The Reverse Mortgage Endorsement (ALTA Endorsement Form 14.3 - 06 Future Advance - Reverse Mortgage, 06-17-06) provides 4 primary coverages:

1.      Future advances will have the same priority as if disbursed at closing.

2.      Variable rates of interest will not affect validity, enforceability or priority.

3.      Compounding of interest (interest on interest) or capitalizing unpaid interest will not result in a loss of priority for increases in the unpaid principal balance (like negative amortization).

4.      The failure of the mortgagors to be at least 62 years of age at Date of Policy.

Lenders will typically require ALTA Endorsement Forms 8.1 and 9 as well. The effective date of the policy will be the date and time of recordation of the first mortgage. Premiums will be quoted and title insurance provided for the maximum principal amount of the loan.

The deed of trust must contain "Maximum Principal Amount". In North Carolina, reverse mortgage priority is governed by Article 21, Chapter 53 of the North Carolina General Statutes, N.C.G.S. 53-255 – 53-272 (effective 10-1-91).  Maximum amount of principal and interest accrued secured by the deed of trust must be shown on the recorded deed of trust (which is usually 150% of the original loan amount). The attorney must verify that the borrowers are 62 or older. The Attorney must verify that the DOT complies with the future advance statute (NCGS 45-68 et seq. or NCGS 45-81 et seq.). Home Equity Conversion Mortgage loans will include a second deed of trust payable to Secretary of Housing and Urban Development, to be shown on Schedule B, Part II, of the policy. 

The requirements in schedule B of the Commitment will typically appear something like the following:

In order to issue the ALTA Endorsement – Form 14.3-06 (Future Advance – Reverse Mortgage) the attorney must verify that the borrowers are at least 62 years of age, that the deed(s) of trust (one to the lender, one to HUD) comply with North Carolina’s future advance statute (NCGS 45-68 et seq. or NCGS 45-81 et seq.), that the deed of trust to be insured contains provisions identifying that it is a Reverse Mortgage in compliance with the Act as well as the maximum amount to be secured.

Dirt Tales From the Deed Vault - Episode 10
John Dillard, Vice President and Legal Counsel

This month we look again at the doctrine of Insurable Title and how damages are calculated and paid when title losses occur.

Jimmy Homeowner and his wife Rebecca thought they had found the perfect home after months of looking.  It was on a nicely landscaped lot with several shade trees in the back that made a nice border between their house and the houses behind them.  His realtor even told him she could save them a great deal of money by using “her” attorney who could “tack onto” an existing title policy.  Not only would the Homeowners be able to close quickly they would save a lot of money by not having to pay for a full title search. 

The couple closed on the home and lived blissfully for a few years until Jimmy came home from work one afternoon to discover survey stakes in his back yard that came almost to the edge of the patio. 

He called his neighbor who lived behind him to see if he knew anything about why the stakes were in his yard and was informed that the neighbor was selling his home and moving away.  The new buyers had gotten a survey as required by the bank.  Jimmy called the attorney who had closed his purchase and was advised he had title insurance and should file a claim with them.   Jimmy promptly did so and the title company hired an attorney to examine the title.  The title examination disclosed an error in a deed a couple of links back in the chain of title.  In that deed the grantors purportedly conveyed a tract of land they had conveyed earlier and had forgotten about.  Unfortunately for Jimmy that tract comprised most of his back yard.

The title company wrote Jimmy a check for $15,000 and told him the claim was settled.  Jimmy told him he wanted them to try to do something to get his land back and if they couldn’t do that, the money they tendered was not sufficient to cover his loss.  After all, he had lost most of his back yard and on a $300,00.00 purchase the amount they were offering wasn’t sufficient.  And he had used most of his vacation in dealing with this problem and he wanted to be compensated for that too.

Should the title insurer have tried to defend the title to the property Jimmy lost?  And is there anything he can do about the amount of damages they paid him?  To find the answer to these questions we must look at well established law in these areas.  Item 6 of the ALTA Policy (10-17-92) summarizes the Company’s options with respect to the insured in the event a loss has been determined to be compensable.  The first is to pay the amount of the insured’s loss.  The second, is to elect to defend against pending litigation and upon losing, pay the amount of the loss plus litigation costs.  The third option is to settle with the insured or with parties other than the insured.  The fourth is to take some affirmative action to clear the title defect.  The fifth course of action is to purchase an indebtedness or judgment affecting the insured property. 

            The courts have held that if an insurer follows one of the above courses of action they have satisfied their legal obligation to the insured and they cannot be required to do anything further.  Martinka v. Commonwealth Land Title Insurance Company 836 S.W. 2nd 773 (1992).

Under the terms of the title policy the Company clearly had the right to settle and pay for the loss as opposed to filing an action to quiet title. 

The next question to consider is if the title company chooses to settle the loss as opposed to defending title what measure of damages should be applied?  According to A.J. Appleman, Insurance Law and Practice, §5201 a policy of title insurance is an agreement to indemnify against actual monetary loss or damage suffered by the insured.  It is not a covenant against encumbrances or defects (emphasis added).  In order to be compensable, the loss or damage must arise from a risk insured against under the terms of the policy. The question then becomes how are those monetary losses calculated?  Burke Law of Title Insurance, §13.3 (1986) states “the liability of the Company where there has been a total failure of title is the lesser of the fair market value of the insured property or the face amount of the policy”. This principle has also been adopted by the courts in determining the measure of damages to apply where there has been a partial failure of title.   Allison v. Ticor Title Ins. Co., 907 F2d 645 (7th Cir. 1990).

Under the term’s of the standard ALTA title insurance policy and existing title insurance law it was the title company’s prerogative to choose to pay monetary damages rather than quieting title for the Homeowners’.  And although the measure of damages they calculated may not have met the insured’s expectations, it nevertheless was a proper application under current title insurance policy law. 

This example illustrates another shortcoming of relying upon insurable title and one of the inherent risks in tacking onto existing title policies.  Remember, title insurance is not a covenant against title, but merely a contract of indemnity.  It does not cover incidental damages or losses the insured may suffer, nor may it fully compensate the insured for loss due to the manner in which losses may be calculated under the policy.