New HECM Rules For Surviving Spouses Fall Short

The Department of Housing and Urban Development recently published Mortgagee Letter 2015-03, which provides servicers of FHA-insured Home Equity Conversion Mortgages a way to proceed after a borrower dies and is survived by a non-borrower spouse. Under the Letter, lenders and servicers can assign to HUD those HECMs that are in default due to the death of the borrower, and with properties still occupied by non-borrowing spouses, provided that certain conditions are met. This much-needed guidance follows a period of uncertainty facing lenders and servicers. Although the new rules address many of the issues presented by non-borrowing spouses, one of the rules' principal shortcomings is that they do not sufficiently outline the rebalancing of principal that is often required to substitute these new borrowers.

The Mortgagee Letter simply states that "[a] payment may be made to reduce the unpaid principal balance in order to meet the requirements." It does not specify how to calculate this payment or whether the appreciation of the associated property would increase the non-borrowing spouse's principal loan factor. The PLF is the amount that would have been advanced had the surviving non-borrowing spouse been an original borrower on the loan. In practice, this means that if a surviving, non-borrowing, spouse is younger than the original borrower, he or she will likely have to make an immediate, lump sum, principal repayment on the loan — a payment that the surviving non-borrowing spouse might not have the means to make.

To compute the new principal loan factor, HUD must clarify the method by which servicers should calculate the current principal limit for the non-borrowing spouse. In addition, HUD should clarify whether and how servicers of HECMs apply funds where a payment is made to reduce the unpaid principal balance. Examples of these pay-down scenarios are critical for the understanding of this calculation. HUD should also clarify how to deal with non-borrowing spouses under the minimum age for HECM eligibility.

For eighteen months, HECM lenders have had to grapple with issues related to the foreclosure of homes occupied by non-borrowers who survived their borrower spouses. Historically, some couples applying for reverse mortgages went to great pains to not include the younger spouse on the loan in order to increase the initial disbursement amount and related line of credit available under the loan. Under the terms of HUD's HECM regulations, the lifetime deferral of loan repayment obligations only applies to the borrower on the HECM and is not extended to non-borrowing spouses. If the borrower dies or moves out of the home, the loan becomes due and payable, meaning that a non-borrowing spouse has to either pay the loan in full, or face foreclosure.

On Sept. 30, 2013, a federal district court entered an order in a case filed against HUD, Bennett v. Donovan. The decision upended the way HUD has long-required HECM servicers to proceed after the death of a borrower who is survived by a non-borrowing spouse. The court held that a provision of the HECM statute allowed HUD to insure only HECMs that came due after the deaths of both the homeowner-borrower and the spouse of that homeowner, regardless of whether that spouse is non-borrowing or a co-borrower.

On June 25, 2014, in the wake of a similar order in a separate case, HUD issued a release, FHA INFO #14-34, which granted HECM servicers an indefinite extension of time in which to take first legal action to begin foreclosure and to comply with the reasonable diligence timeframes set forth in HUD's rules. The indefinite extension rests on the satisfaction of several factors, the most notable of which is that the loan amount has effectively to be rebalanced to the non-borrowing spouse's principal limit factor.

Unfortunately, HUD's guidance does not address how HECM servicers should calculate a non-borrowing spouse's new PLF in order to qualify for an indefinite foreclosure extension. This omission creates the risk that HUD could impose financial penalties on servicers for the period of the indefinite foreclosure extension if HUD later determines that the servicers improperly calculated the rebalancing factor.

Mortgagee Letter 2015-03 does not adequately address the very issues at which it was aimed, specifically one of the industry's biggest questions about FHA INFO # 14-34: how to perform the rebalancing calculation necessary to make an HECM eligible for assignment to HUD. If the servicer does not assign the HECM to HUD, it must initiate foreclosure.

Without further clarification of these issues, HECM servicers will continue to face many of the same issues that have confounded the industry since the Bennett decision was entered.

Robert M. Couch, Counsel, Bradley Arant Boult Cummings LLP.