Mortgages: Fundamentals, Issues and Perspectives

MORTGAGES: FUNDAMENTALS, ISSUES AND PERSPECTIVES MORTGAGES: FUNDAMENTALS, ISSUES AND PERSPECTIVES HANK C. SENTOWSKI ...

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MORTGAGES: FUNDAMENTALS, ISSUES AND PERSPECTIVES

MORTGAGES: FUNDAMENTALS, ISSUES AND PERSPECTIVES

HANK C. SENTOWSKI EDITOR

Nova Science Publishers, Inc. New York

Copyright © 2007 by Nova Science Publishers, Inc.

All rights reserved. No part of this book may be reproduced, stored in a retrieval system or transmitted in any form or by any means: electronic, electrostatic, magnetic, tape, mechanical photocopying, recording or otherwise without the written permission of the Publisher. For permission to use material from this book please contact us: Telephone 631-231-7269; Fax 631-231-8175 Web Site: http://www.novapublishers.com NOTICE TO THE READER The Publisher has taken reasonable care in the preparation of this book, but makes no expressed or implied warranty of any kind and assumes no responsibility for any errors or omissions. No liability is assumed for incidental or consequential damages in connection with or arising out of information contained in this book. The Publisher shall not be liable for any special, consequential, or exemplary damages resulting, in whole or in part, from the readers’ use of, or reliance upon, this material. Independent verification should be sought for any data, advice or recommendations contained in this book. In addition, no responsibility is assumed by the publisher for any injury and/or damage to persons or property arising from any methods, products, instructions, ideas or otherwise contained in this publication. This publication is designed to provide accurate and authoritative information with regard to the subject matter covered herein. It is sold with the clear understanding that the Publisher is not engaged in rendering legal or any other professional services. If legal or any other expert assistance is required, the services of a competent person should be sought. FROM A DECLARATION OF PARTICIPANTS JOINTLY ADOPTED BY A COMMITTEE OF THE AMERICAN BAR ASSOCIATION AND A COMMITTEE OF PUBLISHERS. Library of Congress Cataloging-in-Publication Data Mortgages : fundamentals, issues and perspectives / Hank C. Sentowski (editors). p. cm. Includes index. ISBN-13: 978-1-60692-603-1 1. Mortgages--United States. 2. Mortgage loans--United States. I. Sentowski, Hank C. HG2040.5.U5M67 2008 332.7'20973--dc22 2007031837

Published by Nova Science Publishers, Inc.

New York

CONTENTS Preface Chapter 1

vii Title Insurance (Actions Needed to Improve Oversight of the Title Industry and Better Protect Consumers) United States Government Accountability Office

1

Chapter 2

Reverse Mortgages: Background and Issues Bruce E. Foote

49

Chapter 3

One Hundred Questions and Answers about Buying a New Home United States Department of Housing and Urban Development

71

Chapter 4

Alternative Mortgages: Risks to Consumers and Lenders in the Current Housing Cycle Edward Vincent Murphy

95

Chapter 5

Consumer Handbook on Adjustable-Rate Mortgages Federal Reserve Board

117

Chapter 6

A Consumer's Guide to Mortgage Settlement Costs Federal Reserve Board

139

Chapter 7

A Consumer's Guide to Mortgage Lock-Ins Federal Reserve Board

151

Glossary

157

Index

165

PREFACE As of this writing, the complete mortgage industry coast to coast and all of its support services (appraisers, credit agencies, title companies, realtors, mortgage brokers, lenders, attorneys and settlement agents) find themselves in the midst of an unprecedented mortgaging industry meltdown. If you are looking to purchase or refinance a home for the first time or have not applied for a mortgage since perhaps you purchased your original home, possibly some 20+ years ago, you can be in for an exhaustive, frustrating and 2-3 month gut-wrenching ride of your life. Because of the many advances in banking technology today, coupled with the sometimes unintended and impersonal lack of customer service given to mortgage applicants’ needs, concerns, and general thirst to understand the mortgaging process, this book is an excellent primer for everyone and a must read cover to cover. Mortgages will guide you through the complete process of understanding the array of mortgage products available, such as (fixed vs. adjustable), (interest only vs. negative amortization), (combo and piggy back type mortgages) and the differences between a conforming mortgage loan amount vs. a jumbo mortgage. It will explain how lenders handle their lock-in interest rate time frames and its costs and then eventually take you through the complete funds necessary for settlement costs (closing costs). After you have read and digested the material, you must always keep in mind that while each bank or lender of mortgages subscribes to a general uniform code of underwriting and lending standards, there are exceptions to the rule. Every lender in any particular state has its nuances when it comes to items such as rate locking, products of availability, rates of interest, settlement costs expenses and, yes, even the relaxation of underwriting guidelines. I encourage you to read Mortgages thoroughly, then write down all of your questions and concerns in order that you can engage and challenge your loan originator for clarity and answers to each and every one of your mortgaging questions – from the initial application interview through and up to the settlement date (closing day). Still, you and only you must take the personal responsibility to understand the mortgage products being offered to you, to understand your financial capabilities and to possess the economic maturity to enter into what will be the largest purchase of a lifetime.

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Hank C. Sentowski

Now, with your newfound knowledge and with all sincerity, I wish you the best of speed and good luck in your pursuit of the American Dream of home ownership. H.C. Sentowski The Journey Now Begins

In: Mortgages: Fundamentals, Issues and Perspectives ISBN: 978-1-60021-918-4 Editor: Hank C. Sentowski, pp. 1-48 © 2007 Nova Science Publishers, Inc.

Chapter 1

TITLE INSURANCE (ACTIONS NEEDED TO IMPROVE OVERSIGHT OF THE TITLE INDUSTRY AND BETTER PROTECT CONSUMERS) United States Government Accountability Office WHY THIS STUDY WAS DONE In a previous report and testimony, GAO identified issues related to title insurance markets, including questions about the extent to which premium rates reflect underlying costs, oversight of title agent practices, and the implications of recent state and federal investigations. This report addresses those issues by examining (1) the characteristics of title insurance markets across states, (2) factors influencing competition and prices within those markets, and (3) the current regulatory environment and planned regulatory changes. To conduct this review, GAO analyzed available industry data and studies, and interviewed industry and regulatory officials in a sample of six states selected on the basis of differences in size, industry practices, regulatory environments, and number of investigations.

WHAT IS RECOMMENDED GAO recommends that HUD and state insurance regulators take actions to improve consumers’ ability to comparison shop for title insurance and strengthen the regulation and oversight of the title insurance market, including the collection of data on title agents’ operations. Further, Congress may want to consider, as part of its oversight of HUD, exploring the need for modifications to RESPA, including increasing HUD’s enforcement authority. HUD generally agreed with these recommendations, and NAIC agreed they should be explored.

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United States Governement Accountability Office

WHAT WAS FOUND The U.S. title insurance market is highly concentrated at the insurer level, but market characteristics varied across states. In 2005, for example, five insurers accounted for 92 percent of the national market, with most states dominated by two or three large insurers. Variations across states included the way title agents conducted their searches as well as the number of affiliated business arrangements (ABA) in which real estate agents, brokers, and others have a stake in a title agency. Finally, premiums varied across states due to cost and market variations that can also make understanding and overseeing title insurance markets a challenge on the national level. Certain factors raise questions about the extent of competition and the reasonableness of prices that consumers pay for title insurance. Consumers find it difficult to comparison shop for title insurance because it is an unfamiliar and small part of a larger transaction that most consumers do not want to disrupt or delay for comparatively small potential savings. In addition, because consumers generally do not pick their title agent or insurer, title agents do not market to them but to the real estate and mortgage professionals who generally make the decision. This can create conflicts of interest if those making the referrals have a financial interest in the agent. These and other factors put consumers in a potentially vulnerable situation where, to a great extent, they have little or no influence over the price of title insurance but have little choice but to purchase it. Furthermore, recent investigations by the Department of Housing and Urban Development (HUD) and state insurance regulators have identified instances of alleged illegal activities within the title industry that appeared to take advantage of consumers’ vulnerability by compensating realtors, builders, and others for consumer referrals. Combined, these factors raise questions about whether consumers are overpaying for title insurance. Given consumers’ weak position in the title insurance market, regulatory efforts to ensure reasonable prices and deter illegal marketing activities are critical. However, state regulators have not collected the type of data, primarily on title agents’ costs and operations, needed to analyze premium prices and underlying costs. In addition, the efforts of HUD and state insurance regulators to identify inappropriate marketing and sales activities under the Real Estate Settlement Procedures Act (RESPA), have faced obstacles, including constrained resources, HUD’s lack of statutory civil money penalty authority, some state regulators’ minimal oversight of title agents, and the increasing number of complicated ABAs. Finally, given the variety of professionals involved in a real estate transaction, a lack of coordination among different regulators within states, and between HUD and the states, could potentially hinder enforcement efforts against compensation for consumer referrals. Because of the involvement of both federal and state regulators, including multiple regulators at the state level, effective regulatory improvements will be a challenge and will require a coordinated effort among all involved.

ABBREVIATIONS ABA ALTA

affiliated business arrangement American Land Title Association

Title Insurance (Actions Needed to Improve Oversight… Fannie Mae Freddie Mac HUD NAIC RESPA RESPRO SEC

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Federal National Mortgage Association Federal Home Loan and Mortgage Corporation Department of Housing and Urban Development National Association of Insurance Commissioners Real Estate Settlement Procedures Act Real Estate Services Providers Council Securities and Exchange Commission

April 13, 2007 The Honorable Spencer Bachus Ranking Member Committee on Financial Services House of Representatives Dear Mr. Bachus: Title insurance is designed to guarantee clear ownership of a property that is being sold and is a required part of most real estate transactions across the United States. Although home buyers pay for title insurance premiums, they often know little about the insurers themselves or the title insurance industry. Recent state and federal investigations into the sale of title insurance have identified practices by some title insurers, their agents, and others involved in the sale of title insurance, that allegedly allowed these entities to make undue profits at consumers’ expense. At the same time, insurance regulators in at least four states have concluded that consumers are being overcharged for title insurance, and the California insurance regulator has recommended rate rollbacks—an action that some in the title industry have strongly criticized. Because virtually everyone who buys a home or refinances a home mortgage in the United States typically must purchase title insurance, the potential effects of such practices are enormous. We previously provided a report and testimony identifying issues in the title insurance market that merited further study because they could shed light on competition and the prices consumers pay.[1] In response to the former Chairman’s request, we prepared this report to address and elaborate on those issues. Specifically, we address (1) the characteristics of title insurance markets and differences across states, (2) prices and competition in the industry, and (3) the current regulatory environment and planned regulatory changes. To do this work, we performed a detailed review of the laws, regulations, and market practices in California, Colorado, Illinois, Iowa, New York, and Texas.[2] We chose these six states on the basis of differences in the size of their markets, title insurance practices and customs, the rate-setting and regulatory environments, and the number of federal and state investigative actions. In some of these states, we were able to tour title plant facilities and observe the title search and examination process. We reviewed available studies of the title insurance industry and discussed their results with the authors.[3] We also gathered the views of officials from a variety of national organizations whose members are involved in the marketing or sale of title insurance or related activities, and we spoke with insurers, agents, and title industry associations. We asked for, but did not receive, cost data from agents and insurers that would allow us to analyze agents’ costs. We obtained and analyzed data collected by the National Association of Insurance Commissioners (NAIC), the Texas

4


Department of Insurance, the California Department of Insurance, and the American Land Title Association (ALTA).[4] We also consulted other publicly available financial information on title insurers and agents and spoke with agents about costs, examined financial data filed with the Securities and Exchange Commission (SEC), and spoke with officials from three of the largest title insurance underwriters. We interviewed key insurance, banking, mortgage, and real estate regulators in each state about the regulatory environments, spoke to officials from the Department of Housing and Urban Development (HUD), and reviewed relevant federal laws and regulations. We also discussed these issues with officials from the Federal National Mortgage Association and the Federal Home Loan and Mortgage Corporation to better understand the relationship between the secondary mortgage market and title insurance. Lastly, we interviewed staff and state regulators working with NAIC to get their views on the industry and to obtain information on the activities of their Title Insurance Working Group. We performed our work in Washington, D.C.; Chicago, Illinois; and six sample states between February 2006 and March 2007 in accordance with generally accepted government auditing standards. Appendix I contains a more detailed description of our objectives, scope, and methodology.

RESULTS IN BRIEF In the United States, the title insurance market is highly concentrated at the insurer (or underwriter) level, but market characteristics varied across the states. In 2005, for example, five insurers accounted for 92 percent of the national market, and most states were dominated by two or three large insurers. However, state markets differed in several ways. For example, large insurers tended to use local or regional title agents to conduct their business, and the mix of affiliated agents (those in which the insurer has an ownership interest) and independent agents varied across states. The extent of affiliated business arrangements (ABA)—situations in which real estate or other professionals are part or full owners of title agencies—also varied. In some states the number of ABAs, which have been cited in many of the regulatory investigations into industry practices, has grown substantially. Furthermore, title agents use different processes to carry out title searches and examinations, largely because of variations in the way the industry has developed across states. Title agents in some states have automated “title plants” containing most public records, while, in other states, title agents rely on the less-efficient process of hiring people to search physical records. The extent of agents’ activities also varied widely across states, including how they set prices for their services, the portion of claims they paid, and the extent of their participation in the escrow and closing processes. Finally, we found that premiums varied across states, due to cost and market variations that can make understanding and overseeing title insurance markets a challenge on the national level. Several factors related to the way that title insurance is marketed and priced raise questions about the extent of price competition in the title insurance industry and the ability of consumers to affect market prices. First, consumers find it difficult to shop for title insurance based on price. Purchasing title insurance is a transaction that consumers are unfamiliar with, and it can be difficult for them to gather information on all title insurance-

Title Insurance (Actions Needed to Improve Oversight…

5

related costs. HUD provides educational information on title insurance. However, the benefit of this information is limited because consumers may receive it after a title agent and insurer have been selected, and lenders are not required to provide it on mortgage refinance transactions. In addition, purchasing title insurance is generally a small part of a larger home purchase or mortgage refinancing process that most consumers do not want to disrupt or delay for relatively small potential savings. Second, consumers generally do not select their title agent or insurer, and title agents do not market to consumers but rather compete among themselves for referrals from those who do—that is, real estate and mortgage professionals. This arrangement can create conflicts of interest if professionals making the referrals have a financial interest in the agent recommended. HUD and state insurance regulators have recently identified instances of alleged illegal activities within the title industry that appeared to compensate real estate agents, builders, and others for referring consumers to particular title insurers or agents. These alleged activities, which include referral fees, captive reinsurance arrangements, and inappropriate ABAs, potentially reduce price competition and, according to some insurance regulators, could indicate excessive pricing by insurers.[5] Third, as property values or loan amounts increase, prices that consumers paid for title insurance appeared to increase faster than insurers’ and agents’ costs. Insurers we spoke with argued that such a pricing structure reflected regulators’ intent to subsidize consumers in lowvalue transactions, but they could not provide data to support the existence of such subsidization. Of the six regulators we spoke with, only one said that such subsidization was intentional. Finally, in states where agents’ search and examination services are not included in the premium, it is not clear that the underlying costs justify the additional amounts consumers may pay to title agents. Insurers told us that they generally shared the same portion of premiums with their agents, regardless of whether agents’ costs for search and examination services were to be included in the premium. Ultimately, disagreement exists between title industry officials and regulators over the actual extent of price competition within title insurance markets. Industry officials generally assert that price competition exists, while many regulators argue (1) that it does not exist and (2) that consumers may be paying too much for title insurance compared with the cost of providing the insurance. Data collection efforts and regulatory oversight, especially of title agents, were limited across the states we reviewed. Given consumers’ apparently limited ability to exert pressure on title agents and insurers to compete on price, the critical question is whether amounts paid by consumers for title insurance reflect the actual underlying costs of producing title insurance policies. Potentially understanding the relationship between costs and the amounts consumers pay could help regulators improve their ability to protect consumers. Yet, states rarely audit agents; few require strong insurer oversight of agents; and, until recently, state regulators had done little to oversee ABAs or enforce laws intended to restrict business from affiliated sources. Also, because title insurance is a relatively small line of insurance, title insurers and agents get less than the usual limited market conduct scrutiny given other types of insurers by state insurance regulators.[6] All of the regulators, both state and federal, face a number of challenges. For example, varying levels of cooperation exist within each state among the regulators who oversee entities involved in the sale and marketing of title insurance, with some states demonstrating little or no cooperation and others having somewhat more structured arrangements. HUD—the primary federal agency responsible for enforcing the Real Estate Settlement Procedures Act (RESPA)—has taken a number of enforcement actions under RESPA recently, but HUD officials told us that they face resource

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limitations and difficulties in investigating increasingly complex ABA arrangements. Furthermore, HUD is authorized to seek injunctions against alleged violations of section 8 of RESPA’s provisions on referral fees and affiliated businesses, but HUD is not authorized to levy civil money penalties. Moreover, a lack of formal coordination between HUD and state regulators on referral fee cases may have hindered enforcement efforts. In response to these and other concerns, several state regulators and HUD are either planning or making changes to their regulatory regimes for the marketing and sale of title insurance. These changes include potentially reducing premium rates; collecting detailed cost data from title agents; and seeking changes to RESPA, including enhancing HUD’s enforcement authority. Some industry stakeholders see the current model of selling and marketing title insurance as irretrievably broken and have put forth the following two alternatives: (1) requiring lenders to pay for title insurance and (2) following the Iowa model of a state-run title insurer. We are recommending that HUD take two actions to improve the functioning of the title insurance market. Specifically, we are recommending that HUD (1) improve consumers’ ability to shop for title insurance based on price and (2) improve its ability to detect and deter violations of section 8 of RESPA. In taking these actions, we recommend that HUD consider expanding the information in its home-buyer information booklet; evaluating the costs and benefits to consumers from ABAs; clarifying regulations related to referral fees and ABAs; and enhancing the agency’s coordination with state regulators. Likewise, we are recommending that state insurance regulators, working through NAIC where appropriate, take two actions to improve the functioning of the title insurance market. Specifically, we are recommending that state regulators take action to (1) improve consumers’ ability to shop for title insurance and (2) improve their oversight of title agents. As part of this process, we are recommending that these regulators consider evaluating the competitive benefits of publicizing complete title insurance cost information; strengthening their regulation of title agents and ABAs, including the collection of data on title agents’ operations; and exploring ways to improve their cooperation with other state regulators and HUD. We also suggest, as a matter for congressional consideration, amending RESPA to give HUD increased enforcement authority for violations of RESPA’s section 8 prohibitions on referral fees by granting the ability to levy civil money penalties and enhance the information required to be provided to consumers. We provided a draft copy of this report to HUD and NAIC. The Assistant Secretary for Housing at HUD and the Executive Vice President of NAIC provided written comments on the draft. Their comments are included in appendixes III and IV, respectively, of this report. The Assistant Secretary for HUD generally agreed with the recommendations in the report, and also indicated that the report accurately assessed the issues that adversely affect consumers in the title insurance market. In response to our recommendation to better protect consumers and improve their ability to shop for title insurance, he acknowledged the importance of these goals and noted that HUD is taking several actions in these areas. Specifically, he said that HUD is (1) considering ways to improve its home-buyer information booklet; (2) evaluating whether various ABA structures, even though they may be legal, are operating as Congress intended; and (3) continuing its efforts to develop and clarify guidelines regarding practices that negatively effect consumers. With respect to our recommendation to consider improving regulatory coordination with state regulator agencies, the Assistant Secretary agreed that such coordination is necessary and pointed out past instances of successful cooperation between HUD and state insurance regulators. Lastly, he


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emphasized the ongoing challenge of RESPA enforcement without civil money penalty authority, stating that consumers would benefit if such authority were granted to HUD. The Executive Vice President of NAIC stated that the recommendations in the report were worthy of exploration, and she noted that the report recognizes that shortcomings exist in the area of consumer protection. Both HUD and NAIC also offered clarifying remarks.

BACKGROUND In any real estate transaction, the lender providing the mortgage needs a guarantee that the buyer will have clear ownership of the property. Title insurance is designed to provide that guarantee by generally agreeing to compensate the lender (through a lender’s policy) or the buyer (through an owner’s policy) up to the amount of the loan or the purchase price, respectively. Lenders also need title insurance if they want to sell mortgages on the secondary market, since they are required to provide a guarantee of ownership on the home used to secure the mortgage.[7] As a result, lenders require borrowers to obtain title insurance for the lender as a condition of granting the loan (although the buyer, the seller, or some combination of both may actually pay for the lender’s policy). Lenders’ policies are in force for as long as the loan is outstanding, but end when the loan is paid off (e.g., through a refinancing transaction); however, owners’ policies remain in effect as long as the purchaser of the policy owns the property. Title insurance is sold primarily through title agents, although insurers may also sell policies themselves. Before issuing a policy, a title agent checks the history of a title by examining public records, such as deeds, mortgages, wills, divorce decrees, court judgments, and tax records. If the title search reveals a problem, such as a tax lien that has not been paid, the agent arranges to resolve the problem, decides to provide coverage despite the problem, or excludes it from coverage. The title policy insures the policyholder against any claims that might have existed at the time of the purchase but were not identified in the public record. The title policy does not require that title problems be fixed, but compensates policyholders if a covered problem arises. Except in very limited instances, title insurance does not generally insure against title defects that arise after the date of sale. Title searches are generally carried out locally because the public records to be searched are usually only available locally. Title agents or their employees conduct the searches. The variety of sources that agents must check during a title search has fostered the development of privately owned, indexed databases called “title plants.” These plants contain copies of the documents obtained through searches of public records, and they index the copies by property address and update them regularly. Insurers, title agents, or a combination of entities may own a title plant. In some cases, owners allow other insurers and agents access to their plants for a fee. Title insurance premiums are paid only once, at the time of sale or refinancing, to the title agent. In what is called a premium split, agents retain or are paid a portion of the premium amount as a fee for conducting the title search and related work and for their commission. Agents have a fiduciary duty to account for premiums paid to them, and insurers generally have the right to audit the agents’ relevant financial records. The party responsible for paying for the title policies varies by state and even by areas within states. In many cases, the seller

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pays for the owner’s policy and the buyer pays for the lender’s policy, but the buyer may also pay for both policies or split some or all of the costs with the seller. In most cases, the owner’s and lender’s policies are issued simultaneously by the same insurer, so that the same title search can be used for both policies. The price that the consumer pays for title insurance is determined by applying a rate set by the underwriter or state to the loan value (for the lender’s policy) and home price (for the owner’s policy). In a recent nationwide survey, the average cost for simultaneously issuing lender’s and owner’s policies on a $200,000 loan, plus other associated title costs, was approximately $859, or approximately 28 percent of the average total loan origination and closing fees.[8] Title insurance differs from other types of insurance in key ways. First, in most property and casualty lines, losses incurred by the underwriter account for most of the premium. For example, property-casualty insurers’ losses and loss adjustment expenses accounted for approximately 73 percent of written premiums in 2005.[9] In contrast, losses and loss adjustment expenses incurred by title insurers as a whole were approximately 5 percent of the total premiums written, while the amount paid to or retained by agents (primarily for work related to title searches and examinations and for commissions) was approximately 70 percent. Second, title agents’ roles and responsibilities differ from those of agents for other lines of insurance. Agents in lines of insurance other than title insurance primarily serve as salespeople, while title agents’ work can be a labor-intensive process of searching, examining, and clearing property titles as well as underwriting and traditional sales and marketing. Title agents access and examine numerous public documents, among them tax records, liens, judgments, property records, deeds, encumbrances, and government documents, and then clear or exclude from coverage any title problems that emerge. Depending on the level of technology used, the accessibility of public documents, the relative efficiency of local government recorders’ offices, and other factors, this process can take from a few minutes up to a few weeks or more. In some states, title agents also are responsible for claims up to a specific dollar amount. Most title agents also handle the escrow and closing processes and document recordation after the closing. In general, title agents issue the actual insurance policy and, after deducting expenses, remit the title insurer’s portion of the premium. Third, unlike premiums for other types of insurance, title insurance premiums are nonrecurring. That is, title insurers have only one chance to capture the cost of the product from the consumer, unlike other types of insurers that collect premiums at regular intervals for providing ongoing coverage. The title insurance premium amount must cover losses for any future problems that were either not uncovered in the title agent’s search or, for a small number of policies, problems that emerge after the day of closing. Fourth, title insurance has a different coverage period than other types of insurance. With title insurance, coverage begins on the day of closing and goes back in time. Most policies cover events that occurred in the past, including unpaid tax liens, judgments, issues with missing heirs, and forgeries in the document chain of title. The purpose of the title agent’s search is to turn up these problems before closing so that they can be cleared or excluded from coverage. However, if a problem occurred in the past but only emerged after the day of closing and was not excluded from coverage, then the policy would offer protection to the lender and home owner. The comprehensiveness of the agent’s search can be a factor in minimizing such losses. For this reason, title insurance is often referred to as loss prevention


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insurance, in contrast to other types of insurance that attempt to prospectively minimize exposure to claims. Finally, the title insurance market’s business cycle is more closely related to the real estate market and to interest rates than the business cycle for other types of insurance. Typically, this relationship is inverse, so that the revenues of title companies rise when interest rates fall, largely because lower interest rates usually lead to a surge in home buying and refinancing and thus increase demand for title services and products. Under current federal law, the regulation of insurance, including title insurance, is primarily the responsibility of the states. However, title insurance entities are also subject to RESPA, a federal law intended to improve the settlement process for residential real estate. Section 8 of RESPA generally prohibits the giving or accepting of kickbacks and referral fees among persons involved in the real estate settlement process. Section 8 also lays out the conditions under which ABAs are permissible. First, the affiliation must be disclosed to the consumer, along with a written estimate of charges. Second, ABA representatives may not require consumers to use a particular settlement service provider. Third, the only thing of value that ABA owners may receive, other than payment for services rendered, is a return on their ownership interest. In addition, HUD has issued policy statements that describe multiple factors, including what it considers to be core title services, that HUD will use in determining if an entity is a bona fide provider of settlement services. HUD is responsible for administering section 8 of RESPA, but its enforcement authority is limited to seeking injunctions against potential violations. Unlike other sections of RESPA (e.g., section 10, which authorizes HUD to assess civil money penalties for certain violations by entities that fail to provide escrow account statements), section 8 of RESPA does not authorize HUD to levy civil money penalties for violations.

TITLE INSURANCE MARKET IS HIGHLY CONCENTRATED AT THE INSURER LEVEL, BUT OTHERWISE DIFFERS ACROSS STATES Title insurance markets can be described by various characteristics, such as the following: •

• • •

While high market concentration exists among national title insurers, they market insurance through large numbers of independent and affiliated agents, with the mix varying across states. The use of ABAs—in which a real estate professional, such as a real estate agent, owned a share of a title agency—varied. Processes used by agents to conduct searches and examinations in some states were more efficient than others, and the responsibilities of title agents also varied. Premiums across states are difficult to compare, but they appeared to vary significantly.

Nationally, five title insurers, or underwriters, captured about 92 percent of the market in 2005 (see figure 1). Most states were dominated by a group of two or three insurers, sometimes including a regional insurer. For example, in California, about 66 percent of the

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market share in 2005 was split nearly evenly between the largest two insurers—First American and Fidelity. The remaining approximately 33 percent of the market was predominantly split among the other three national insurers (25 percent) and five regional independent insurers (8 percent). Although they are national insurers, these five major underwriters sell and market title insurance in local markets through networks of direct operations, partial or full ownership of affiliates, and contracts with independent agents. According to the annual reports of the four largest title insurers, they each use between 8,000 and 11,000 agencies to sell their insurance nationwide.

Source: GAO analysis of industry data. Note: Total may not add up to 100 percent due to rounding. Figure 1. Title Insurer National Market Share as a Percentage of Direct Premiums Written, 2005.

Mix of Affiliated and Independent Agents Differs by State Most state markets have two types of title agents: affiliated and independent. Title insurers use both types of agents, depending on conditions in the local market, including local tax policies and established market practices, as well as the level of service the underwriter provides to the agents. Affiliated agents carry higher fixed costs to the insurer as owner, and underwriters told us that these costs were especially challenging when the market softened and the insurer’s tax liability for affiliated agents rose. However, insurers also said that with affiliated agents they had more control over the premium split and, because the agents were


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closely aligned with the underwriter, did not have to provide as much in services, such as training. Underwriters noted that they also benefited from contracting with independent agents because doing so kept their fixed costs low and allowed them to benefit from some tax advantages. However, according to the insurers, contracting has its disadvantages, by obliging the insurers to negotiate a competitive premium split (in nonpromulgated states) or risk having the agent establish a relationship with another underwriter.[10] Independent agents, who work with several underwriters, also may not provide the guaranteed flow of business, and thus the same revenue stream, as affiliated agents. Underwriters balance these benefits and risks when determining which agents they will use in each state. Two underwriters told us that they strive to maintain about an equal balance between affiliated agents and independent agents. Other insurers told us that, because their expenses can be higher by virtue of their ownership interest in affiliated agents, they were reluctant to take on too many affiliated agents and preferred to contract with independent agents, especially when market conditions declined. However, several industry participants told us that underwriters’ purchase and use of affiliated agents in some states had increased significantly over the last 5 years. As shown in figure 2, affiliated agents dominated the market in California, the state with the largest total of premiums written, while independent agents capture the majority of the markets in Colorado, Illinois, and New York. Conversely, the Texas market was relatively more evenly balanced, with insurers, affiliated agents, and independent agents sharing the number of premiums written. In Iowa, the state-run Title Guarantee Division of the Iowa Finance Authority has a slight majority of the market and independent agents have most of the remainder.

Source: GAO analysis of title industry data. a Premiums listed as being written directly by insurer are those written by the state-run Title Guarantee Division of the Iowa Finance Authority. Premiums written by affiliated or independent agents are premiums written by out-of-state title insurers on properties in Iowa. Figure 2. Title Insurance Premiums Written, by Source, 2005.

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Use of Affiliated Business Arrangements Appears to be Increasing We found that the use of ABAs varied by insurer and location. ABAs generally involved a referring entity, such as a real estate or mortgage professional, or builder, having full or partial ownership of an agency (see figure 3). For example, a mortgage lender and a title agent might form a new jointly owned title agency, or a builder might buy a portion of a title agency. The owners of ABAs are to split the revenues in proportion to their ownership shares to satisfy antirebating laws.

Source: GAO analysis of interviews with industry officials. Figure 3. Example of an Affiliated Business Arrangement.

Nationally, the use of ABAs appears to be growing. For example, according to a study done for the Real Estate Services Providers Council (RESPRO), affiliated title agents accounted for approximately 26 percent of title-related closing costs in 2005, up from about 22 percent in 2003.[11] Although precise data showing state-by-stategrowth were not available, industry participants in some states—especially Colorado, Illinois, Minnesota, and Texas—told us that the number of ABAs in their states had grown significantly.[12]

Agents Conduct the Title Search and Examination Process Differently Across States We found that while the basic title search and examination process shared certain elements across states, the process was more efficient in some states than in others. Figure 4 describes the common elements of the title search and examination process, which begins with a request from the consumer’s representative and intake by the title agent. The agent then performs the search, and a title examiner hired by the title agent analyzes the collected documents to identify any potential problems to be cleared. Once any identified problems are cleared, exempted from coverage, or insured over, the title agent prepares the closing documents and collects and disburses checks at the closing. Finally, the agent deposits


13

collected funds in escrow accounts, records the deed or title with the relevant local government offices, and submits the title commitment to the insurer for policy issuance.

Sources: GAO observation of title plant operations and analysis of comments made by title industry officials; Art Explosion (images). Figure 4. Common Elements of the Title Search and Examination Process.

Agents in some states use primarily automated processes, either owning or purchasing access to a title plant.[13] Because of these plants, the title search process in these states can be very efficient, which can decrease the amount of time required to issue a title insurance policy. Some of the most advanced of these title plants have documents scanned from local government sources, indexed and cross-referenced by various types of identifying information. Four of the title data centers we visited had electronic records going back 20 years or more. During a tour of one title plant in Texas, we observed a title examiner obtain nearly all documents pertinent to the title search and examination in electronic format within seconds. If the title examiner did not have immediate access to a necessary document, she would e-mail the owner of that information and have it sent electronically or through the mail from one of the search services to which the plant subscribed, usually within 1 day or less. For this plant, typical turnaround time for a completed title search, examination, and commitment for a title examiner simultaneously working on several titles was 2 to 3 days. In another highly automated plant located in a large urban center, we were told that the typical title search and examination took about 25 minutes. One of the nation’s largest title insurers, First American, recently announced that with new software developments, its agents could produce a fully insured title commitment in 60 seconds for many refinance transactions. In contrast, in a less-efficient process, agents in some states must physically search public records, which can add to the time required to issue a policy. In New York, for example, title plants are rare, and title agents commonly employ abstractors and independent examiners who must go to various county offices and courthouses to manually conduct searches. Including the process of clearing title problems and attorney review, one underwriter told us that in New York, the typical title insurance issuance took 90 to120 days for a purchase and 30 to 45 days for a refinance. Most historical data are proprietary to each underwriter and are based on previously insured titles. At an underwriter-owned title plant in an East Coast city, described as typical for the region, we saw that although the plant held approximately 1.5 million records of previously insured titles, few records were updated when a new search came in on that same property. Personnel at the plant said that it was too labor-intensive to

14


consolidate all of the files, although not updating the files resulted in a large number of redundancies in records across the plant. Also, in some states, industry participants told us that delays in recording and processing at local government offices contributed greatly to inefficiencies in the issuance process.

Title Agents’ Responsibilities Also Differ Across States We found that the extent of title agents’ responsibility for claims losses, involvement in the closing process, and ability to set premiums varied widely across states. For example, in some states, agents are responsible for a specific portion of losses on claims. In California and Colorado, the underwriter-agent agreement stipulates that title agents are responsible for up to the first $5,000 of a title claim.[14] Underwriters said that this deductible gave agents an incentive to conduct more diligent searches and examinations. In other states, agents are not responsible for a specific portion of a claim but may take responsibility for some part or all of it, especially if the claim is small. According to agents in New York and Minnesota, it is faster, more efficient, and more customer-friendly for the agent to handle smaller claims rather than passing them on to the underwriter. An industry organization said that current, informal agent claims practices show that agents generally take responsibility for claims under $2,500. Independent agents told us that the industry is moving toward more risk borne by the agents. In fact, agent application and review documents that we obtained from underwriters showed that the number and amount of claims the agent was responsible for were criteria insurers used when deciding whether to retain independent agents. One underwriter told us that although their agents did not have deductibles, the insurer was able to recover about $10 million in funds from agents on claims the underwriter had already paid through aggressive follow-up on and investigation into possible errors on previously paid claims. Some agents are also involved in more aspects of the closing process. We found that some agents handled the entire closing process, including the escrow, while others did not handle the escrow portion. These practices varied within as well as across states. In California, for example, title agencies have both underwriter and agent-controlled escrow companies that handle the full escrow process and actively market those services. These agencies offer a full package of closing services, from title search, examination, and clearance to document preparation and disbursement of funds at the closing. Other title agents were independent from escrow companies. In some states, such as New York, where it is customary for the home buyer and seller to have a lawyer present at the closing, title agents employ closers, whose chief duty is to handle the checks for taxes and escrow and to record the deed. Similarly, in Illinois, the lawyers actually serve as attorney-agents and are prohibited by the underwriter from handling the escrow. Finally, in some states, title agents determine the amount to charge consumers for the search and examination portion of the premium, while in other states, they do not. The states where they do are referred to as “risk-rate” states because only the insurance, or risk-based, portion of the premium is regulated. In these states, state regulators review underwriters’ rates for the risk-based portion of the premium, but the agents set the fees for search and examination services (generally the larger part of the cost to consumers) without regulatory review. According to ALTA, 30 states plus the District of Columbia are considered risk-rate


15

states. The rest of the states, excluding Iowa, are considered to be all-inclusive because they incorporate charges for the risk-based portion of title insurance and other fees, such as those for the search and examination, in the regulated premium. The premium may or may not include settlement and closing costs. In these all-inclusive states, agents are not able to determine the price they will charge for searches and examinations, because they are required to charge the rates set by the state or the underwriter. Insurers set their premium rates based on their own expected costs and how much of the premium they have agreed to split with the agent.

Premiums Are Difficult to Compare Across Markets, but Appear to Vary Significantly Because title insurance premium rates depend on the amount of the loan or value of the home being insured, premiums differ widely across states. Figure 5 shows the premium rates for median-priced homes in major cities in our sample states.

Source: GAO analysis of National Association of Realtors’ and title industry data. Note: Rates are either from the largest underwriter or are promulgated rates. a Lender’s policy rate used in the Iowa data because a rate was not given for the owner’s policy. Although the premium would be $146, according to Iowa Title Guaranty officials, additional required services would add approximately another $550, for a total of approximately $700. Figure 5. Title Insurance Premium Rates for a Basic Owner’s Policy on Median-Priced Homes in Selected Areas, 2005.

One reason title insurance premium rate comparisons are difficult is because, as we previously mentioned, items included in the premium varied by state. A study from insurance regulators in Florida, where rates are promulgated and include the risk portion only, noted that what all-inclusive rates include varies even among the all-inclusive states.[15] According to the study, in Texas and Pennsylvania, the premium includes the risk portion, search and examination costs, and settlement fees, while in California, the all-inclusive rate does not include settlement and closing costs. The Florida study also noted that one state (Utah) includes closing costs but not searches and examinations, and another state (Illinois) allows the entire rate to be determined competitively as either risk-based or all-inclusive.

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A national survey conducted by Bankrate.com in 2006 also showed significant differences in title premiums across states.[16] This survey of the 50 states and the District of Columbia compiled average mortgage closing costs, including title insurance, search and examination and settlement costs, and origination fees, using data obtained from as many as 15 of the largest national lenders’ online quote systems. The survey calculated costs for a standard $200,000 loan in one Zip Code of the largest urban center in each state. The data showed costs ranging from a high of $3,887 to a low of $2,713, with a national average of $3,024. Bankrate.com representatives attributed most of the difference across states to wide disparities in the cost of title insurance, which they found varied almost 64 percent, from a high of $1,164 to a low of $418. The average was $663. However, these data must be viewed with caution because they do not account for differences in what could be included in the premium. Moreover, since these data came from only one Zip Code per state, they may not be representative of other localities. Industry officials said that rates vary because of differences in what was included in the rate and in standard business costs in each area. Nearly all of the industry participants we spoke with emphasized that title insurance is a local business, varying both within and across states. They said that state property, trustee, probate, and estate laws could partially explain the rate differences. In some states, these requirements make it much more expensive to do the search and examination work and clear all of the risks through the examination process. Experts told us that trying to compare rates across states would not be meaningful because of the differences in the components of the premium.

MULTIPLE FACTORS RAISE QUESTIONS ABOUT THE EXTENT OF COMPETITION AND THE REASONABLENESS OF PRICES IN THE TITLE INSURANCE INDUSTRY Among the factors raising questions about the existence of price competition and the resulting prices paid by consumers within the title insurance industry are the following: • •

•

• •

Consumers find it difficult to shop for title insurance, therefore, they put little pressure on insurers and agents to compete based on price; Title agents do not market to consumers, who pay for title insurance, but to those in the position to refer consumers to particular title agents, thus creating potential conflicts of interest; A number of recent investigations by HUD and state regulatory officials have identified instances of alleged illegal activities within the title industry that appear to reduce price competition and could indicate excessive prices; As property values or loan amounts increase, prices paid for title insurance by consumers appear to increase faster than insurers’ and agents’ costs; and In states where agents’ search and examination services are not included in the premium paid by consumers, it is not clear that additional amounts paid to title agents are fully supported by underlying costs.


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Disagreement exists between title industry officials and regulators over the actual extent of price competition within title insurance markets, with industry officials asserting that such competition exists and a number of regulators stating that a lack of competition ultimately results in excessive prices paid by consumers.

Lack of Consumer Knowledge about Title Insurance Results in Little Pressure on Insurers to Compete on Price For several reasons, consumers find it difficult to shop for title insurance based on price, raising questions about the existence of price competition in title insurance markets. First, most consumers buy real estate—and with it, title insurance—infrequently. As a result, they are not familiar with what title insurance is, what reasonable prices might be, or which title agents might provide the best service. According to a study commissioned by the Fidelity National Title Group, Inc., in response to proposed regulatory changes in California, it is typically not worth an individual’s time to become more educated about title insurance, because any resulting savings would likely be relatively small.[17] That is, the cost to consumers of becoming sufficiently educated to make an informed decision is potentially higher than the risk of paying more to a title agent suggested by a real estate or mortgage professional. However, one potential consequence of a failure to shop around was noted by several of the state insurance regulatory officials that we spoke with, who expressed concern that consumers may not be getting the discounts for which they are eligible. For instance, insurers may give (1) discounts on mortgage refinance transactions because the previous search and examination were fairly recent and (2) discounts to first-time home buyers or senior citizens. Several title industry officials agreed that consumers might not be aware of such discounts and may, in some cases, not be receiving discounts to which they are entitled. Second, consumers may have difficulty comparing price information from different title agents because many title agents also charge for services that are not included in the premium rate, such as fees related to real estate closing and other administrative fees. In states where title agents charge separately for search and examination services, such charges can be as large as the title insurance premium itself. Thus, even if consumers collected and compared premium rates, which are posted on some states’ Web sites, they might not get an accurate picture of all the title-related costs they might pay when using a particular agent. Third, title insurance is a smaller but required part of a larger transaction that consumers are generally unwilling to disrupt or delay. As we have seen, lenders generally require home buyers to purchase title insurance as part of any real estate purchase or mortgage refinancing transaction. However, purchasing title insurance is a relatively small part of such transactions. For example, according to an analysis by the Fidelity National Title Group, Inc., in 2005 in California, on a transaction with a sales price of $500,000 and a loan amount of $450,000, title insurance costs, on average, amounted to only 4 percent of total closing costs, including the real estate agent’s commission (see figure 6). Even when the seller pays the real estate agent’s commission, title insurance costs are still small compared with the size of the buyer’s transaction. In addition, it appears that by the time consumers receive an estimate from the lender of their title insurance costs as part of the Good Faith Estimate, a title agent has already been selected, and the title search has already been requested or completed.[18] To shop around for another title insurer at that point in the process could also threaten to delay the

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scheduled closing. According to a number of title industry officials and state insurance regulators we spoke with, most consumers place a higher priority on completing their real estate transaction than on disrupting or delaying that transaction to shop around for potentially small savings.

Source: Fidelity National Title Group, Inc. Note: Calculations done using a $500,000 sales price and a $450,000 loan amount. We did not verify the data supporting this analysis. Figure 6. Average Allocation of Closing Costs in California, 2005.

HUD publishes an informational booklet designed to help fulfill RESPA’s goal of helping consumers become better shoppers for mortgage settlement services, including title insurance. Although this document provides much useful information, it is generally distributed too late in the home-buying process to help consumers with respect to title insurance, and it lacks some potentially useful information. RESPA currently requires lenders to provide the booklet to consumers within 3 days of the loan application. HUD officials recognize the need to get this information to consumers earlier and recommended in a 1998 study that real estate agents, as well as lenders, provide the information at first contact.[19] Furthermore, RESPA only requires the information to be distributed in a transaction involving a real estate purchase, and not in other transactions, such as mortgage refinances, where title insurance is also required by lenders. The usefulness of the informational booklet is further limited by the absence of information on the discounts most title insurers provide and on potentially illegal ABAs.


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Because consumers may not have access to potentially useful information when purchasing title insurance, they may not be able to make well-informed decisions on the purchase of title insurance. Specifically, consumers may face difficulty in independently collecting information on all amounts charged by title agents in order to comparison shop. In addition, the limitations in the content of HUD’s information booklet and when consumers receive it can result in consumers’ getting information too late in the process, thereby hindering their ability to influence the selection of a title agent or insurer. Moreover, several state insurance regulators expressed concern that consumers might not be getting all available discounts because they do not know they are available or that they are entitled to the discounts. In addition, HUD officials said that the use and complexity of ABAs in the title industry has increased, and consumers could benefit from additional information in this area.

Title Agents Market Not to Consumers, but to Those in a Position to Make Referrals, Creating Potential Conflicts of Interest Another factor that raises questions about the existence of price competition is that title agents market to those from whom they get consumer referrals, and not to consumers themselves, creating potential conflicts of interest where the referrals could be made in the best interest of the referrer and not the consumer. Because of the difficulties faced by consumers in shopping for title insurance, consumers almost always rely on a referral from a real estate or mortgage professional. In fact, some insurance regulatory officials we spoke with said they are concerned that consumers may not even be aware they are able to choose their own title agent and insurer. According to title industry officials, because of consumers’ unfamiliarity with and infrequent purchases of title insurance, it is not cost-effective to market to them. Rather, title agents market to and compete for referrals from real estate and mortgage professionals. According to title industry officials, competition among title agents for consumer referrals is very intense and motivates them to provide excellent service to real estate and mortgage professionals. This is because if they do not provide good service, those professionals will send their future referrals elsewhere. Both title and real estate industry officials told us that such professionals have a strong interest in customers’ having a good experience with respect to the portion of a closing conducted by a title agent, because customers’ experiences there will reflect back on the professional. As a result, they said, such competition on the basis of service benefits consumers. However, this competition among title agents for consumer referrals is also characterized by potential conflicts of interest, since those making the referrals may have the motivation to do so based on their own best interests rather than consumers’ best interests. Real estate and mortgage professionals interact more regularly with title agents and insurers than do consumers and, thus, are likely to have better information than consumers on the prices and quality of work of particular title agents and insurers. To the extent the interests of those professionals are aligned with those of the consumers they are referring, the knowledge and expertise of those professionals can benefit consumers. However, conflicts of interest may arise when the professional making the referral has a financial interest in directing the consumer to a particular title agent. Under such circumstances, the real estate or mortgage professional may be motivated to make a consumer referral not based on the customer’s best

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interests but on the professional’s best interests. For example, a real estate professional may be a partial or full owner of a title agency, such as through an ABA, and therefore receive a share of the profits earned by that agency. As such, the professional may have an incentive to refer customers to that title agency.

Alleged Illegal Activities Appear to Reduce Competition and Could Indicate Excessive Prices Paid by Consumers Examples of Allegedly Illegal Referral Fees Described in Investigations by HUD and State Insurance Regulators • • • • •

A title agent paid real estate agents’ business training and printing expenses. A title agent provided trips, entertainment, and catering for entities involved in real estate transactions. A title agent contributed to a pool of funds that was given away in a drawing among real estate agents. A title agent paid an excessive rate to rent a conference room from a real estate company. Title agents provided free or below-cost marketing services to real estate agents.

In recent years, HUD and state insurance regulators have identified a number of allegedly illegal activities related to the marketing and sale of title insurance that appear to be designed to obtain consumer referrals and, thus, raise questions about competition and, in some cases, the prices paid by consumers (see sidebar). In addition, several title insurers and agents told us that they lost market share because they did not provide some compensation for consumer referrals. The payment or receipt of compensation for consumer referrals potentially reduces competition because the selection of title insurer or agent might not be based on the price or quality of service provided, but on the benefit provided to the one making the referral. The giving or receiving of anything of value in return for referral of consumers’ title insurance business is a potential violation of RESPA and many state laws. For example, it might be illegal for a title insurer to provide free business services to a realtor in exchange for that realtor’s referring consumers to the title agent. It might also be illegal for the realtor to accept those services. Nonetheless, state and federal regulators have identified a number of alleged instances of such payments, resulting in those involved paying over $100 million in fines, penalties, or settlement agreements. Table 1 summarizes these investigations. From 2003 to 2006, insurance regulators in three of our six sample states had concluded at least 20 investigations related to the alleged payment of referral fees, involving over 52 entities, including title insurers, title agents, and builders.[21] As a result of these investigations, the entities involved were ordered to pay or agreed to pay approximately $90.6 million in the form of consumer refunds, fines, and settlements. Over the same period, HUD concluded at least 38 enforcement actions resulting in settlements related to alleged referral fee violations. These actions involved at least 62 entities and resulted in those entities’ being ordered to pay or agreeing to pay approximately $10.7 million.


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Table 1. Information on Closed Cases and Settlements Involving Referral Fees Resulting from Investigations by Insurance Regulators in Six Sample States and HUD, 2003-2006 Dollars in millions Investigating organizationa

State insurance regulators California Department of Insurance Colorado Department of Regulatory Agencies, Division of Insurance New York State Insurance Department Subtotal HUDe Subtotal Total

Closed cases and settlements involving referral fees

Entities involvedb

Amount that entities were ordered to pay or agreed to payc

Portion of total payments involving captive reinsuranced

12

26

$61.3

$37.9

6

24

$25.3

$25.3

2

2

$4.0

-

20 38 38 58

52 62 62 114

$90.6 $10.7 $10.7 $101.3

$63.2 $3.6 $3.6 $66.8

Source: GAO analysis of state and HUD data. a Insurance regulators in Illinois, Iowa, and Texas, our other sample states, did not have any such closed cases or settlements. b Entities involved in multiple cases and settlements were counted once for each case in which they were involved. c Amounts paid included any refunds to consumers, fines, or settlement amounts. d In captive reinsurance arrangements, a home builder, real estate broker, lender, title insurance company, or some combination of these entities forms a reinsurance company that works in conjunction with a title insurer. Some investigations alleged that these arrangements were used as a means of paying referral fees. e Amounts paid to HUD reflect only negotiated settlements, because HUD cannot levy civil money penalties.

Several insurance regulators in states outside of our sample states, while not completing enforcement actions or reaching settlement agreements, expressed concerns over activities related to referral fees. For example, in October 2006, the Washington State Office of the Insurance Commissioner published the results of its investigations into referral practices in the title industry in Washington.21 According to the report, the use of inducements and incentives by title companies to obtain title insurance business appeared to be “widespread and pervasive,” and these inducements were used to influence referrals by real estate agents, banks, lenders, builders, developers, and others. The inducements included, among other things, the provision of advertising services, open houses, entertainment, and educational classes. According to the report, the regulator decided not to take any enforcement actions on the basis of the activities they identified because of the expense of doing so and because the regulator accepted some responsibility for allowing such a situation to develop. However, the report also stated that the regulator would put the industry on notice that there would be consequences for any future violations.

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In Illinois, the state title insurance regulator issued a series of bulletins and informational handouts in 2005 and 2006 that expressed concerns over potentially illegal referral fees and inappropriate ABAs.[22] The regulator had found that some title agents were using title service companies (owned by title insurers) that in some cases performed almost all titlerelated work, such that all the title agent had to do was sign and return some documents in exchange for receiving part of the premium. According to the regulator, such arrangements would violate state law requiring title agents to perform certain minimal activities in return for fees received from consumers. The regulator told us that the companies involved in these activities were cooperative in ceasing such activities and, as a result, the regulator was not pursuing any enforcement actions. Such arrangements, however, (1) may constitute an illegal referral fee under RESPA and (2) appear to be very similar to activities that were the subject in Illinois of state and HUD investigations in 1990 and 1991, resulting in a $1 million settlement between HUD and the title insurer involved. Finally, in April 2006, the state title insurance regulator in Alaska published a summary of title insurance examinations in which they expressed concern that title agents and real estate service providers were entering into business arrangements that blurred the line between legitimate transactions and illegal kickbacks.[23] Such arrangements, the report noted, may undermine competition and be an indication that premium rates are excessively high. The report stated that the insurance regulator is contemplating new regulations regarding the legality of these arrangements, but the regulator will first obtain industry input through public hearings. Overall, the alleged referral fee arrangements identified in the state and HUD investigations could potentially indicate that those making consumer referrals did so based on their own interests, and may not have resulted in obtaining the best prices for consumers.

Allegedly Illegal Captive Reinsurance Arrangements Could Indicate Consumers Were Paying Excessive Prices for Title Insurance Example of a Captive Reinsurance Arrangement In one multistate settlement that involved 26 state insurance regulators, regulators alleged that title insurers and home builders created captive reinsurance arrangements. Under these arrangements, the insurers deducted a processing fee of $350 from the premium, then paid 50 percent of the remainder to a reinsurer for assuming 50 percent of the policy risk. The reinsurers, in turn, provided referrals to the title insurers. For example, in Colorado, a party to the settlement, the premium charged by one of the companies involved for an owner’s and lender’s policy on a $250,000 loan and purchase price was $1,614. In 2005, the combined loss ratio for all insurers in Colorado was approximately 4.5 percent. Under the arrangement described by regulators, on a hypothetical $250,000 transaction, the reinsurer would collect approximately $632 for assuming expected losses of about $36 (4.5 percent of the $1,614 premium), for a net profit of about $596. In other words, about 37 percent of the $1,614 paid by the consumer would allegedly go to the reinsurer as compensation for its builder, lender, or real estate broker-owner allegedly referring business to the insurer. From 2003 through 2006, state and HUD investigations of captive reinsurance arrangements, a potential form of referral fees, resulted in payments by insurers and other entities of approximately $66.8 million, as previously shown in table 1.[24] Specifically, we identified 13 investigations involving 37 entities that were related to captive reinsurance


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arrangements, with 1 multistate settlement agreement involving activities in 26 states. In such arrangements, a home builder, real estate broker, lender, title insurance company, or some combination of these entities forms a reinsurance company that works in conjunction with a title insurer (see sidebar). The insurer agrees to “reinsure” all or part of the business it receives from the reinsurer’s owners with the reinsurer by paying the company a portion of the premium (and allegedly transferring a portion of the risk) for each title transaction. Investigators alleged that the amounts received by these reinsurers exceeded the risk they assumed—particularly because virtually no claims were filed with either the insurer or the reinsurer—and considered these arrangements as a way to pay for referrals, allegedly violating RESPA’s prohibitions on such payments. In settlement agreements with a lender and several home builders in 2006, HUD stated that there is almost never a bona fide need or business purpose for title reinsurance on a single family residence, especially from an entity or an affiliate of an entity that is in a position to refer business to the title insurer. In addition, HUD stated that when the payments to the captive reinsurer far exceed the risk borne by the builders, lenders, or real estate brokers, there is strong evidence that such an arrangement was created to pay referral fees and, therefore, is illegal. Figure 7 provides an example of a captive reinsurance arrangement described in a multistate settlement administered by the Colorado Division of Insurance in 2005.

Source: GAO. Figure 7. Example of an Alleged Captive Reinsurance Arrangement.

According to several state insurance regulators, the activities involved in such captive reinsurance arrangements suggest that title insurance premiums paid by consumers may be substantially higher than the cost of providing that insurance. The arrangements generally involved a title insurer taking the premium from a consumer, subtracting a certain amount to cover the cost of a title search and examination, then splitting the remainder with the reinsurer. On the basis of details provided in a multistate settlement, insurers were allegedly giving away as much as one-third or more of the premiums consumers paid in order to obtain consumer referrals. In 2005, industrywide loss and loss adjustment expenses only totaled

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about 5 percent of the total premiums written. The regulators stated that insurers’ willingness to pay such a large portion of the premium to obtain consumers’ title insurance business suggested that insurers overcharged consumers for this insurance.

A Number of Investigations Found ABAs Allegedly Being Used to Pay Referral Fees, Raising Questions about the Cost and Benefits of ABAs to Consumers A number of investigations found that ABAs were allegedly being used to compensate ABA owners—often real estate or mortgage professionals—for consumer referrals, raising additional questions about competition in the title insurance industry. RESPA allows ABAs, provided that (1) a disclosure is made to the consumer being referred that describes the nature of the relationship, including financial interests, between the real estate settlement service provider and the person making the referral; (2) compensation for the referral is limited to a return on the ownership interest; and (3) the consumer being referred is not required to use a particular title agent. HUD has also issued a policy statement setting forth factors it uses to determine whether an ABA is a sham under RESPA or a bona fide provider of settlement services. These factors include whether the entity actually performs substantial services in return for fees received, the entity has its own employees to perform these services, and the entity has a separate office. Nonetheless, federal and state investigations identified a number of ABAs that were alleged to be “shell” title agencies that either had no physical location, employees, or assets or did not actually perform any title services. Regulators alleged their primary purpose was to serve as a pass-through for payments or preferential treatment given by the title agent to real estate agents and brokers, home builders, attorneys, or mortgage brokers for business referrals. Over the past 4 years, HUD has completed at least 9 investigations of ABAs, involving at least 17 entities and resulting in approximately $1.8 million being paid by those entities in settlements and refunds. A Colorado investigation found that a single licensed title agent was owner or part owner of 13 sham title agencies that were allegedly used to pay referral fees to mortgage brokers. A number of regulators and industry participants we spoke with expressed concerns about the growing use of ABAs in the title industry. For example, HUD officials have said that while properly structured ABAs may provide some consumer benefits, they also create an inherent conflict of interest as the owner of an ABA is in a position to refer a consumer to that same ABA. They expressed concern that ABAs could be used as a means to mask referral fees, which are generally illegal under RESPA, and that they were seeing more complex arrangements in which it was becoming increasingly difficult to trace the flow of money and to determine if the agents involved in ABAs were actually performing core title services. Several state insurance regulators we spoke with expressed similar concerns. For example, Colorado insurance regulatory officials were concerned over the extent of sham ABAs in Colorado that were potentially being used as a means to pay referral fees. Those officials also said that, on the basis of their work with NAIC’s Title Insurance Working Group, other state insurance regulators that had begun to examine ABAs were also finding potentially illegal activities. For instance, in a September 2005 settlement in Florida, 60 sham title agencies affiliated with 1 underwriter were alleged to have been fronts for referral fees. Some title industry participants expressed concern that ABAs might also restrict competition. They said that when a real estate or mortgage brokerage firm, for example, owns an ABA, other title agents are generally barred from marketing their services to individuals working for that firm. In addition, they said that most or all of the consumer referrals from a


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brokerage that is an owner of an ABA generally go to that ABA. As a result of this guaranteed order flow, they said, the title agents at that ABA might not be as interested in competing on price or service. In contrast, some title industry officials said ABAs can be beneficial because they provide consumers with better service and potential cost savings. According to an industry organization, ABAs can increase consumer satisfaction through the convenience of one-stop shopping. Furthermore, they benefit their owners and consumers by giving owners greater accountability and control over quality. Industry participants also stated that because of the ability to take advantage of efficiencies, ABAs can result in potential cost savings for the consumer. A recent study sponsored by RESPRO, an industry group that promotes ABAs, concluded that title agents that are part of an ABA do not charge consumers any more than title agents that are not part of an ABA.[25] ABA proponents, and others, also stated that ABA owners, such as real estate or mortgage brokers, often have little leverage in encouraging their real estate agents and brokers to refer consumers to the ABA title agent. They said that these individuals compete based on their reputation, and that recommending a title agent that provided poor service would damage that reputation. As a result, they will only refer consumers to an ABA title agent if it provides good service. Industry organizations we spoke with said that they did not collect data on the percentage of business ABA title agents get from their owners’ businesses. Overall, the concerns expressed by regulators and some industry participants over ABAs raise questions about the potential effects of some ABAs on consumers. Specifically, concerns about some ABAs being used as a means of paying illegal referral fees raise questions about whether referrals are always being made in consumers’ best interests. In addition, concerns about some ABAs potentially restricting competition among title agents raise questions about the extent of competition that is beneficial to consumers.

As Coverage Amounts Increase, Premiums Paid by Consumers Appear to Increase Faster than Insurer and Agent Costs Another factor that raises questions about the prices consumers pay for title insurance is that as the purchase price or loan amount on which a policy is issued increases, the amount paid by consumers appears to increase faster than the costs incurred by insurers and agents in producing that policy. A number of title insurers and agents we spoke with said that they made more money on high-priced transactions than on low-priced transactions because, while premiums increased with price, insurers’ losses rose only slightly and agents’ search and examination costs generally either did not increase or, in many cases, fell. In fact, several title insurers and agents said that transactions involving less-expensive properties often cost agents more to complete because they required agents to correct more title defects than on more expensive transactions. As a result of this pricing structure, writing title insurance on highervalue purchases and mortgages can be quite profitable for title insurers and agents.

Industry Officials Said that the Current Price Structure Subsidizes Consumers in Lower-Value Transactions, but They Could Not Provide Supporting Data Title industry officials told us that while high-value transactions could be quite profitable for title insurers and agents, this profit was necessary to subsidize the lower profits or even

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losses from smaller transactions. These officials also told us that if insurers charged consumers on the basis of the cost of the actual work done, consumers buying relatively inexpensive properties would pay more than they currently did. However, while we asked title industry officials for data to support their assertion that they often lost money on lowpriced transactions, they said that they did not collect financial information that would allow them to provide such data. Thus, we could not determine whether insurers or agents were actually losing money on any transactions. According to industry officials, insurers and regulators purposely designed the current premium rate structures with an element of subsidization built in—that is, premiums for highpriced transactions were intended to subsidize the costs associated with lower-priced transactions. Among the six state insurance regulators we spoke with, although most agreed that insurers made more money on higher-priced transactions, only one told us that subsidization of consumers on lower-priced transactions was intentional on the part of the state. Among the rest, three said that there was no intentional subsidization, and two said that they did not know.

Industry Officials Said that Recent Higher Profitability Compensated for Years of Lower Profitability, but Industry Return on Equity Has Been Relatively Stable Recent high profits within the title insurance industry have raised additional questions about the prices being paid by consumers. Several title insurance industry officials acknowledged that insurers’ profits had been good over the past several years as a result of increased home prices and large numbers of consumers refinancing their home mortgages, but these officials said that such profits made up for very low profits during weaker markets. However, we found that title insurers’ financial performance, as measured by return on equity, has been positive since at least 1992 and, in every year except one, has been above that of the property-casualty insurance industry as a whole. As shown in figure 8, the combined return on equity for the largest five title insurers has been at or above 9 percent, in every year except one, over the period from 1992 to 2005, and in most years it was above 12 percent. Over that same period, only one insurer had a year with a negative return on equity. In addition, during 2006 public conference calls with financial analysts, several of the largest insurers said that they expected business to be profitable even during the weakest real estate markets. An industry-sponsored study stated that several insurers had reduced title insurance rates in the last several years, and that such reductions provided evidence of price competition, at least in California.[26] We were able to obtain historical premium rate information in five of our six sample states. Between 2000 and 2005, premium rates for the median-priced home went down in three of those five states, stayed the same in one state, and increased by only 2 percent in the other state (see figure 9). However, because total premiums are determined by applying that rate to the home price or loan amount, and median home prices increased substantially over that period, total premiums paid by consumers in most of our sample states also increased substantially. For example, among these five sample states, consumers’ premiums fell in one state, but rose in the remaining four states, sometimes dramatically. Specifically, premiums decreased by 12 percent in one state but increased 93 percent in another, and in one state where premium rates fell by 29 percent, actual premiums paid rose by 75 percent. Historical information on possible additional amounts charged by title agents in our sample states was not available.


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Source: GAO analysis of insurer financial data submitted to SEC and Insurance Services Office and Insurance Information Institute data. Note: The combined return on equity data for title insurers are based on consolidated operating results, which for some title insurers may include some services other than title insurance.

Figure 8. Combined Return on Equity for the Five Largest Title Insurers, and the Property-Casualty Insurance Industry as a Whole, 1992-2005.

Source: GAO analysis of data provided by the National Association of Realtors, state insurance regulators, and title insurers. Note: We were unable to obtain historical premium rate information in the sixth sample state— Colorado. a Premium rates in California, Illinois, and Iowa are those for the insurer writing the most premiums in 2005. b Premium rates in New York and Texas are those promulgated by the state insurance regulator. c Lender’s policy rate was used in the Iowa data because a rate was not given for the owner’s policy. d Premium paid by consumer does not include any additional amounts that may have been charged by title agents. Figure 9. Percentage Change in Premium Rates and Premiums Paid on Median-Priced Homes in Selected Areas in Five Sample States, 2000-2005.

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In States Where Agents Charge Separately for Search and Examination Services, It Is Unclear whether Those Charges Are Fully Supported by Underlying Costs One more factor that raises questions concerning the prices consumers pay for title insurance is that in states where agents’ charges for their search and examination services are not included in the premium paid by the consumer (i.e., agents charge separately for these services), it is unclear whether consumers may be overpaying for those services. The lack of clarity stems from the way in which title insurers determine premium rates that consumers will pay. Officials from title insurance companies told us that they generally determined their premium rates on the basis of their expected expenses, which include losses from claims, as well as the amounts retained by the title agents that write insurance for them. Title insurers know what share of consumers’ premiums the title agents that write policies for them will retain—generally around 80 to 90 percent—and what share the insurer will receive.[27] Insurers then set their premium rates at a level sufficient to ensure that their share of the premiums will be enough to cover their expected costs and earn them a reasonable profit. These calculations take into account the portion of the premiums that title agents retain, but not whether that amount reflects the agents’ actual costs. Officials of insurance companies and title agencies told us that the split was negotiated between the insurer and agent on the basis of a number of factors, including the agent’s volume of business, the quality of the agent’s past work, and the insurer’s desire to increase its share of business in a certain geographic area. Among our sample states, the amount retained by title agents ranged from around 80 percent in one state to 90 percent in another (see figure 10). Some insurance company officials told us that they had an idea of what agents’ costs should be based on their experience with their own direct agents, but these officials said that they did not analyze how the amounts retained by agents compared with those costs.

Source: GAO analysis of interviews with title insurers, title agents, and state insurance regulators. Note: We did not independently verify the information in this figure. a There is no premium split in Iowa on policies issued by the state-owned Iowa Title Guaranty Division. Figure 10. Typical Premium Splits between Insurers and Agents in Six Sample States.


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Insurers that we spoke with also told us that they generally share the same percentage of the premium with their agents, around 80 to 90 percent, regardless of whether those agents were in states where consumers were to pay for agents’ search and examination services within the premium rate—known as all-inclusive states—or whether they were in states where agents can charge consumers separately for those services—known as risk-rate states. However, if title agents are charging separately for their search and examination services, outside of the premium, you would generally expect the percentage of the premium retained by agents to be lower because they would not need to recover the costs for those services from the premium. Because insurers told us that the percentage of the premium given to the agent does not depend on whether the title agent is in a risk-rate or all-inclusive state, this practice raises the possibility that in some risk-rate states, title agents may be (1) retaining 80 to 90 percent of the premium—a percentage meant to be sufficient to cover agents’ search and examination costs in all-inclusive states—and (2) charging the consumer a separate, additional amount intended to pay for those same services. According to HUD officials, in risk-rate states, the amount consumers pay title agents for their search and examination services, which is in addition to the title insurance premium, can sometimes be as large as the premium itself. However, reliable data did not exist to determine whether consumers in riskrate states consistently paid more, in total, than those in all-inclusive states.

Disagreement Exists among Industry and Regulatory Officials Over the Extent of Price Competition and the Appropriateness of Title Insurance Prices While many title industry officials acknowledge that competition in title insurance markets is based primarily on service rather than price, disagreement exists between the industry and regulators over the extent of actual price competition. According to some of the title industry officials we spoke with, price competition does exist within the title insurance industry. While these officials acknowledged that consumers generally rely on referrals from real estate and mortgage professionals, they argued that these professionals could have an interest in obtaining lower-priced title services for their customers and, thus, could exert downward pressure on premium rates. Others cited various factors, such as changes in premium rates and increased levels of coverage, as evidence of price competition and have stressed the benefits for consumers of competition that is based on service. In contrast, insurance regulators in two of our sample states have concluded that premium rates are too high relative to costs, potentially due to a lack of price competition. In California, the state insurance regulator concluded in 2006 that title insurance markets were lacking competition, resulting in increased prices for consumers. The regulator there has also proposed lowering current title rates. In Texas, where title insurance premium rates are promulgated by the state insurance regulator, in each of the last two rate hearings, the regulator has proposed a premium rate reduction to account for a competitive structure that inflates prices for consumers. That is, the regulator has requested premium rate reductions to account for a market structure in which consumers pay for title insurance but others generally choose the title agent and insurer, which the Texas regulator says can result in unnecessary and unreasonable expenses.

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LIMITED STATE AND FEDERAL OVERSIGHT OF THE TITLE INSURANCE INDUSTRY HAS RESULTED IN PROPOSALS FOR CHANGE In the states we visited, we found that regulators did not assess title agents’ costs to determine whether they were in line with premium rates; had made only limited efforts to oversee title agents (including ABAs involving insurers and agents); and, until recently, had taken few actions against alleged violations of antikickback laws. In part, this situation has resulted from a lack of resources and limited coordination among different regulators within states. On the federal level, authority for alleged violations of section 8 of RESPA, including those involving increasingly complex ABAs, is limited to seeking injunctive relief.[28] Some state regulators expressed frustration with HUD’s level of responsiveness to their requests for help with enforcement, and some industry officials said that RESPA rules regarding ABAs and referral fees need to be clarified. Industry and government stakeholders have proposed several regulatory changes, including RESPA reform, strengthened regulation of agents, a competitor right of action with no monetary penalty, and alternative title insurance models.[29]

Regulators Do Not Fully Assess Title Agents’ Costs During Rate Reviews Because consumers can do little to influence the price of title insurance, they depend on regulators to protect buyers from, for example, excessive premium rates. As they do with most lines of insurance, such as property-casualty coverage, regulators seek to ensure that title insurance premium rates are representative of the underlying risks and costs associated with the policies that are issued. In reviewing insurance rates, regulators generally focus on confirming that insurers’ projections of their expected losses on claims are accurate, because for virtually all lines of insurance, the majority of consumers’ premiums go to pay such losses. For property-casualty insurance in 2005, for example, 73 percent of total premiums were used to cover losses. For title insurers, however, only 5 percent of title insurance premiums went to cover losses (see figure 11), while more than 70 percent went to title agents. Despite this difference, few regulators review the costs that title agents incur to determine whether they are in line with the prices charged. In fact, in the majority of states, agents’ costs for search and examination services are not considered part of the premium and, thus, receive no review by regulators. Therefore, title agents charge separately for their search and examination services, yet they receive about the same percentage of the premium as agents in states where these costs are included in the premium. In our six sample states, one regulator did not regulate premium rates for title insurance at all, and one state sold title insurance through a state-run program that did not regulate title search and examination costs. In the remaining four states, agents’ search and examination costs were considered part of the premium, but regulators in only one of those states regularly reviewed title agents’ costs as part of the rate review process. The other three regulators saw the amount retained by the agents as a cost to the insurer that they would review as justification for insurers’ premium rates. However, these states did not go beyond the insurer to review the agents’ costs.


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Source: GAO analysis of NAIC data. a The “Other expenses” category includes salaries, rent, and equipment costs, among other things. Figure 11. Title Industry Costs as a Percentage of Premiums Written, 2005.

Furthermore, only two of the six regulators we reviewed collected financial and operational data on title agents, and regulatory officials in both those states said that the data that they currently collect were insufficient to analyze the appropriateness of current premium rates. For example, while officials from the California insurance regulator have concluded that a lack of competition exists and that premium rates are excessive, they have determined that they would need to collect a significant amount of additional information before they could assess the extent of overpricing. In July 2006, the officials proposed an extensive plan for collecting these data that involved gathering information at the individual transaction level. Similarly, the Texas insurance regulator has been collecting financial data on title agents, but officials there have concluded that these data, which are not organized by functional categories, are insufficient for determining the extent of potentially excessive costs. Because costs incurred by title agents receive such limited review, most state insurance regulators are limited in their ability to assess whether the amounts that consumers are charged for title insurance reflect the costs they are intended to cover. Appendix II describes the types of information that would be helpful in assessing title agents’ costs and operations.

States Conduct Only Limited Regulation and Oversight of Title Agents Some aspects of agent regulation, such as licensing, varied across our sample states, while other aspects, such as capitalization and education requirements, were minimal. Of our six sample states, four required agents to register or obtain a license. Iowa had no title agents, and New York had no licensing or registration requirements.[30] Furthermore, state

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regulators rarely audited agents, and the audits that were done were usually limited to examining only accounts that title agents use to hold customers’ money, known as escrow accounts. Audits of operating accounts were uncommon, although some industry participants said that these accounts were a source of agent defalcations.[31] Table 2 summarizes some aspects of title agent regulation in our sample states. Table 2. Regulation of Title Insurance Agents in Six Sample States State California

State licensing Yes

Continuing education No

Capitalization requirements Net worth of $75,000 to $400,000

State audits Quarterly financial statements

Colorado

Yes

No

$10,000

With cause

Illinois

Yes No (registration only)

No

With cause

Iowa

Must have No law licensea

No

Attorneys are subject to state audits.

New York

No

No

No

No

Texas

Yes

Yes

No

Annual

Insurer oversight Oversees escrow procedures and approves agent bonding Compliance with title insurance laws, report fraud or late premium payments Can withdraw agent registration. Participating attorneys are subject to relevant state law. General Agency Law governs Report failure to provide annual audit report

Proposed regulations Yes

Yes

No

N/A

Yes

Plans to call for more agent data

Source: GAO analysis of state insurance laws and regulations. a Attorneys and abstractors, rather than title agents, perform title work in Iowa.

Moreover, few states we visited require strong insurer oversight of agents. The nature of such oversight is usually negotiated between the insurer and the agent and defined by contract. Typically, the insurers sign up agents based on the quality of their service and their reputation in a certain area and audit their escrow accounts every 18 to 36 months. Industry participants told us that contractual stipulations and questions of unfair competitive practices were among the reasons that prevented insurers from looking into independent agents’ operating accounts. When we asked the major title insurers that we spoke with for information on title agents’ costs, they said that they did not collect data from title agents in a


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manner that would allow for an analysis of costs and profitability and, thus, could not provide us with such information For example, these insurers said that while they reviewed the records of agencies that wrote policies for them, contracts with the agencies generally limited such reviews to escrow accounts and policy records—that is, only enough review to ensure that the insurer had received its share of premiums for the policies issued, but not enough review to evaluate the components of agent costs. Although insurers may not have access to all of the data they need from independent title agents (1) that write for several companies and (2) that do not want insurers to see financial information related to their entire business, the situation with affiliated title agents is generally different. In affiliated arrangements, the insurer has an ownership interest in the title agent and seemingly would have access to the agent’s financial records—especially in cases where the insurer has a controlling interest in the agent and may be required to consolidate its affiliated agent’s financial statements with its own. According to regulators, however, the industry has been resistant to calls for more extensive data collection because of the potential cost burden on the insurers and their agents. Regulators in California and Colorado have recently implemented or plan to implement stronger regulations for title agents, including more stringent qualifying examinations, higher capitalization requirements, criteria to identify sham business arrangements, and more detailed data calls focusing on the costs of providing title insurance. The regulators said that these stronger regulations would be key to preventing illegal actions by agents by eliminating both bad actors and questionable practices in the title industry. Until recently, state regulators had done little to oversee ABAs. Although three of our six sample states have some type of restriction on the amount of business a title company can get from an affiliated source, enforcement of these laws appeared to be limited. In California, the laws specify that a title company can get no more than 50 percent of its orders from a controlled source. In Colorado, until recently, an insurance licensee was prohibited from receiving more in aggregate premium from controlled business sources than from noncontrolled sources.[32] However, one regulator told us that, until recently, it had not rigorously examined data from agents to verify their compliance with the percentage restrictions. Amid recent reports of enforcement actions taken by HUD and some states against allegedly inappropriate ABAs, some state insurance regulators told us that they had begun looking into these increasingly popular arrangements. Regulatory officials told us that they had found various problems, including the level of compliance with mandatory percentage restrictions from controlled sources; the existence of potentially illegal referral fees and kickbacks among ABA owners; and title work performed at some agencies that might not qualify as “core” title work for which liability arises (such as the evaluation of title to determine insurability, clearance of underwriting objections, issuance of the title commitment and policy, and conducting the title search and closing). In Colorado and Minnesota, officials estimated that the number of ABAs had doubled in the past few years. Colorado regulatory officials attributed some of the growth to lax agent-licensing requirements, including low capitalization requirements and minimal prelicense testing. In contrast, California regulatory officials credited the relative lack of ABAs in their state to more stringent licensing and capitalization requirements. Agents in California, referred to as Underwritten Title Companies, must raise between $75,000 and $400,000 in capital to conduct business, depending on the number of documents recorded and filed with the local recorder’s office.

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Furthermore, California has an extensive licensing process, including a review of the character, competency, and integrity of prospective owners; a financial assessment; and a review of the reasonableness of their business plan. As we previously noted, from 2003 to 2006, a growing number of federal and state investigations into ABAs alleged that these arrangements were being used to provide illegal referral fees and kickbacks. Colorado’s regulator has implemented stronger agent regulation, such as a stricter review of agents’ applications, mandated disclosure of any affiliated relationships, and higher capitalization and testing requirements. Regulatory officials said that these changes would help prevent future illegal actions by title agents, especially through the improper use of questionable ABAs. However, the more limited regulation and oversight of title agents and ABAs in other states could provide greater opportunity for potentially illegal marketing and sales practices.

States’ Enforcement of Antikickback and Referral Fee Provisions Was Uneven Kickbacks are generally illegal under both RESPA and most state insurance laws. Although the enforcement provisions of laws in five of the six states in our sample included suspension or revocation of agents’ licenses and monetary penalties, state regulators and others did not see these sanctions as effective deterrents against kickbacks. One state regulator and some industry participants expressed concern that title insurers and agents saw the fines simply as a cost of doing business, since these businesses stood to gain much more in market share and revenue through illegal kickbacks than they would lose in state-assessed monetary penalties. From 2003 to 2006, officials in states we reviewed settled with insurers for over $90 million in penalties for alleged referral fee violations. In comparison, in 2005 alone net earnings for the five biggest title insurers totaled almost $2 billion. In addition, at least one group of industry participants told us they took the fact that regulators had taken little action in the past to mean that they would not get caught if they engaged in illegal activity. RESPA specifies that states—through their attorneys general or insurance commissioners—may bring actions to enjoin violations of section 8 of RESPA. In nearly all of our sample states, title insurance laws contain antikickback and referral fee provisions similar to those in RESPA. Also, although RESPA provides for injunctive action by state regulators, they have hesitated to use it and have only recently begun to look into RESPA section 8 violations. In one state, regulators concluded that they were prevented by state law from seeking injunctive relief under section 8 of RESPA because their only available court for complaints was an administrative one that did not satisfy RESPA requirements.[33] Moreover, some state insurance regulators said that they had limited enforcement options against those that they identified as the major contributors to the kickback problem: real estate agents, mortgage brokers, and other real estate professionals. Even though receiving kickbacks is generally illegal under RESPA, some state regulators told us that they had no authority to go after these entities, which were regulated by other state agencies. Meanwhile, the regulators that oversee these real estate professionals have shown little interest in or knowledge of potential violations of their licensees. In California and, until recently, in Colorado, regulators said that inconsistencies in laws governing kickbacks for title insurers and other real estate professionals have made it difficult to pursue recipients of illegal


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kickbacks. Furthermore, some state officials told us that they received little response when they forwarded potential kickback cases to HUD investigators. A lack of consistent enforcement of antikickback and referral fee provisions by all relevant state regulators, as well as HUD, could limit the effectiveness of enforcement efforts.

Limited Resources and Lack of Coordination among Regulators within States May Limit the Effectiveness of Enforcement Efforts Regulators at the state and federal levels told us that limited resources were available to address issues in title insurance markets. Title insurance is a relatively small line of insurance, and title insurers and agents often get even less than the usual limited market conduct scrutiny that state insurance regulators give other types of insurers.[34] With little ongoing monitoring, selected regulators told us that their attention is drawn to problems largely through complaints from competitors. Complaints from consumers have been rare because, as we have discussed, they generally do not know enough about title insurance to know that they have a problem. Furthermore, the many entities besides title insurers and agents that are involved in the marketing and sale of title insurance often have their own regulators. These entities include real estate agents, mortgage brokers, lenders, builders, and attorneys, all of which may be regulated by different state departments. Our previous work has shown the benefits of coordinated enforcement efforts between state insurance regulators and other federal and state regulators in detecting and preventing illegal activity.[35] According to some state officials’ comments, varying levels of cooperation exist among different state regulators, with some states demonstrating little or no cooperation and other states having more structured arrangements, such as a task force that might include the state insurance regulator, mortgage lending department, real estate commission, and law enforcement officials. Until a recent Colorado law was passed, however, these arrangements stopped short of being codified in legislation or regulation in any of our sample states. The previously mentioned task force in Texas meets monthly to discuss current and potential fraud cases, and the regulators involved noted that it has helped them identify and investigate cases of which they would have otherwise been unaware. In our discussions with some noninsurance regulators, we observed that they had an apparently nominal understanding of violations of laws such as RESPA, and that they had taken few actions against their licensees for violations. Two of the state real estate regulators we spoke with, for instance, said that they were not aware that referral fees were illegal under their state laws or under RESPA.[36] Another real estate regulator said that the department did not maintain a complaint category for RESPA violations against licensees and, thus, could not provide us with the number of RESPA-specific complaints the agency had received. In 3 years, this department had not revoked any licenses and could only identify one RESPA violation case in which licensees were publicly censured and fined. All of these actions were less than what was allowed by state law. One difficulty for state insurance regulators may be that the state laws and regulations for mortgage brokers, real estate agents, and others may differ from those for title insurers and agents, and these laws and regulations may not view referral fees in the same way, thus making interdepartmental enforcement difficult. For example, Illinois and New York real

36


estate law contains no reference to referral fees related to settlement service providers, although the title insurance laws prohibit these fees. However, given the lack of coordination we noted among regulators in the same state, it is not surprising that different regulatory agencies were not aware of differences in the way state laws and regulations treat certain activities. Without greater communication and coordination among the various state regulators, some potentially illegal activities carried out by those involved in the sale and marketing of title insurance could go undiscovered and uncorrected.

HUD Officials Expressed Concern Over Lack of Enforcement Authority for Violations of Section 8 of RESPA The investigative actions HUD has taken have largely resulted in voluntary settlements without admission of wrongdoing by the involved parties. According to HUD officials, it is difficult to deter future violations without stronger enforcement authority, such as civil money penalties, because, as we previously mentioned, companies view small settlements as simply a cost of doing business. While HUD has obtained a number of voluntary settlements from 2003 to 2006, the average amount assessed by the department was approximately $302,000. During the same period, the combined net earnings of the five major national title insurers averaged about $1.6 billion each year. One particular area of possible section 8 violations about which HUD officials expressed concern was the difficulty of investigating complex ABA relationships. RESPA provides an exemption to the antikickback provision for compensation for goods or services actually provided. However, HUD officials told us that it was often difficult to establish what type of and how much work an entity actually did. In the past, the most common type of ABA was an entity, such as a real estate broker, that owned another entity, such as a title agent. Recently, the arrangements have begun to involve three or more entities, making it difficult to trace the flow of money among entities and the responsibilities of each entity. HUD’s enforcement mechanism is also complaint-driven, but, as we previously noted, most consumers are not well-informed enough to bring complaints. Thus, violations could exist that HUD would not know about. HUD has few staff focused on RESPA issues, although their number has increased from 5 full-time employees in 2001 to more than 19 in 2006. According to other regulators, these employees are generally limited to responding to some complaints and pursuing a few large cases. Recently, HUD officials responsible for enforcing RESPA have begun training employees in HUD’s Office of the Inspector General on RESPA issues. The officials said that they have received some forwarded cases as a result of the training. In addition to staff specifically assigned to RESPA issues, resources in other parts of HUD, such as the Office of the General Counsel, also provide support, according to HUD officials. HUD also spends $500,000 per year on an investigative services contract to assist RESPA enforcement efforts. HUD tracks cases of alleged RESPA violations along with their disposition, staff assigned, closing date, and settlement, but we did not obtain this information by the time this report went to print. Some state regulators expressed frustration with HUD’s level of responsiveness, saying that the agency did not always follow up with them on forwarded cases, potentially limiting the success of investigative efforts. State regulators told us that they looked to HUD to enforce kickback provisions beyond what they had concluded was allowed by state insurance


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laws—for example, against mortgage brokers, real estate agents, and others that state insurance regulators do not oversee. Yet HUD officials and state regulators told us that there was no formal plan for coordinating with states, and that cooperation, where it existed, relied on requests and informal relationships. HUD officials cited several possible reasons for not communicating the results of forwarded cases to the states. Among these reasons were state and federal jurisdictional issues, constrained resources, and complaint-driven enforcement that limited HUD’s scope. As we mentioned, our previous work has shown the benefits of coordinated enforcement efforts between state insurance regulators and other federal and state regulators to detect and prevent illegal activity. A September 2000 report recommended that state insurance regulators improve information sharing by developing mechanisms for routinely obtaining data from other regulators and implementing policies and procedures for sharing regulatory concerns with other state insurance departments.[37]7 Some industry officials also said that the rules under RESPA were not always clear and that HUD had not been responsive in answering their inquiries, potentially resulting in activities that HUD later deemed to be illegal. For example, in the case of captive reinsurance, two large underwriters told us that they had never received clear answers from HUD to inquiries about the legality of such arrangements, and that they entered into them as a result of competitive pressures. Eventually, these underwriters ended the arrangements after federal regulators investigated and deemed them improper. As a result, these underwriters and other entities paid over $66 million in settlements with states and HUD. Some industry participants, including HUD’s former general counsel, have suggested that HUD clarify RESPA by instituting a no-action letter process similar to the one that the SEC uses to address industry questions on potential activities and to the process that HUD uses in its Interstate Land Sales Program.[38] Although clarifying regulations can provide benefits, without greater enforcement authority and more coordination with state regulators, HUD’s effectiveness at deterring, uncovering, and stopping potentially illegal title insurance activities may be limited.

HUD, State Regulators, and Industry Stakeholders Have Developed Proposals for Improving the Regulation and Sale of Title Insurance With knowledge gained from their recent investigations into the title insurance industry, and in line with their mission to increase access to affordable housing, HUD has developed a two-pronged approach to regulatory changes. First, HUD plans to propose reforms to the regulations that govern RESPA. Agency officials said that the reforms will help consumers shop for settlement services, and that, hopefully, consumer-driven competition will put downward pressure on prices. However, agency officials have not yet made public the specifics of these reforms. Second, HUD plans to seek substantial authority to levy civil money penalties that it expects will deter future violations of section 8 of RESPA. HUD officials said that having the authority to levy civil money penalties would greatly enhance their RESPA enforcement efforts. HUD’s obtaining civil money penalty authority in section 8 of RESPA, however, would require a legislative change.

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Some state regulators also have proposed changes in oversight of the title insurance industry. Regulatory officials found that weak licensing regulations may have contributed to problems in the industry, and that a lack of data on title agents’ costs hindered their ability to analyze prices paid by consumers and to ensure such prices were not excessive. As a result, regulators have proposed the following changes: •

• •

In Colorado, state regulators have made changes that are primarily aimed at making the identification and, thus, the elimination of improper ABAs easier—for example, through mandatory disclosure of ownership structures on agent applications and higher capitalization requirements. At least one industry participant has welcomed the changes, which it said will help level the playing field for independent agents. In California, state regulators have concluded that premium rates are excessive and have proposed premium rate rollbacks derived from a detailed evaluation of costs. In Texas, state regulators are attempting to collect more detailed information on agent costs, shifting their emphasis to comprehensive data on functional categories that would allow them to more easily identify excess costs and illegal kickbacks.

In addition, the NAIC Title Working Group is looking at modifications to the model laws in an effort to align referral fee provisions with those of RESPA and enhance state regulators’ enforcement authority. Finally, some industry officials have said that state and federal regulators either did not have the ability or lacked the will to address violations, which the officials said was the fault of only some in the industry. Other officials said that they had concluded that the industry would be better off policing itself, and some underwriters proposed giving insurers the right to seek private injunctive relief against competitors suspected of engaging in illegal activities, but with no monetary award. One underwriter official said such self-policing by the industry would help government enforcement and maintain honesty among industry participants. However, it was not clear whether such actions could be used punitively or as a way to stifle competition. Some industry stakeholders, however, see the current model of selling and marketing title insurance as irretrievably broken and have put forth two alternative title insurance models designed to benefit and protect consumers through lower prices and government intervention. The first alternative model would require lenders to pay for title insurance, on the theory that as regular purchasers of title insurance, lenders would be better informed and could potentially use their market power to obtain lower prices. However, some fear that this model would make the process less transparent, and that lenders would not pass on any cost savings. The second alternative model would be a system like Iowa’s, with state-run title underwriters. But it is not clear that this system would make the necessary changes to the current model or that it would save consumers money. For example, although title underwriters are barred from selling title insurance in Iowa, nothing prevents consumers from choosing to purchase it from them out of state, and the underwriters end up providing title insurance to about half of the market. Furthermore, while premium rates for Iowa Title Guaranty might be lower, although not the lowest, than rates in many other states, the total costs that consumers pay for title searches, examinations, and clearing of any title problems might not differ substantially. In Bankrate.com’s survey of closing costs, Iowa’s total costs were about the same as those in


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Maryland, Nebraska, South Dakota, Washington State, and West Virginia, where private title underwriters are free to do business.

CONCLUSIONS Title insurance can provide real benefits to consumers and lenders by protecting them from undiscovered claims against property that they are buying or selling. However, multiple characteristics of current title insurance markets, as well as allegedly illegal activities by a number of those involved in the marketing of title insurance, suggest that normal competitive forces may not be working properly, raising questions about the prices consumers are paying. Compounding this concern is the apparently very limited role that most consumers play in the selection of a title insurer or agent, and the fact that consumers must purchase title insurance to complete a real estate purchase or mortgage transaction. This puts consumers in a potentially vulnerable situation where, to a great extent, they have little or no influence over the price of title insurance but, at the same time, they have little choice but to purchase that insurance. Furthermore, federal and state regulators have identified a number of recent allegedly illegal activities related to the marketing and sale of title insurance, which suggests that some in the title insurance industry are taking advantage of consumers’ vulnerability. To begin to better protect consumers, improvements need to be made in at least three different areas. First, price competition between title insurers and between agents, from which consumers would benefit, needs to be encouraged. Educating consumers about title insurance is critical to achieving this objective. Some state regulators have begun to encourage competition by attempting to educate consumers and improve transparency by publicizing premium rate information on their Web sites. While HUD’s existing home-buyer information booklet also provides some useful information on buying a home, the information on title agent ABAs and available title insurance discounts is outdated and fails to provide sufficient detail. As a result, home owners may not be making informed title insurance purchases. Moreover, although some in the industry complain about ambiguity in the regulations concerning referral fees associated with ABAs, their use has continued to grow even while the extent to which any realized benefits from such arrangements are passed along to consumers is unknown. In addition, these arrangements can create potential conflicts of interest for the real estate and lending professionals involved that may disadvantage consumers. Second, to ensure that consumers are paying reasonable prices for title insurance, more detailed analysis is needed on the relationship between the prices consumers pay and the underlying costs incurred by title insurers and, especially, title agents. Because of the key role played by title agents, such analysis will not be possible until state regulators collect and analyze data on those agents’ costs and operations, including those operating as ABAs. Third, to ensure that consumers are not taken advantage of because of their limited role in the selection of a title insurer or agent, more needs to be done to detect and deter potentially illegal practices in the marketing and sale of title insurance, particularly among title agents. HUD and several state regulators have already begun to take steps in this area, but these efforts often face challenges, such as HUD’s limited enforcement authority, statutory limitations of RESPA, potentially confusing regulations, and a lack of coordination among

40


multiple regulators. Increased regulatory scrutiny of the increasing number of complex ABAs appears to be particularly important because although only a few state regulators have looked at such arrangements in detail, those that have looked at this issue have discovered potentially illegal activities. Because entities other than insurance companies are integrally involved in these transactions, identifying approaches to increase cooperation among HUD, state insurance, real estate, and other regulators in the oversight of title insurance sales and marketing practices is also critical. Ultimately, because of the involvement of both federal and state regulators, including multiple regulators at the state-level, effective regulatory improvements will be a challenge and will require a coordinated effort among all involved. Congress can also play a role in improving consumers’ position in the title insurance market by reevaluating certain aspects of RESPA. For example, HUD currently lacks the authority to assess civil money penalties for violations of section 8 of RESPA, generally forcing HUD to rely on voluntary settlements, which can be seen by some in the title insurance industry as simply a cost of doing business. In addition, RESPA dictates when and under what circumstances HUD’s home-buyer information booklet is to be distributed to prospective buyers and borrowers. Revisiting RESPA to ensure that consumers receive this information as soon as possible when they are considering any type of mortgage transaction, not just when purchasing real estate, could be beneficial.

MATTERS FOR CONGRESSIONAL CONSIDERATION As part of congressional oversight of HUD’s ability to effectively deter violations of RESPA related to the marketing and sale of title insurance, Congress should consider exploring whether modifications are needed to RESPA, including providing HUD with increased enforcement authority for section 8 RESPA violations, such as the ability to levy civil money penalties. Congress also should consider exploring the costs and benefits of other changes to enhance consumers’ ability to make informed decision, such as earlier delivery of HUD’s home-buyer information booklet—perhaps at a real estate agent’s first substantive contact with a prospective home buyer—and a requirement that the booklet be distributed with all types of consumer mortgage transactions, including refinancings.

RECOMMENDATIONS FOR EXECUTIVE ACTION We are recommending that HUD take the following two actions, as appropriate. The Secretary of HUD should take action to (1) protect consumers from illegal title insurance marketing practices and (2) improve consumers’ ability to comparison shop for title insurance. Among the actions they should consider are the following: • • •

expanding the sections of the home-buyer information booklet on title agent ABAs and available title insurance discounts; evaluating the costs and benefits to consumers of title agents’ operating as ABAs; clarifying regulations concerning referral fees and ABAs; and

Title Insurance (Actions Needed to Improve Oversight… •

• •

•

•

41

developing a more formalized coordination plan with state insurance, real estate, and mortgage banking regulators on RESPA enforcement efforts. Likewise, we are recommending that state insurance regulators, working through NAIC where appropriate, take the following two actions. State regulators should take action to (1) detect and deter inappropriate practices in the marketing and sale of title insurance, particularly among title agents, and (2) increase consumers’ ability to shop for title insurance based on price. Among the actions they should consider are the following: strengthening the regulation of title agents through means such as establishing meaningful requirements for capitalization, licensing, and continuing education; improving the oversight of title agents, including those operating as ABAs, through means such as more detailed audits and the collection of data that would allow indepth analyses of agents’ costs and revenues; increasing the transparency of title insurance prices to consumers, which could include evaluating the competitive benefits of using state or industry Web sites to publicize complete title insurance price information, including amounts charged by title agents; and identifying approaches to increase cooperation among state insurance, real estate, and other regulators in the oversight of title insurance sales and marketing practices.

AGENCY COMMENTS AND OUR EVALUATION We requested comments on a draft of this report from HUD and NAIC. We received written comments from the Assistant Secretary for Housing of HUD and the Executive Vice President of NAIC. Their letters are summarized below and reprinted in appendixes III and IV, respectively. The Assistant Secretary for Housing at HUD generally agreed with our findings, conclusions, and recommendations. Specifically, he indicated that the report accurately assessed the issues that adversely affect consumers in the title insurance market. He also acknowledged the importance of protecting consumers and improving their ability to shop for title insurance. In response to our recommendation to expand the sections of the home-buyer information booklet on ABAs and discounts, he noted the importance of home-buyer education and amending the home-buyer’s booklet to include this information. Addressing our recommendation to evaluate the costs and benefits of ABAs, he said that while ABAs are currently legal, HUD is in the process of evaluating various ABA structures to ensure they operate as Congress intended. We also recommended that HUD clarify regulations about referral fees and ABAs. The Assistant Secretary stated that HUD will continue its efforts to clarify existing guidelines, as well as develop new guidelines, to address practices that negatively impact consumers. Furthermore, he generally agreed with our recommendation for greater coordination with state regulators, noting that such coordination is necessary and pointing out past instances of HUD coordination with state regulators on RESPA enforcement that have resulted in successful outcomes. Lastly, he emphasized the ongoing challenge of RESPA enforcement without civil money penalty authority, stating that consumers would benefit if such authority were granted to HUD.

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The Executive Vice President of NAIC agreed that our report identified concerns in the area of consumer protection. She also said that our recommendations are worthy of exploration, and that NAIC would continue to work to improve consumer education, consumer protections, and price transparency in the title insurance market. We also received separate technical comments from staff at HUD and NAIC. We have incorporated their comments into the report, as appropriate. As agreed with your office, unless you publicly announce its contents earlier, we plan no further distribution of this report until 30 days from the report date. At that time, we will send copies to the Chairman, House Committee on Financial Services, and the Chairman and Ranking Member, Senate Committee on Banking, Housing, and Urban Development. We will also send copies to the Secretary of Housing and Urban Development, the President of the National Association of Insurance Commissioners, and each of the state insurance commissioners. We will make copies available to others upon request. The report will also be available at no charge on our Web site at http://www.gao.gov. Please contact me at (202) 512-8678 or [email protected] if you or your staff have any questions about this report. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors to this report are listed in appendix V. Sincerely yours, Orice M. Williams Director, Financial Markets and Community Investment

APPENDIX I: OBJECTIVES, SCOPE, AND METHODOLOGY We previously provided a report and testimony identifying characteristics of current title insurance markets that merited additional study, including the extent to which title insurance premium rates reflect underlying costs and the extent of state oversight of title agents and other real estate professionals.[39] This report focuses on issues related to (1) the characteristics of title insurance markets across states, (2) the factors that raise questions about prices and competition in the industry, and (3) the current regulatory environment and planned regulatory changes. Because of our awareness that title insurance regulation varies considerably from state to state, we chose six states in which to perform a detailed review of their laws, and regulatory and market practices. These states were California, Colorado, Illinois, Iowa, New York, and Texas. We chose these states to obtain a broad variety of state title insurance activity across the following dimensions: • •

• •

Proportion of the premiums written nationwide. Differences in the process of purchasing title insurance and the real estate transaction, including the relative importance of attorneys and alternative systems for title insurance. Domiciling of the largest national insurers and larger regional insurers. Varying rate-setting regimes and total premiums.

Title Insurance (Actions Needed to Improve Oversight… • • •

43

The existence of ongoing or past Department of Housing and Urban Development (HUD) investigations in the state. Different combinations of premium rates, annual home sales, and rate-setting regimes. The activity of known proactive regulators in some states.

Except where noted, our analysis is limited to these states. We used the information obtained in the states to address each of our objectives, in addition to other work detailed in the following text. To gain an overall understanding of the characteristics of national and local title insurance markets, we reviewed available studies. These included the study on the California title insurance market (as well as numerous criticisms of that study) and recent studies conducted on behalf of the Fidelity National Title Group, Inc., and the Real Estate Settlement Providers Council (RESPRO).[40] We discussed the studies’ results with the authors and raised questions about their methodology and conclusions to further broaden our knowledge of the varying approaches in analyzing title insurance markets. To better understand the effect consumers have on the price and selection of title insurance, we obtained information from title insurers, title agents, and state title industry associations about typical consumer behavior in the title insurance transaction. To deepen our understanding of the dynamics of the industry and current practices and issues within the title insurance industry that affect consumers, we gathered views from a variety of national organizations whose members are involved in the marketing or sale of title insurance or related activities. These organizations included the American Land Title Association (ALTA), RESPRO, the National Association of Realtors, the Mortgage Bankers Association of America, the American Bar Association, the National Association of Home Builders, and the National Association of Mortgage Brokers. To better understand the relationship between premium rates and underlying costs, we discussed these issues with insurers, agents, and title industry associations. We attempted to obtain cost data from agents and insurers, but they were not able to provide us with data that would allow analysis of agent costs. In some states, we toured title plant facilities and observed the title search and examination process to broaden our analysis of underlying title insurance costs. To gain a better understanding of how title insurance premiums are shared between insurance companies and agents, we reviewed annual financial data collected by the National Association of Insurance Commissioners (NAIC) from title insurance companies and, to some extent, data collected by the Texas Department of Insurance, the California Department of Insurance, and ALTA.[41] We analyzed these data to deepen our understanding of title insurer and agent costs and revenues. We also consulted other publicly available financial information on title insurers and agents and spoke with agents. To determine how insurers account for premiums, we also looked at financial data filed with the Securities and Exchange Commission and spoke with officials from three of the largest title insurance underwriters. To assess the current state and federal regulatory environment, we reviewed laws and regulations, and interviewed key regulators. To determine the role that states play in overseeing the various parties involved in the title insurance industry, we reviewed laws and regulations governing title insurance, real estate, and mortgage banking in six selected states.

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We also spoke with insurance, banking, mortgage, and real estate regulators in each state. To obtain an understanding of the federal oversight role in the title insurance market, we interviewed officials from HUD and reviewed relevant laws and regulations. We also discussed these issues with officials at the Federal National Mortgage Association and the Federal Home Loan and Mortgage Corporation to better understand the relationship between the secondary mortgage market and title insurance. Furthermore, we interviewed staff and state regulators working with NAIC to get their views on the industry and to obtain information on the activities of their Title Insurance Working Group. We performed our work in Washington, D.C.; Chicago, Illinois; and selected sample states between February 2006 and March 2007 in accordance with generally accepted government auditing standards.

APPENDIX II: POTENTIAL APPROACH TO BETTER UNDERSTAND TITLE AGENTS’ COSTS AND HOW THESE COSTS RELATE TO INSURANCE PREMIUMS Understanding title agents’ costs and how these costs relate to title insurance premiums that consumers pay is important because title agents do or coordinate most of the work necessary for issuing title insurance policies, and they retain most of the premium. Understanding these costs would require state insurance regulators to gather and analyze financial data on title agents. The list below illustrates the types of data that might be gathered and analyzed. This would be a multistep process and could involve detailed analysis of some title agents, such as those that look quite different financially from group (such as county or statewide) averages. Reasonable explanation for such differences could be informative of agency costs, while the absence of reasonable explanation could raise questions about the legitimacy of such costs. We identified the following information on affiliated agents and direct operations that could be requested from insurers: 1. A complete list of underwriters’ affiliated title agents and title service companies that would include the company name and address and the year acquired or established by the underwriter. 2. Financial data on each affiliate that would include balance sheets and statements of changes in owners’ equity. 3. Revenue data that would include title premium revenues and production fees earned from others (e.g., search and examination, closing, and recording). 4. Title premium revenues and policies written that would be broken out between residential and commercial. 5. Personnel cost data that would include salaries, commissions, bonuses, benefits, and full-time equivalent employees, by function. 6. Other personnel data that would include average salaries, bonuses and benefits, and brief descriptions of any incentive pay systems, by job type and function.


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7. Five years of other expense data that would include search and examination fees paid to contractors, advertising, entertainment, plant maintenance, rent, office supplies, and legal fees and settlements. 8. Expenses allocated to and from the underwriter. 9. For each affiliated title service company, the names of the 10 largest clients. 10. For each subsidiary of the underwriter, the names of any other underwriters, escrow companies, realtors, builders, developers, mortgage brokers, lenders, or other entities in the title, real estate, or mortgage industry • that have ownership interests in the subsidiary, • in which the subsidiary has an ownership interest, or • that are vendors of the subsidiary and owned by subsidiary management. Likewise, we identified the following information on independent title agents that could be requested from insurers: 1. The number of independent agents, by state. 2. The number of offices of each independent agent, by state. 3. Each agent’s title premiums written for the underwriter as a percentage of the agent’s total title premiums written. 4. Premiums written by each agent for this underwriter, by state. 5. Revenue data that would include title premium revenues and production fees earned from others (e.g., search and examination, closing, and recording). 6. Expense data that would include employee and owner salaries, commissions, bonuses, and benefits; director fees; search and examination fees paid to contractors; advertising; entertainment; plant maintenance; rent; office supplies; legal fees and settlements; and claim losses.

REFERENCES [1]

[2] [3]

[4]

GAO, Title Insurance: Preliminary Views and Issues for Further Study, GAO-06-568 (Washington, D.C.: Apr. 24, 2006); and Title Insurance: Preliminary Views and Issues for Further Study, GAO-06-569T (Washington, D.C.: Apr. 26, 2006). Except where noted, our analysis is limited to these states. Birny Birnbaum, Report to the California Insurance Commissioner: An Analysis of Competition in the California Title Insurance and Escrow Industry (Austin, TX: December 2005); Donald Martin, PhD, and Richard Ludwick, Jr., PhD, Affiliated Business Arrangements and Their Effects on Residential Real Estate Settlement Costs: An Economic Analysis (Washington, D.C.: October 2006); and Gregory Vistnes, An Economic Analysis of Competition in the Title Insurance Industry (Washington, D.C.: March 2006). NAIC is a voluntary organization of the chief insurance regulatory officials of the 50 states, the District of Columbia, and the four U.S. territories. NAIC assists state insurance regulators by providing guidance, model (or recommended) laws and guidelines, and information-sharing tools. ALTA is a national trade association for title

46

[5]

[6]

[7]

[8]

[9]

[10] [11]

[12] [13] [14] [15]

[16]

United States Governement Accountability Office insurers and agents, but its members may also include attorneys, builders, developers, lenders, and real estate brokers. In captive reinsurance arrangements, a home builder, real estate broker, lender, title insurance company, or some combination of these entities forms a reinsurance company that works in conjunction with a title insurer. Sham ABA arrangements are those in which the affiliated entity performs little or no actual settlement services and is allegedly being used just to compensate ABA owners for consumer referrals. Other arrangements include the use of inducements and incentives by title companies to obtain title insurance business, especially when these inducements were used to influence referrals by real estate agents, banks, lenders, builders, developers, and others. Market conduct examinations are performed by state insurance commissioners, and they review agent-licensing issues, complaints, types of products sold by the company and agents, agent sales practices, proper rating, claims handling, and other marketrelated aspects of an insurer’s operation. See GAO, Insurance Regulation: Common Standards and Improved Coordination Needed to Strengthen Market Regulation, GAO03-433 (Washington, D.C.: Sept. 30, 2003). Both the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation require a guarantee of title as a condition of purchasing loans from mortgage lenders. Bankrate.com, Closing Costs Survey, http://www.bankrate.com/brm/news/mortgages/ ccmain2006a1.asp (North Palm Beach, FL: August 2006). The survey was conducted by Bankrate.com in 2006 by obtaining online information where available. We did not assess the validity of the data collected in the survey. According to industry experts and analysts, the different loss and expense structure of the title insurance industry reflects the fact that title insurance is primarily focused on preventing losses through title searches and examinations, and that most propertycasualty insurance is focused on compensating policyholders for losses. The term “nonpromulgated states” refers to those states where the title rate is determined by a method other than a state regulatory body setting it. RESPRO is a national nonprofit trade association of settlement service providers, including real estate broker-owners, real estate franchisers, mortgage lenders/brokers, title insurers/agents, home builders, and home warranty companies. Many of its members offer affiliated services through subsidiaries, joint ventures, and partnerships. Although Minnesota was not in our sample, we spoke to state insurance regulators in the state. Some state laws, such as those in Iowa and Texas, require title agents or abstractors to have access to a title plant. California insurance department guidelines say that title agents cannot pay more than $5,000 of a claim. Florida Office of Insurance Regulation, An Analysis of Florida’s Title Insurance Market: Three Studies That Provide a Comprehensive, Multi-Faceted Review of the Florida Title Insurance Industry (Tallahassee, FL: July 2006). Closing Costs Survey, http://www.bankrate.com/brm/news/mortgages/ccmain 2006a1.asp.


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[17] Gregory Vistnes, An Economic Analysis of the California Department of Insurance Proposal to Impose Rate Regulation in the California Title Insurance Industry (Washington, D.C.: August 2006). [18] RESPA requires lenders to provide consumers with an estimate of the costs a consumer will likely have to pay, called a Good Faith Estimate, prior to the closing of a mortgage transaction. [19] Board of Governors of the Federal Reserve System, Department of Housing and Urban Development, Joint Report to the Congress Concerning Reform to the Truth in Lending Act and the Real Estate Settlement Procedures Act (Washington, D.C.: July 1998). [20] Entities involved in multiple cases and settlements were counted once for each case and settlement in which they were involved. [21] Washington State Office of the Insurance Commissioner, An Investigation into the Use of Incentives and Inducements by Title Insurance Companies (Olympia, WA: October 2006). [22] Title Insurance Section, Division of Financial Institutions, Illinois Department of Financial and Professional Regulation, Bulletin 1-05: Title Insurance Agent Requirements (Springfield, IL: July 2005); Title Insurance Industry Meeting Informational Handout 106 (Springfield, IL: February 2006); and Title Insurance Industry Meeting Informational Handout 2-06 (Springfield, IL: February 2006). [23] Division of Insurance, Alaska Department of Commerce, Community, and Economic Development, Summary of Title Insurance Examinations: Division of Insurance (Juneau, AK: April 2006). [24] Reinsurance is a mechanism that insurance companies routinely use to spread risk associated with insurance policies. Simply put, it is insurance for insurance companies. [25] Donald Martin and Richard Ludwick, Affiliated Business Arrangements and Their Effects on Residential Real Estate Settlement Costs: An Economic Analysis (October 2006). [26] An Economic Analysis of the California Department of Insurance Proposal. [27] Title insurers also have direct operations where none of the premium is retained by an agent. As a result, while title agents typically retain from 80 to 90 percent of the premium paid by consumers, in 2005, agents retained only 70 percent of total premiums written by insurers. [28] RESPA does provide criminal sanctions for violations of section 8, a fine of up to $10,000 or up to 1 year in prison. However, according to HUD officials, such sanctions are rarely used, in part because they require prosecutions to be conducted by U.S. attorneys from the Department of Justice. [29] A competitor right of action would allow industry participants to seek to stop activities of their competitors that they think violate the law. [30] Because the sale of title insurance within Iowa—one of our sample states—is prohibited, attorneys and abstractors do title work. [31] Agent defalcation occurs when an agent misappropriates funds and fails to pay off a prior mortgage. [32] Under Colorado’s new law, ABAs are authorized provided that they meet conditions similar to those in RESPA, and ABAs must be disclosed to the state division of insurance or real estate in connection with license applications. In addition, the divisions of insurance and real estate are to consult with one another to promulgate

48

[33]

[34]

[35] [36] [37] [38]

[39]

[40]

[41]

United States Governement Accountability Office ABA rules, and to share information derived from investigations of ABAs. New Colorado regulations include specific rate and fee rules; standards of conduct for title insurance entities, including standards for ABAs; and rules regarding consumer protections. Actions pursuant to section 8 of RESPA may be brought in the United States district court or in any other court of competent jurisdiction, with certain other limitations. HUD officials disputed the regulators’ assertion. Market conduct examinations are performed by state insurance commissioners, and they review agent-licensing issues, complaints, types of products sold by the company and agents, agent sales practices, proper rating, claims handling, and other marketrelated aspects of an insurer’s operation. See GAO-03-433. GAO, Insurance Regulation: Scandal Highlights Need for Strengthened Regulatory Oversight, GAO/GGD-00-198 (Washington, D.C.: Sept. 19, 2000). During the course of our communication with these regulators, we informed them that referral fees were generally illegal under the state law in question and under RESPA. GAO/GGD-00-198. SEC’s no-action letter process allows an individual or entity that is not certain whether a particular product, service, or action would constitute a violation of the federal securities law to request a “no-action” letter from the SEC staff. GAO, Title Insurance: Preliminary Views and Issues for Further Study, GAO-06-568 (Washington, D.C.: Apr. 24, 2006); and Title Insurance: Preliminary Views and Issues for Further Study, GAO-06-569T (Washington, D.C.: Apr. 24, 2006). Birny Birnbaum, Report to the California Insurance Commissioner: An Analysis of Competition in the California Title Insurance and Escrow Industry (Austin, TX: December 2005); Donald Martin, PhD, and Richard Ludwick, Jr., PhD, Affiliated Business Arrangements and Their Effects on Residential Real Estate Settlement Costs: An Economic Analysis (Washington, D.C.: October 2006); and Gregory Vistnes, An Economic Analysis of Competition in the Title Insurance Industry (Washington, D.C.: March 2006). NAIC is a voluntary organization of the chief insurance regulatory officials of the 50 states, the District of Columbia, and the four U.S. territories. NAIC assists state insurance regulators by providing guidance, model (or recommended) laws and guidelines, and information-sharing tools. ALTA is a national trade association for title insurers and agents, but its members also may include attorneys, builders, developers, lenders, and real estate brokers.


Chapter 2

REVERSE MORTGAGES: BACKGROUND AND ISSUES* Bruce E. Foote ABSTRACT Since the 1970s, parties have sought to create mortgage instruments that would enable elderly homeowners to obtain loans to convert their equity into income, while providing that no repayments would be due for a specified period or, ideally, for the lifetime of the borrower. These instruments have been referred to as reverse mortgages, reverse annuity mortgages, and home equity conversion loans. Reverse mortgages are the opposite of traditional mortgages in the sense that the borrower receives payments from the lender instead of making such payments to the lender. Reverse mortgages are designed to enable elderly homeowners to remain in their homes while using the equity in their homes as a form of income. In general, reverse mortgages may take one of two forms — term or tenure. Under a term reverse mortgage, the borrower is provided with income for a specified period. Under a tenure reverse mortgage, the borrower is provided with income for as long as he or she continues to occupy the property. For borrowers, the most risky reverse mortgage is the term reverse mortgage. Borrowers have been reluctant to enter such mortgages because at the end of the loan term the borrower would likely have to sell the home and move. For lenders, the most risky reverse mortgage is the tenure reverse mortgage. Lenders have been reluctant to originate such mortgages because the borrower is guaranteed lifetime income and lifetime occupancy of the home. This is risky because the mortgage debt grows over time, and the debt could exceed the value of the home if the borrower lives longer than his or her life expectancy. The use of tenure reverse mortgages has grown in recent years due to the availability of an FHA-insured reverse mortgage. Under the FHA program, the risk of the borrower living too long is shifted to the federal government. At present, the three major reverse mortgage products are the FHA-insured reverse mortgage, the Fannie Mae reverse mortgage, and a proprietary plan from a private lender.

*

Excerpted from CRS Report RL33843, dated January 26, 2007.

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Bruce E. Foote In most cases, the FHA program provides higher cash benefits to the borrower than the private plans; it is the one most borrowers choose. Currently, FHA-insured reverse mortgages are subject to the FHA loan limit for the area in which a property is located, and these limits vary according to the median home prices in the area. An issue for policymakers is whether to have a national reverse mortgage limit under the FHA program instead of having the limit vary according to the area FHA loan limit.

INTRODUCTION According to the American Housing Survey (AHS), nearly 25 million American homeowners have no mortgage debt, and more than 12.5 million of them are elderly (age 65 or older).[1] For many of the elderly homeowners, the equity in their homes represents their largest asset. The AHS finds that the median value of these unmortgaged homes is $127,959. Many elderly homeowners find that while inflation has increased the value of their homes, it has also eroded the purchasing power of their fixed incomes. They find it increasingly difficult to maintain their homes while also paying for needed food, medical, and other expenses. Because of their low incomes, many may be unable to qualify for loans to pay for unexpected expenses. “House rich and cash poor” is the phrase often used to describe their dilemma. One option is to sell the home and move to rental housing or purchase a lower-cost home. For a variety of reasons, however, many older Americans prefer to remain in the homes in which they may have spent most of their working years. Since the 1970s, academics and housing advocates have sought to create mortgage instruments that would enable elderly homeowners to obtain loans to convert their equity into income, while providing that no repayments would be due for a specified period or, ideally, for the lifetime of the borrower. These instruments have been referred to as reverse mortgages, reverse annuity mortgages, and home equity conversion loans. Generally, when a borrower obtains a mortgage, a lender advances a lump-sum payment to or on behalf of the borrower, and the borrower becomes committed to making a stream of monthly payments to repay the loan. With the reverse mortgage, the lender becomes committed to making a stream of payments to the borrower, and such payments are repaid to the lender in a lump sum at some future date. Thus, reverse mortgages are the opposite of traditional mortgages in that the borrower receives payments from the lender instead of making such payments to the lender. Reverse mortgages are designed to enable elderly homeowners to remain in their homes while using the equity in their homes as a form of income. While reverse mortgages are a small part of the total mortgage market, their use has increased substantially in recent years. This report discusses the evolution and history of reverse mortgages, compares reverse mortgage products currently available, discusses the potential use of reverse mortgages as a way to finance long-term care, and raises a number of issues for policymakers and the elderly.

Reverse Mortgages: Background and Issues

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THE EVOLUTION OF REVERSE MORTGAGES Sale-Leaseback Transactions Under a sale-leaseback transaction a property is sold to a buyer who simultaneously leases the property to the seller. Often, sale-leaseback transactions are used by businesses that seek to raise working capital by selling and leasing back some property that is used in the trade or business. The technique enables firms to raise capital and avoid high borrowing costs. Capital that was formerly frozen in real estate assets can be used to generate a higher rate of return in the business itself. If the business obtained a mortgage against the property, the mortgage would cover only 75 to 80% of the market value of the property. Through the saleleaseback transaction, the business can obtain cash for 100% of the value of the property (less transaction costs) and still maintain use and possession of the property. In the 1970s, some advocates suggested sale-leaseback transactions as a way for elderly homeowners to convert the equity in their homes into a source of income. Under this plan, the elderly homeowner would sell the home and lease it back from the new owner. The seller could retain the right of occupancy for life or for a fixed number of years. In either case the seller would become a renter of the home which he or she formerly owned. The burden of property taxes, home insurance, and repair and maintenance costs would rest with the new owner. It is argued that these costs make it difficult for elderly homeowners to remain in their homes or cause them to make trade-offs between making home repairs and taking care of necessities such as food and health care. Such trade-offs may result in the elderly having owner-occupied but substandard property. Under a sale-leaseback plan, the owner/investor would be paying the operating costs of the property and be eligible for the associated tax writeoffs. Proponents hold that the elderly would remain in well-maintained homes without the financial burden of such maintenance. The sale-leaseback plan is a complicated form of equity conversion because of the number of variables that must be negotiated between the buyer and seller. The parties must negotiate the sales price, downpayment, loan term, and lease agreement. The items are interrelated and may affect the net benefit of the transaction to the elderly homeowner. A few programs were initiated. Under the so-called “Grannie Mae” program, a company would arrange for the children or grandchildren to purchase and leaseback the home of the elderly person.[2] Under another plan, the Fouratt Senior Citizen Equity Plan, the leaseback payments took two forms: a promissory note (mortgage) and a deferred annuity.[3] The promissory note would provide for monthly payments to the seller over a term equal to the greater of the seller’s life expectancy or 10 years. When the payments from the promissory note ended, the annuity would make the same payments for the lifetime of the seller. Only three Grannie Mae loans were made. There was interest in the Fouratt program but no loans were ever made. Sale-leaseback transactions are still being suggested as an option for elderly homeowners. Data are not available on whether homeowners are choosing that option.

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Bruce E. Foote

Reverse Annuity Mortgage The reverse annuity mortgage is another concept that was suggested in the 1970s by advocates of reverse mortgages. Under a reverse annuity mortgage (RAM), equity in the home is used as security for a loan. An annuity is purchased with the loan proceeds and the borrower receives monthly annuity income, less mortgage interest. The borrower pays only interest on the loan — repayment of the principal is deferred until the death of the owner, the sale of the property, or some prescribed date. Table 1 shows the net annuity that would be available under a RAM to a female homeowner for a range of ages and interest rates. The age shown is the borrower’s age when the loan was taken. It is assumed that a borrower obtains a $200,000 interest-only mortgage on the property and uses the proceeds to purchase an annuity. That means that the loan balance will always be $200,000. Upon the death of the borrower, the sale of the property, or some prescribed date, the borrower or the borrower’s heirs would owe the lender $200,000. For a 55-year-old borrower the annuity would be $1,062 monthly. If interest rates are 5%, the lender would deduct $833 from the annuity and forward the borrower a net annuity of $229. If interest rates are 12%, the interest payment would be greater than the annuity payments so the borrower would owe the lender $938 (a net annuity of $-938). This would defeat the purpose of entering into a RAM. The table shows that rising interest rates are a risk for homeowners and that the interest rate risk is greater for younger borrowers. For 55 and 60-year-old borrowers, the net annuity would become negative when interest rates are at 7% or higher. The net annuity would become negative at 8% for 65-year-olds, 9% for 70-year-olds, 10% for 75-year-olds, and 12% for 80-year olds. But RAMs may become a bad financial choice long before the net annuity becomes negative. For example, the net annuity becomes negative at 9% for a 70-year old, but would it make economic sense for a 70-year-old to mortgage the home and only receive a net income of $380 monthly when interest rates are 6%? For the homeowner, another risk of the RAM is that the borrower may die too soon. Suppose a 75-year old female obtained a RAM and died after receiving 12 payments. The estate would owe $200,000, even though the owner only received $19,332 in gross benefits. Of course the owner could have purchased an annuity with a 10 years certain option or cash refund option. The 10 years certain option provides that if the annuitant lives less than ten years after the plan is issued, the payments would continue to the beneficiary’s estate until the 10-year period is completed. The cash refund option provides that if the total payments to the annuitant are less than the original premium (in this example, $200,000) the beneficiary would receive the balance in a lump sum. These options reduce the monthly annuity payments and thereby reduce the financial viability of the RAM. Under RAMs, the risks for lenders are that the owner may live too long (mortality risk). The purchase of the annuity shifts the mortality risk to an insurance company. Though the concept appeared promising, CRS is aware of only one program that offered RAMs, though they were not marketed as such. In the 1990s, Homefirst, a subsidiary of Transamerica Corporation, offered a reverse mortgage plan in many parts of the country. Under the so-called “Lifetime” plan the borrower would receive monthly loan advances for a specified number of years. A deferred annuity was purchased from Metropolitan Life Insurance Company on behalf of the borrower, and it would begin lifetime monthly annuity


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payments once the borrower received the last loan advance. The borrower would receive lifetime income regardless of whether they continued to occupy the property. Table 1. Comparison of Monthly Reverse Annuity Mortgage Benefits

Gross Annuitya Less Interest:b at 5% Net Annuity at 6% Net Annuity at 7% Net Annuity at 8% Net Annuity at 9% Net Annuity at 10% Net Annuity at 11% Net Annuity at 12% Net Annuity

Age of Homeowner 55 60 65 $1,062 $1,114 $1,243

70 $1,380

75 $1,611

80 $1,937

833 229 1,000 62 1,167 -105 1,333 -271 1,500 -438 1,667 -605 1,833 -771 2,000 -938

833 547 1,000 380 1,167 213 1,333 47 1,500 -120 1,667 -287 1,833 -453 2,000 -620

833 778 1,000 611 1,167 444 1,333 278 1,500 111 1,667 -56 1,833 -222 2,000 -389

833 1,104 1,000 937 1,167 770 1,333 604 1,500 437 1,667 270 1,833 104 2,000 -63

833 281 1,000 114 1,167 -53 1,333 -219 1,500 -386 1,667 -553 1,833 -719 2,000 -886

833 410 1,000 243 1,167 76 1,333 -90 1,500 — 257 1,667 -424 1,833 -590 2,000 -757

Source: Calculations by CRS using annuities generated at [http://www.immediateannuities.com]. a. Monthly payment to a female on a $200,000 immediate annuity. b. Monthly interest due on a $200,000 interest-only mortgage.

By the late 1990s, there were several complaints regarding the reverse mortgages from Homefirst. An extreme example is illustrated by the case of a New York woman. She took out a reverse mortgage and received loan advances until she died after receiving 32 monthly payments. When her home was sold a few months later, Financial Freedom (Homefirst) demanded more than $765,000 as repayment under the terms of the reverse mortgage. The monthly payments she had received during the life of the loan totaled about $58,000.[4] As a result of this case and similar cases, three class action lawsuits were filed against Transamerica HomeFirst, Inc., Transamerica Corporation, Metropolitan Life Insurance Company, and Financial Freedom Senior Funding Corporation. The cases were combined and settled before a single judge in the Superior Court of California in San Mateo County under Judicial Council Coordination Proceeding No. 4061. The above example illustrates the risks to borrowers and lenders of reverse annuity mortgages. Financial Freedom no longer offers the “Lifetime Plan.” Instead, it offers the “Cash Account Plan” as a proprietary reverse mortgage product, and that plan is discussed in a section below.

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Reverse Mortgage In general, reverse mortgages may take one of two forms — term or tenure. Under term reverse mortgages the borrower is provided with income for a specified period. Under tenure reverse mortgage the borrower is provided with income for as long as they continue to occupy the property. From the lender’s perspective, reverse mortgages are deferred-payment loans. The lender makes a stream of payments (or a lump-sum payment) to the homeowner and expects repayment at some future date. The repayment is predicated upon the sale of the home at some price which exceeds the debt that has accumulated against the home. The largest risk the lender faces is the risk that over time the outstanding debt may grow to be greater than the property value. This may be referred to as collateral risk. Collateral risk is partly determined by the type of reverse mortgage. The least risky reverse mortgage is the term reverse mortgage under which payments stop after a specified number of years. Payments to the homeowner are calculated so that the loan reaches a target balance at the predetermined period. That target balance is less than 100% of the property value when the loan was originated. As long as the property has not depreciated during the period, the lender is assured that sale of the property will provide sufficient funds to repay the loan. For lenders, the most risky reverse mortgage is the tenure reverse mortgage because the borrower is guaranteed lifetime income and lifetime occupancy of the home. In this case, the collateral risk may be significant if the age of entry is too low, if property appreciation rates are overestimated, or if occupant survival rates are underestimated. In general, prior to the 1990s lenders were only willing to make term reverse mortgages. The payment options under these term reverse mortgages are relatively easy to calculate — all that is needed is the interest rate, the term of the loan, and the end-of-term loan balance. With these factors it is a simple matter to calculate the monthly payment that would cause the loan balance to grow to the specified amount over the specified term. As shown in table 2 for example, the monthly payment to a homeowner seeking a $100,000 reverse mortgage at a 6.5% interest rate would be $594 for a 10-year term, $943 for a seven-year term, $1,415 for a five-year term, and $2,523 for a three-year term. Table 2 also shows the maximum cash advance that will grow to a loan balance of $100,000 over the given terms. The age of the homeowner is not a factor in term reverse mortgages, homeowners would receive the same income regardless of age. If the owner lives longer than the loan term, the home would have to be sold to pay off the debt. Table 2. Payment Options Under a $100,000 Term Reverse Mortgagea Loan Term 10 years 7 years 5 years 3 years Source: Calculations by CRS. a.

Monthly Payments ($) 594 943 1,415 2,523

Cash Advance ($) 52,296 63,523 72,316 82,327

This example assumes that the interest rate is fixed at 6.5% and that there are no transaction costs.


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This feature, however, made term reverse mortgages unattractive to homeowners who faced the prospect of having to sell their homes at a specified date, and to lenders who faced the prospect of risking their reputations by forcing such sales. For these reasons there have been few takers for term reverse mortgages.

CURRENT REVERSE MORTGAGE PLANS Over time three major reverse mortgage products that offer lifetime occupancy to the borrowers have become available to consumers in the U.S. They are the Home Equity Conversion Mortgage Program (HECM), the Home Keeper reverse mortgage, and the Cash Account Plan. In late 2006, the Lifestyle Plan was introduced in the states of California, Oregon, and Washington, and the plan is expected to be made available nationally during 2007. The HECM, Home Keeper, and Cash Account plan all provide the borrower with lifetime occupancy of the home — “tenure” reverse mortgages. The availability of tenure reverse mortgages is likely the cause of the dramatic growth of reverse mortgages in the past few years. These tenure reverse mortgages also provide the borrower with flexibility on how the income from the mortgage is received. A borrower may receive monthly payments as long as the property is occupied by the borrower. The borrower may receive a line of credit which grows at some specified annual rate and upon which the borrower may make draws as needed. The borrower may choose to receive a large up-front cash advance. Or the borrower may choose any combination of the above, such as a smaller cash advance, a line of credit, and monthly income. The following sections discuss and compare these existing reverse mortgage products.

The Home Equity Conversion Mortgage Program (HECM) The Housing and Community Development Act of 1987 (P.L. 100-242) authorized the Home Equity Conversion Mortgage Program (HECM) in the Department of Housing and Urban Development (HUD) as a demonstration program. It was the first nationwide reverse mortgage program which offered the possibility of lifetime occupancy to elderly homeowners.[5] As noted above, such mortgages are referred to as tenure reverse mortgages. The borrowers must be elderly homeowners who own and occupy their homes.[6] The interest rate on the loan may be fixed or adjustable.[7] The homeowner and the lender may agree to share in any future appreciation in the value of the property.[8] The program has been made permanent and the law was amended to permit its use for 1- to 4- family residences if the owner occupies one of the units.[9] The borrower can choose from five payment plans: •

Tenure - equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence.

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Bruce E. Foote • • • •

Term - equal monthly payments for a fixed period of months selected by the borrower. Line of Credit - installments at times and in amount of borrower’s choosing until the line of credit is exhausted. Modified Tenure - combination of line of credit with monthly payments for as long as the borrower remains in the home. Modified Term - combination of line of credit with monthly payments for a fixed period of months selected by the borrower.

The HECM statute provides that the loan may not exceed the Federal Housing Administration (FHA) mortgage limit for the area in which the property is located. The mortgage must be a first mortgage, which, in essence, implies that any previous mortgage must be fully repaid either prior to the HECM or from the initial proceeds of the HECM. Prior to obtaining a loan, borrowers must be provided with counseling by third parties who will explain the financial implications of entering into home equity conversion mortgages as well as explain the options, other than home equity conversion mortgages, that may be available to elderly homeowners. To prevent displacement of the elderly homeowners, HECMs must include terms that give the homeowner the option of deferring repayment of the loan until the death of the homeowner, the voluntary sale of the home, or the occurrence of some other events as prescribed by HUD regulations. The borrowers may prepay the loans without penalty. Borrowers are required to purchase insurance from FHA. The insurance serves two purposes: (1) it protects lenders from suffering losses if the final loan balance exceeds the proceeds from the sale of a home, and (2) it continues monthly payments to the homeowner if the lender defaults on the loan. At loan origination borrowers are required to pay an upfront mortgage insurance premium (MIP) of 2% of the maximum mortgage amount. In addition, borrowers pay an annual insurance premium of 0.5% of the loan balance. Borrowers do not directly pay the insurance premiums. Instead, lenders make the payments to FHA on behalf of the borrowers and the cost of the insurance is added to the borrower’s loan balance. A lender may choose either the assignment option or the coinsurance option when originating the loan. Under the assignment option, HUD will collect all the MIP and the lender may assign the loan to HUD at the point that the loan balance equals the maximum HUD claim amount for the area. Under the coinsurance option, the lender may keep part of the MIP and forfeit the right to assign the case to HUD. To date, data indicate that all lenders have chosen the assignment option. By choosing this option, effectively, lenders are shifting the collateral risk to HUD. The American Homeownership and Economic Opportunity Act of 2000 (P.L. 106-569) amended the National Housing Act (12 USC 1715z-20) to waive the upfront insurance premium provided that the HECM proceeds are used to pay for long-term care insurance. To date, the regulations to implement this change have not been finalized. A proposed rule was published in December 2004 (69 FR 70344) and the comment period ended on February 1, 2005. When the home is eventually sold, HUD will pay the lender the difference between the loan balance and sales price if the sales price is the lesser of the two. The claim paid to the


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lender may not exceed the lesser of (1) the appraised value of the property when the loan was originated, or (2) the maximum HUD-insured loan for the area. The Federal National Mortgage Association (Fannie Mae) has been purchasing the home equity conversion mortgages originated under the program.

The Home Keeper Mortgage Since November 1996, Fannie Mae has also been offering its own reverse mortgage product — the “Home Keeper Mortgage.” This is the only conventional reverse mortgage that is available on a nationwide basis. Private lenders have developed proprietary reverse mortgage products but they are generally only available in a few states. An eligible borrower must (1) be at least age 62, (2) own the home free and clear or be able to pay off the existing debt from the proceeds of the reverse mortgage or other funds, (3) remain in the home as a primary residence, and (4) attend a counseling course approved by Fannie Mae. The interest rate on the loan adjusts monthly according to changes in the one month certificate of deposit index published by the Federal Reserve. Over the life of the loan the rate may not change by more than 12 percentage points. The loan becomes due and payable when the borrower dies, moves, sells the property, or otherwise transfers title. The borrowers have the option of receiving monthly payments, a line of credit, or a combination of the two. The Home Keeper plan may also be used for home purchase. Elderly homeowners may use the Home Keeper reverse mortgage to purchase homes that better fit their needs. The homeowners would make a downpayment and fund the rest of the purchase price with a reverse mortgage. It would mean no monthly mortgage payments. Under both programs, the homeowner must keep applicable property taxes and hazard insurance current, and maintain the homes in good repair. The loan would become due and payable if the homeowner fails to do either of the above.

The Cash Account Plan Financial Freedom Senior Funding Corp., of Irvine, CA, offers the “Cash Account Plan” as a proprietary reverse mortgage product. The Cash Account Plan is available to seniors 62 years or older who own homes with a minimum value of $75,000. It differs from the two products above in that it does not offer the borrowers an option of getting monthly payments. It provides an open-end line of credit that is available for as long as the borrower occupies the home. The borrower can draw on the line of credit in full or part at any time; the minimum draw is $500. The unused portion of the line of credit grows by 5% annually.[10] Eligible home types include owner-occupied single-family detached, manufactured, condominium, Planned Unit Development units, or 1- to 4-unit residences if one unit is owner-occupied. Borrowers are required to obtain counseling from an independent counselor prior to obtaining the loans. A monthly servicing fee is automatically added to the loan.[11] The interest rate charged to the borrower is equal to the current six-month London Interbank Offered Rate (LIBOR)

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plus 5 percentage points. The rate is adjusted semi-annually, but the interest rate may never rise more than 6 percentage points above the initial rate. The Cash Account Plan is available in two forms: the Standard Option and the Zero Point Option. Under the Standard Option, a borrower pays a loan origination fee that is equal to 2% on the first $500,000 of loan balance, 1.5% on the next $500,000, and 1% on the balance in excess of $1 million. Under the Zero Point Option, the borrower pays no loan origination fee. Closing costs, including third party costs and excluding state and local taxes, will not exceed $3,500. At closing the borrower is required to take a draw on the line of credit, and the minimum draw at closing is 75% of the line of credit. Subsequent draws have a minimum of $500. Full prepayment is permitted and, while there are no prepayment penalties, partial prepayment on the initial draw is not permitted for the first 5 years. The Zero Point Option is generally marketed to elderly homeowners with homes valued at $450,000 or more. The Cash Account Plan is currently available in the District of Columbia and 24 states: Arizona, California, Colorado, Connecticut, Florida, Georgia, Hawaii, Illinois, Indiana, Maryland, Massachusetts, Michigan, Minnesota, Nevada, New Jersey, New York, Ohio, Oregon, Pennsylvania, Utah, Vermont, Virginia, Washington, and Wyoming.

The Lifestyle Plan Reverse Mortgage of America, a subsidiary of Seattle Mortgage, introduced “The Lifestyle Plan” in late 2006. It is the first new reverse mortgage product to be introduced in nearly a decade. Like the Cash Account Plan, the Lifestyle Plan allows homeowners age 62 and older to use some of the equity in their homes while continuing to live there. The product is initially available only in the states of California, Oregon, and Washington. Reverse Mortgage of America plans to market it to the rest of the country in early 2007. The Lifestyle Plan product is similar to the Cash Account plan, and is designed for owners of high value homes. The interest rate on the new Lifestyle Plan is the six-month LIBOR Index, plus 3.6 percentage points.

CHOOSING AMONG THE PLANS Table 3 compares the income that may be received under the three major plans for the same valued home. The table shows the monthly income that would be available if the borrower chose only to receive monthly payments, and the largest line of credit that would be available at loan origination if the borrower chose to only have a line of credit. The HECM plan pays the largest monthly payments and has the largest available lines of credit. It is reasonable to assume that a rational homeowner would choose the HECM since it provides the greatest benefit. So, why do the other plans exist, and who chooses them? Part of the answer lies in home values and permissible loan limits. HECM loans have the same limits as the FHA home loan program. FHA-insured loans are limited to 95% of the median price for an area, subject to the restriction that the loan limit for an area may not be less than 48% nor greater than 87% of the Federal Home Loan Mortgage Corporation


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(Freddie Mac) loan limit. The maximum mortgage that may be purchased by Freddie Mac (and Fannie Mae) is set by statute and is adjusted on January 1st of each year. The Freddie Mac/Fannie Mae loan limits are referred to as the “conforming loan limits.” Loans in excess of the conforming loan limits are referred to as “jumbo loans.” For calendar year 2007 the conforming loan limit for one-family homes is set at $417,000, so the FHA (and HECM) loan limit is set at $362,790. That is the statutory maximum for HECMs, but the individual limits vary by area. For example, the limit is $228,000 in Albany, NY; $213,655 in Louisville, KY; $233,700 in Columbus, OH; and $362,790 in Los Angeles, CA and Boston, MA. Table 3. Payment Options Under Reverse Mortgage Programs by Age of Youngest Homeownera

Age 62 65 70 75 80 85 90

Reverse Mortgage Program HECM Home Keeper Monthly Line of Monthly Line of Income Credit Income Credit $ 557 $ 92,909 $ 206 $ 24,419 603 98,621 255 32,485 696 108,865 417 57,663 815 119,606 632 73,093 983 130,881 800 89,882 1,242 141,942 1,051 107,912 1,736 152,665 1,199 119,579

Cash Account Monthly Line of Credit Income N/A $ 58,201 N/A 64,401 N/A 76,201 N/A 89,001 N/A 94,401 N/A 99,401 N/A 104,401

Source: Calculated by CRS using the Reverse Mortgage Calculator on Financial Freedom’s website. a. Estimates were run on January 10, 2007 and are based on a $200,000 home in Denver, CO. It is assumed that the homeowner had no outstanding loans against the property.

Table 4 compares the benefits available under the reverse mortgage programs for a 70year-old homeowner in Albany, NY. At the current limits, a 70-year old homeowner in Albany would qualify for a maximum HECM credit line of about $125,200. Someone in Albany with a $300,000 home would qualify for a $89,648 credit line under Home Keeper or a $116,664 Cash Account credit line.[12] The HECM would appear to be the better choice for the homeowner because the funds available from a HECM exceed the funds available from a Home Keeper or Cash Account loan based on a higher mortgage amount. Only when an Albany homeowner has a home valued in excess of $350,000 does the cash available from the Cash Account plan exceed the cash available from the HECM. And only when an Albany homeowner has a home valued at $450,000 or more does the cash available from the Home Keeper plan exceed the cash available from the HECM. Note that under table 4 the benefits under a HECM do not increase as the home value increases above $250,000. That is because HECM loans are limited to the FHA loan limit for a particular area, and that limit is $228,000 for Albany, NY. Table 5 has been prepared using the Los Angeles area as a base. Actually, table 5 may be considered a proxy for any area where the FHA limit is at its current maximum of $362,790. The table shows that the Home Keeper plan never offers higher cash benefits to 70-year old homeowners than the HECM.

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Table 4. Comparison of Reverse Mortgage Benefits to a Homeowner in Albany, NYa

Home Value $200,000 250,000 300,000 350,000 400,000 450,000 500,000 550,000

Reverse Mortgage Program HECM Home Keeper Monthly Line of Monthly Line of Incomeb Creditb Incomec Creditc $696 $108,865 $417 $57,663 800 125,179 533 73,656 800 125,179 648 89,648 800 125,179 764 105,640 800 125,179 879 121,633 800 125,179 919 127,070 800 125,179 919 127,070 800 125,179 919 127,070

Cash Account Monthly Line of Income Credite N/A $76,201 N/A 96,433 N/A 116,664 N/A 136,533 N/A 156,356 N/A 176,178 N/A 195,178 N/A 215,963

Source: Calculated by CRS using Reverse Mortgage Calculator on Financial Freedom’s website. a. Estimates were run on January 10, 2007 and are based on a loan to a 70-year old in Albany, NY. It is assumed that the homeowner had no outstanding loans against the property. b. The FHA mortgage limit is $228,000 for Albany, and that determines the maximum payments available under a reverse mortgage in the area. c. The Fannie Mae loan limit is $417,000 and that determines the maximum payments available under the program.

Table 5. Comparison of Reverse Mortgage Benefits to a Homeowner in Glendale, CAa

Home Value $200,000

Reverse Mortgage Program HECM Home Keeper Line of Monthly Line of Monthly Creditb Incomec Creditc Incomeb $ 702 $109,815 $421 $ 58,184

Cash Account Monthly Line of Income Credit N/A $ 76,941

250,000 300,000 350,000 400,000 450,000 500,000 550,000

889 1,076 1,263 1,311 1,311 1,311 1,311

N/A N/A N/A N/A N/A N/A N/A

139,072 168,329 197,605 205,094 205,094 205,094 205,094

537 653 769 885 925 925 925

74,241 90,297 106,354 122,411 127,870 127,870 127,870

97,298 117,655 137,669 157,636 177,604 197,571 217,539

Source: Calculated by CRS using the Reverse Mortgage Calculator on Financial Freedom’s website. a. Estimates were run on January 10, 2007 and are based on a loan to a 70-year old in Glendale, CA. It is assumed that the homeowner had no outstanding loans against the property. b. The FHA mortgage limit is $362,790 during 2007, and that determines the maximum payments available under a reverse mortgage. c. The Fannie Mae loan limit is $417,000 during 2007, and that determines the maximum payments available under the program.

Only when home values approach $550,000 or more does the Cash Account plan offer higher lines of credit than the HECM. That is by design. The Cash Account was not created to compete with the HECM, but to offer reverse mortgages to borrowers with homes valued above the HECM and Home Keeper limits.


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Thus, it is not surprising that reverse mortgages made under HECM account for about 90% of the reverse mortgages made nationwide. One financial writer, Jane Bryant Quinn, suggests that elderly homeowners should choose the Cash Account plan if the homeowners only plan to be borrowing for 3 or 4 years.[13] The Cash Account Plan has higher interest rates than the HECM but the HECM has higher upfront costs.[14] The lower upfront costs make the Cash Account Plan cheaper for short term loans. Quinn suggests that borrowers choose the HECM if they expect to keep the loan for many years. If borrowers choose a loan with a credit line, HECM will provide them with more long-term borrowing power.

USING REVERSE MORTGAGES FOR LONG-TERM CARE As indicated previously, the AHS estimates that more than 12.5 million homeowners age 65 older, have homes which are free of mortgage debt. With the growth in the public cost of long-term care for the elderly, there has been research and discussion of ways that elderly homeowners may use reverse mortgages to tap this home equity and fund their own long-term care.

Funding Long-Term Care Directly One option is for the homeowners to use reverse mortgages to fund long-term care directly. Primarily this would involve paying for home modifications and in-home care which would permit them to “age-in-place.” Under its “Use Your Home to Stay at Home” initiative, the National Council for the Aging (NCOA) is encouraging the use of reverse mortgages to fund long-term care. Of the nearly 28 million American households age 62 and older, NCOA has found that about 13.2 million (48%) are good candidates for a reverse mortgage. According to NCOA, an estimated $953 billion could be available from reverse mortgages for immediate long-term care needs and to promote aging in place.[15] That $953 billion figure, however, appears to have been calculated by assuming that the homeowners would, on average, be eligible for about $72,200 in reverse mortgage loans and then multiplying by the 13.2 million potential reverse mortgage candidates. In effect, that is assuming a 100% participation rate. The 2005 Annual Housing Survey estimates that of the 17.8 million homes owned by the elderly, only 64,000, or 0.4%, have reverse mortgages.[16] By using reverse mortgages, some of the elderly would be able to fund their long-term care expenses for a number of years, and thereby delay potential entry into the Medicaid program. It is debatable, however, whether and how much savings this approach would provide for the Medicaid program. The Medicaid program has the ultimate claim on the home equity of program participants. If participants fund their care through reverse mortgages, they may use up most or all of their equity, so there may be little or none left to be claimed by Medicaid. There may be cases where the net cost to the Medicaid program would be less if the participants had entered the Medicaid program earlier instead of consuming their equity through reverse mortgages.

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Funding Long-Term Care Insurance Another option is to use reverse mortgages to pay for long-term care insurance (LTCI). As noted above, the American Homeownership and Economic Opportunity Act of 2000 amended the National Housing Act to waive the up-front insurance premium for HECMs, provided that the HECM proceeds are used to pay for long-term care insurance. Regulations to implement the law have not been finalized. The demographics of reverse mortgages and long-term care insurance do not match for either consumers or the industry. Long-term care insurers want young consumers. Reverse mortgage lenders want old consumers. For consumers, LTCI is best taken at an older age when the benefits are greater, but the premiums are more expensive. For insurers, the major risk is that the purchasers will get sick too soon and need long-term care before they have paid enough premiums into the insurance fund. For reverse mortgage lenders, the major risk is that the borrower will live too long and accumulate debt against the property which exceeds the property value. The different risks result in different outcomes for consumers with the same profile. For example, insurers are reluctant to provide insurance to borrowers with certain health problems, because of the likelihood that the borrowers may need to use the insurance. Lenders, however, will make reverse mortgages to such borrowers, because there is less likelihood that the borrowers will occupy the property too long. The cost of the insurance is another issue. In recent years, insurers have raised the insurance premiums on current customers. This suggests that a homeowner who used a reverse mortgage to purchase long-term care insurance could face the risk that the cost of the policy could increase at some later date. That would not be a problem if the homeowner could afford the increased cost. But if the increase were unaffordable, the borrower would have to drop the insurance. If this occurred, it might be possible that the borrower would still have some paid-up benefits, but the level of coverage would be less than the borrower had planned when initially purchasing the policy. This creates another potential problem because HUD, in its proposed regulation, is considering the requirement that the HECM loan be repaid within 90 days if the LTC insurance is dropped, unless a new policy is purchased or the borrower pays the premium that HUD has previously waived. If the homeowner is unable to obtain a new policy or repay the premium, it is likely that the home would be sold, because it is unlikely that the homeowner would have sufficient income to make repayments on the debt. The homeowner would have mortgaged the home with an instrument promising lifetime occupancy of the property, and would have used the proceeds to purchase long-term care insurance as protection from being impoverished by the cost of long-term care. Yet the homeowner would have to prematurely sell the home and would have less protection from future costs of long-term care.

ISSUES FOR THE ELDERLY Though there has been growth in use of reverse mortgages in recent years, it is still a relatively little used option for elderly homeowners. Many elderly homeowners do not understand the program and are reluctant to participate. After spending many years paying for


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their homes, elderly owners may not want to mortgage the property again. There are several options to be considered.[17]

Downsizing One option is to sell the home and purchase something smaller. Present law permits a seller to exclude from taxation up to$250,000 ($500,000 for a married couple) of the gain from sale of a home. The home must have been used as the principal residence for two out of five years before the sale. Funds not used for the new purchase could be used for investment and as a source of cash to meet future needs.

Selling and Renting Instead of purchasing another property the homeowner could consider renting an apartment, perhaps in a complex designated for those 55 and older. The proceeds from the sale of the home could be saved and invested and used for income when needed.

Finding Tenants Rather than sell the home, the homeowner could consider renting part of the home to students, young couples, other retirees. The rental income would help with ongoing expenses. In addition to the economic benefit, a rental might also provide some companionship to the owner.

Reverse Mortgage The homeowner might consider a reverse mortgage. As mentioned above, a reverse mortgage enables an elderly homeowner to use the equity in the home to receive monthly income, a line of credit, or some combination of the two. Repayments are delayed until the home is no longer occupied as a principal residence. Then the borrower or the heirs must repay the loan. If the home is sold and the sales price exceeds the loan balance, the borrower or the heirs keep any proceeds that remain.[18] If the sales price is less than the loan balance, then the lender suffers the loss. The funds received from the reverse mortgage are tax free because the funds are considered as loan proceeds instead of income. The payments from reverse mortgages do not affect the income or eligibility from Social Security or Medicare. But homeowners who receive Supplemental Security Income (SSI) or Medicaid[19] might have these benefits reduced if the recipients do not spend their entire sum received under the reverse mortgage each month. When considering a reverse mortgage, there are several questions which should be addressed:

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Bruce E. Foote • •

• • • • • • • • • • • •

Participants may be provided with lifetime occupancy, but will borrowers generate sufficient income to meet future health care needs? Will they obtain equity conversion loans when they are too “young” and, as a result, have limited resources from which to draw when they are older and more frail and sick? Table 7 shows that the younger elderly will accumulate significant debt against the homes if they live too long. Will the “young” elderly spend the extra income on travel and luxury consumer items? Should home equity conversion mechanisms be limited as last resort options for elderly homeowners? Will some of the home equity be conserved? How would an equity conversion loan affect the homeowner’s estate planning? Does the homeowner have other assets? How large is the home equity relative to the other assets? Will the homeowner have any survivors? What is the financial position of the heirs apparent? Are the children of the elderly homeowner relatively well-off and with no need to inherit the “family home” or the funds that would result from the sale of that home? Alternatively, would the ultimate sale of the home result in significant improvement in the financial position of the heirs? How healthy is the homeowner? What has been the individual’s health history? Are large medical expenses pending? At any given age, a healthy borrower will have a longer life expectancy than a borrower in poor health. What has been the history of property appreciation in the area?

The above questions are interrelated. Their answers should help determine whether an individual should consider a reverse mortgage, what type of loan to consider, and at what age a reverse mortgage should be considered.

ISSUES FOR POLICYMAKERS Potential Federal Liability As revealed in table 6, there has been dramatic growth in the use of HECMs over the past few years. More than 76,300 loans were made in FY2006 compared to little more than 157 in 1990. What does this mean for HUD, since the department has potential liability for these loans? As noted previously, one of the greatest risks for lenders is that the borrower will live too long and that the loan balance will exceed the home value — collateral risk. Under the HECM program this risk falls to HUD because the lender can assign the loan to HUD in those cases. The collateral risk then becomes a potential liability for the FHA insurance fund.


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Table 6. HECM Loans by Fiscal Year Fiscal Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Number of HECM Loans 157 389 1,019 1,964 3,365 4,165 3,596 5,208 7,896 7,982 6,640a 7,781 13,049 18,097b 37,829 43,131 76,351

Percent Change (%) 148 162 93 71 24 -14 45 52 1 -17 17 68 39 109 14 77

Source: Data from HUD. Year-to-year percentage change calculated by CRS. a. HECMs could not be made for part of FY2000 (July to early October 2000) because FHA insurance authority had been exhausted temporarily. b. HUD ran out of insurance authority and couldn’t insure HECMs during the last two weeks of September 2003.

Table 7 presents the potential FHA liability for different scenarios. The life expectancy is the average number of years a person is expected to live, given that they have reached a specific age. Column 1 is the monthly income to a borrower of various ages obtaining a HECM in Denver on a home valued at $200,000. Column 4 is the loan balance that would accumulate at that life expectancy. Column 5 show what loan balance would be accumulated if the borrower defies the life tables and lives and occupies the home until age 95. Column 6 shows the potential liability to HUD if the borrower survives to age 95. Column 5 of table 7 may also be interpreted as the sales price (and home value) that must be obtained at the sale of the house in order for the lender to break even (assuming no transaction costs). If a borrower obtains a HECM at age 62, the originally $200,000 home must be worth about $289,770 at the borrower’s life expectancy and more than $770,000 if the borrower lives and occupies the property to age 95. The table suggests that at the expected life of the borrower there is little collateral risk for HUD when making HECMs to homeowners age 70 and above. Loans to younger borrowers are more risky. If borrowers lived to age 95 there would be significant collateral risk for homeowners younger than 80 years old when obtaining a HECM. The calculations in table 7 assume that interest rates were 6.5% and stayed that way throughout the period. That is an unreasonable assumption given the history of interest rates over the past 30 years. It is quite likely that interest rates will rise during a 30-year span. Rising rates would increase the potential liability for HUD.

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Bruce E. Foote Table 7. Potential Federal Liability Under the HECM Age of Borrower (1)

Life Expectancya (2)

Monthly Paymentb (3)

62 65 70 75 80 85 90

20.7 18.4 14.9 11.8 9.0 6.8 5.0

$ 557 603 696 815 983 1,242 1,736

Loan Balance at Lifec (4) $289,770 254,038 207,616 171,811 143,759 125,866 122,690

Loan Balance at Age 95 (5) $770,484 667,025 521,190 399,693 298,385 209,157 122,690

Potential Liabilityd (6) $570,484 467,025 321,190 199,693 98,385 9,157 N/A

Source: Life expectancies are from the National Center for Health Statistics. Calculations by CRS. a. The average number of years a person (all races, male and female) is expected live once they have reached a specific age. b. Monthly payment for a HECM on a $200,000 home in Denver, CO. c. The loan balance at the life expectancy of the borrower, assuming a 6.5% interest rate. d. The amount by which the loan balance exceeds the initial home value ($200,000), assuming a 6.5% interest rate.

In any case, the table suggests that, given the interest rates, the potential liability the government faces under the HECM program will depend on the extent to which the program is used by borrowers age 70 and older, and the extent to which those borrowers meet or exceed their life expectancies. HECM loans to 62 and 65-year old homeowners could be quite risky for HUD.

National HECM Limit Some proponents of the HECM program suggest that the law should be amended to provide a national HECM mortgage limit instead of having the limit be subject to the area FHA limit. For convenience, the HECM data from table 4 and table 5 have been placed in table 8. Table 8 compares the HECM benefits in low-cost and high-cost areas. Albany, NY is being used as a proxy for low-cost areas and Glendale, CA is used as a proxy for high-cost areas. The FHA loan limit for one-family homes is $228,000 in Albany and it is $362,790 for Glendale. Owners of $200,000 homes would receive nearly the same payments from a HECM in either Albany or Glendale. Regardless of the home value, HECMs for Albany homeowners would be limited to what may be obtained on a $228,000 home, while homeowners in Glendale would receive larger cash benefits based on their higher home values.[20] A national HECM limit is something that Congress has considered in the past, since P.L. 105-276 required HUD to conduct an actuarial study to determine the adequacy of the insurance premiums collected with respect to the establishment of a national HECM mortgage limit.[21]


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It could be argued, however, that there is a sense in which the present program benefits both borrowers and the government. Borrowers, whose homes are valued above the FHA limit, are forced to conserve more equity than if they could borrow more. This provides the possibility of larger distributions to heirs upon the death of the borrowers, or the availability of more funds for other needs should future illness require a sooner than expected sale of the home. For the government it lessens the frequency and severity of future FHA insurance losses. Table 8. Comparison of HECM Payments in Low-Cost and High-Cost Areas

Home Value $200,000 250,000 300,000 350,000 400,000 450,000

Limited HECMa Monthly Line of Credit Income $696 $108,865 800 125,179 800 125,179 800 125,179 800 125,179 800 125,179

Maximum HECMb Monthly Line of Credit Income $702 $109,815 889 139,072 1,076 168,329 1,263 197,605 1,311 205,094 1,311 205,094

Source: Table 4 and table 5. a. HECM limited to $228,000 b. HECM limited to the $362,790 FHA maximum.

Long-Term Care Insurance As noted above, current law provides that a borrower may waive the up-front insurance premium for HECMs, provided that the HECM proceeds are used to pay for long-term care insurance.[22] The law is very restrictive in that it requires that all the proceeds of the HECM (after paying off any existing debt on the property) must be used exclusively for long-term care insurance. In exchange for savings on the insurance premium (which would be $4,000 on a $200,000 home), the homeowner would be giving up the option of using future HECM funds to pay for future home repairs, unexpected health costs, or increases in daily living expenses. This feature makes the proposal risky and unattractive to some elderly homeowners. For this reason it has been suggested that Congress consider modifying the legislation to make it more flexible.

Number of HECM Loans The HECM program was begun as a demonstration program which authorized only 2,500 loans to be made under the program (50 per state).[23] The program has been made permanent and the limit on the aggregate number of HECMs that may be insured has been amended several times. It was raised to 150,000 by P.L. 106-569, to 250,000 by P.L. 109-13, and to 275,000 by P.L. 109-289. As passed by the House in the 109th Congress, H.R. 5576 would have removed the limit on the number of HECM loans that may be the made.

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Bruce E. Foote

HUD and lenders are suggesting that the program is now approaching the present 275,000 limit. If that limit is reached, then HUD may no longer insure mortgages under the program. As passed by the House on January 17, 2007, H.R. 391 would authorize HUD to continue to insure HECM mortgages through February 15, 2007, regardless of the limit contained in current law.

Aging in Place Stephen Golant, a University of Florida professor and former consultant to the Commission on Affordable Housing and Health Facility Needs for Seniors in the 21st Century, suggests that the explosive growth of reverse mortgages may backfire for both elderly homeowners and the nation’s cities.[24] He suggests that society should not romanticize the notion of older people aging in place in their homes and be blind to the downside. According to Golant, the downside is that reverse mortgages encourage the elderly to remain in older housing that may be unsafe because of physical deficiencies. Holders of reverse mortgages are disproportionately poor, they often are in their 70s and 80s, and more likely to live alone. More than half occupy dwellings that are at least 40 years old, which means they are more likely to live in houses with physical deficiencies. They often do not make improvements in their homes that could help them avoid accidents. Golant suggests that we are doing a disservice to elderly homeowners by encouraging them to remain in such homes. Instead, the homes could be sold to younger homebuyers who are more likely to make improvements to the homes which would contribute to revitalization of neighborhoods. Golant suggests that, although the elderly may prefer to remain in their own homes, many would be better off in places appropriate for their frailties and close to the support services they may need.

BIBLIOGRAPHY Ahlstrom, Alexis A, and Anne Tumlinson and Jeanne Lambrew. Primer: Linking Reverse Mortgages and Long-term Care Insurance. The Brookings Institution. The George Washington University Case, Bradford and Ann B. Schnare. Preliminary Evaluation of the HECM Reverse Mortgage Program. Journal of the American Real Estate and Urban Economics Association; Summer 1994. Cutler, Neal E. Homeownership and Retirement Planning: Financial Worries and Reverse Mortgages. Journal of Financial Services Professionals, Mar 2003. Davodoff, Thomas and Gerd Welke. Selection and Moral Hazard in the Reverse Mortgage Market. Hass School of Business, University of California at Berkeley, Oct 21, 2004. Eschtruth, Andrew D., and Wie Sun and Anthony Webb. Will Reverse Mortgages Save Baby Boomers? Boston College, Center for Retirement Research, Issue in Brief, No 54. September 2006.


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Gibler, Karen Martin and Joseph Rabianski, Elderly Interest in Home Equity Conversion, Housing Policy Debate. V4, Issue 4, 1993. Golant, Stephan. Housing America’s Elderly: Many Possibilities/Few Choices. Sage, 1992. ————Why Urban Mayors Should Dislike Reverse Mortgages. Paper delivered at the 57th Annual Scientific Meeting of the Gerontological Society of America, Washington, DC, Nov 20, 2004. Holt, Michael A., House Rich but Cash Poor. The CPA Journal. Pp. 70-74, Feb 1994. Kelly, Tom. New Reverse Mortgage Formula: How to Convert Home Equity into Tax-Free Income. John Wiley and Sons, 2005. Klein, Linda S. and C.F. Sirmans. Financial Innovation and the Development of Reverse Mortgage Programs. Benefits Quarterly, First Quarter 1993. Merlis, Mark. Home Equity Conversion Mortgages and Long-term Care. Health Policy Institute, Long-term Care Financing Project, Georgetown University, March 2005. Quinn, Jane Bryant. Mortgage Smarts, Newsweek, Oct. 23, 2006. Sloan, Katrinka Smith. New Developments in Home Equity Conversion. The Real Estate Finance Journal. V3, Issue 4, Mar 1988. Stucki, Barbara R. Use Your Home to Stay at Home: Expanding the Use of Reverse Mortgages for Long-Term Care: A Blueprint for Action, The National Council on the Aging, January 2005. Symanoski, Edward J. Jr. Risk and the Home Equity Conversion Mortgage. Journal of the American Real Estate and Urban Economics Association; Summer 1994. U.S. Bureau of the Census. Current Population Reports. P70-88. Net Worth and Asset Ownership of Households: 1998 and 2000. May 2003. U.S. Department of Health and Human Services, National Center for Health Statistics. National Vital Statistics Reports, United States Life Tables, 2003, V54, No 14, April 2006. U.S. Department of Housing and Urban Development, Home Equity Conversion Mortgages: Long Term Care Insurance; Proposed Rule, 69 FR70344. Dec 3, 2004.

REFERENCES [1]

[2] [3] [4] [5]

American Housing Survey for the United States:2005, Current Housing Reports. H150/05. U.S. Department of Housing and Urban Development and U.S. Census Bureau. August 2006, p. 156. Q and A on Grannie Mae, Home Equity News, National Center for Home Equity Conversion, No 8, June 1984, p 3. Sloan, Katrinka Smith. New Developments in Home Equity Conversion. The Real Estate Finance Journal. V3, Issue 4, March 1988, p 44. Kenneth R. Harney, “Settlement Shows How Costly Reverse Mortgages Can Be,” Washington Post, Feb. 8, 2003, p. H3. The mortgages were not initially available in Texas because state law prohibited reverse mortgages. Texas law has been subsequently amended to permit reverse mortgages.

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[8] [9] [10] [11] [12] [13] [14] [15]

[16] [17] [18]

[19] [20]

[21] [22] [23] [24]

Bruce E. Foote If the property has multiple owners, the youngest owner must be at least 62 years of age. Virtually all of the HECM loans are sold to the Federal National Mortgage Association (Fannie Mae). Since lenders generally make HECM loans with the intention of selling them to Fannie Mae, and since Fannie Mae only buys HECM loans that have adjustable rates, all HECM loans are made with adjustable interest rates. Fannie Mae will not buy HECM loans that feature equity sharing, so none are made with this feature. Section 593 of P.L. 105-276. For example, if a borrower had a $150,000 line of credit and had not drawn on it during the year, the next year the line of credit would be $157,500. No servicing fee is permitted in Illinois and Maryland. This figure were calculated using the reverse mortgage calculator at [http://www.financialfreedom.com/ReverseMortgageCalculator/]. Jane Bryant Quinn. Mortgage Smarts, Newsweek, Oct. 23, 2006. But the Cash Account plan is not available in all states. So this may not be an option for some homeowners. Stucki, Barbara R. Use Your Home to Stay at Home: Expanding the Use of Reverse Mortgages for Long-Term Care: A Blueprint for Action, The National Council on the Aging, January 2005, p 9. op cit American Housing Survey for the United States:2005 Table 7-15, p. 460. This list is illustrative rather than exhaustive. Selling the home is not a requirement. The borrower or the heirs have the option of keeping the home and obtaining a loan or using other funds to repay the reverse mortgage debt. Medi-Cal in California. Table 4 reveals, however, that even though the owner of a $300,000 home in Albany would get less from a HECM than a homeowner in Glendale, the Albany homeowner would get more than would be available from the alternatives offered by the Home Keeper and Cash Account plans. 12U.S.C. 1715z-20(k)(5) 12 U.S.C. 1715z-20(l) 12 U.S.C. 1715z-20(g) Stephan M. Golant. Why Urban Mayors Should Dislike Reverse Mortgages. Paper delivered at the 57th Annual Scientific Meeting of the Gerontological Society of America, Washington, DC, Nov. 20, 2004.


Chapter 3

ONE HUNDRED QUESTIONS AND ANSWERS * ABOUT BUYING A NEW HOME United States Department of Housing and Urban Development GETTING STARTED 1. HOW DO I KNOW IF I'M READY TO BUY A HOME? You can find out by asking yourself some questions: • • • • •

Do I have a steady source of income (usually a job)? Have I been employed on a regular basis for the last 2-3 years? Is my current income reliable? Do I have a good record of paying my bills? Do I have few outstanding long-term debts, like car payments? Do I have money saved for a down payment? Do I have the ability to pay a mortgage every month, plus additional costs?

If you can answer "yes" to these questions, you are probably ready to buy your own home. 2. HOW DO I BEGIN THE PROCESS OF BUYING A HOME? Start by thinking about your situation. Are you ready to buy a home? How much can you afford in a monthly mortgage payment (see Question 4 for help)? How much space do you need? What areas of town do you like? After you answer these questions, make a "To Do" list and start doing casual research. Talk to friends and family, drive through neighborhoods, and look in the "Homes" section of the newspaper.

*

Extracted from http://www.hud.gov/offices/hsg/sfh/buying/buyhm.cfm.

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United States Department of Housing and Urban Development

3. HOW DOES PURCHASING A HOME COMPARE WITH RENTING? The two don't really compare at all. The one advantage of renting is being generally free of most maintenance responsibilities. But by renting, you lose the chance to build equity, take advantage of tax benefits, and protect yourself against rent increases. Also, you may not be free to decorate without permission and may be at the mercy of the landlord for housing. Owning a home has many benefits. When you make a mortgage payment, you are building equity. And that's an investment. Owning a home also qualifies you for tax breaks that assist you in dealing with your new financial responsibilities- like insurance, real estate taxes, and upkeep- which can be substantial. But given the freedom, stability, and security of owning your own home, they are worth it. 4. HOW DOES THE LENDER DECIDE THE MAXIMUM LOAN AMOUNT THAT CAN AFFORD? The lender considers your debt-to-income ratio, which is a comparison of your gross (pre-tax) income to housing and non-housing expenses. Non-housing expenses include such long-term debts as car or student loan payments, alimony, or child support. According to the FHA,monthly mortgage payments should be no more than 29% of gross income, while the mortgage payment, combined with non-housing expenses, 4 should total no more than 41% of income. The lender also considers cash available for down payment and closing costs, credit history, etc. when determining your maximum loan amount. 5. HOW DO I SELECT THE RIGHT REAL ESTATE AGENT? Start by asking family and friends if they can recommend an agent. Compile a list of several agents and talk to each before choosing one. Look for an agent who listens well and understands your needs, and whose judgment you trust. The ideal agent knows the local area well and has resources and contacts to help you in your search. Overall, you want to choose an agent that makes you feel comfortable and can provide all the knowledge and services you need. 6. HOW CAN I DETERMINE MY HOUSING NEEDS BEFORE I BEGIN THE SEARCH? Your home should fit way you live, with spaces and features that appeal to the whole family. Before you begin looking at homes, make a list of your priorities - things like location and size. Should the house be close to certain schools? your job? to public transportation? How large should the house be? What type of lot do you prefer? What kinds of amenities are you looking for? Establish a set of minimum requirements and a 'wish list." Minimum requirements are things that a house must have for you to consider it, while a "wish list" covers things that you'd like to have but aren't essential.

One Hundred Questions and Answers about Buying a New Home

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FINDING YOUR HOME 7. WHAT SHOULD I LOOK FOR WHEN DECIDING ON A COMMUNITY? Select a community that will allow you to best live your daily life. Many people choose communities based on schools. Do you want access to shopping and public transportation? Is access to local facilities like libraries and museums important to you? Or do you prefer the peace and quiet of a rural community? When you find places that you like, talk to people that live there. They know the most about the area and will be your future neighbors. More than anything, you want a neighborhood where you feel comfortable in. 8. WHAT SHOULD I DO IF I'M FEELING EXCLUDED FROM CERTAIN NEIGHBORHOODS? Immediately contact the U.S. Department of Housing and Urban Development (HUD) if you ever feel excluded from a neighborhood or particular house. Also, contact HUD if you believe you are being discriminated against on the basis of race, color, religion, sex, nationality, familial status, or disability. HUD's Office of Fair Housing has a hotline for reporting incidents of discrimination: 1-800-669-9777 (and 1-800-927-9275 for the hearing impaired). 9. HOW CAN I FIND OUT ABOUT LOCAL SCHOOLS? You can get information about school systems by contacting the city or county school board or the local schools. Your real estate agent may also be knowledgeable about schools in the area. 10. HOW CAN I FIND OUT ABOUT COMMUNITY RESOURCES? Contact the local chamber of commerce for promotional literature or talk to your real estate agent about welcome kits, maps, and other information. You may also want to visit the local library. It can be an excellent source for information on local events and resources, and the librarians will probably be able to answer many of the questions you have. 11. HOW CAN I FIND OUT HOW MUCH HOMES ARE SELLING FOR IN CERTAIN COMMUNITIES AND NEIGHBORHOODS? Your real estate agent can give you a ballpark figure by showing you comparable listings. If you are working with a REALTOR, they may have access to comparable sales maintained on a database. 12. HOW CAN I FIND INFORMATION ON THE PROPERTY TAX LIABILITY? The total amount of the previous year's property taxes is usually included in the listing information. If it's not, ask the seller for a tax receipt or contact the local assessor's off ice. Tax rates can change from year to year, so these figures may be approximate.

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13. WHAT OTHER TAX ISSUES SHOULD I TAKE INTO CONSIDERATION? Keep in mind that your mortgage interest and real estate taxes will be deductible. A qualified real estate professional can give you more details on other tax benefits and liabilities, 14. IS AN OLDER HOME A BETTER VALUE THAN A NEW ONE? There isn't a definitive answer to this question. You should look at each home for its individual characteristics. Generally, older homes may be in more established neighborhoods, offer more ambiance, and have lower property tax rates. People who buy older homes, however, shouldn't mind maintaining their home and making some repairs. Newer homes tend to use more modern architecture and systems, are usually easier to maintain, and may be more energy-efficient. People who buy new homes often don't want to worry initially about upkeep and repairs. 15. WHAT SHOULD I LOOK FOR WHEN WALKING THROUGH A HOME? In addition to comparing the home to your minimum requirement and wish lists, use the HUD Home Scorecard and consider the following: • • • • • • • • •

Is there enough room for both the present and the future? Are there enough bedrooms and bathrooms? Is the house structurally sound? Do the mechanical systems and appliances work? Is the yard big enough? Do you like the floor plan? Will your furniture fit in the space? Is there enough storage space? (Bring a tape measure to better answer these questions.) Does anything need to repaired or replaced? Will the seller repair or replace the items? Imagine the house in good weather and bad, and in each season. Will you be happy with it year-round?

Take your time and think carefully about each house you see. Ask your real estate agent to point out the pros and cons of each home from a professional standpoint. 16. WHAT QUESTIONS SHOULD I ASK WHEN LOOKING AT HOMES? Many of your questions should focus on potential problems and maintenance issues. Does anything need to be replaced? What things require ongoing maintenance (e.g., paint, roof, HVAC, appliances, carpet)? Also ask about the house and neighborhood, focusing on quality of life issues. Be sure the seller's or real estate agent's answers are clear and complete. Ask questions until you understand all of the information they've given. Making a list of


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questions ahead of time will help you organize your thoughts and arrange all of the information you receive. The HUD Home Scorecard can help you develop your question list. 17. HOW CAN I KEEP TRACK OF ALL THE HOMES I SEE? If possible, take photographs of each house: the outside, the major rooms, the yard, and extra features that you like or ones you see as potential problems. And don't hesitate to return for a second look. Use the HUD Home Scorecard to organize your photos and notes for each house. 18. HOW MANY HOMES SHOULD I CONSIDER BEFORE CHOOSING ONE? There isn't a set number of houses you should see before you decide. Visit as many as it takes to find the one you want. On average, homebuyers see 15 houses before choosing one. Just be sure to communicate often with your real estate agent about everything you're looking for. It will help avoid wasting your time.

YOU'VE FOUND IT 19. WHAT DOES A HOME INSPECTOR DO, AND HOW DOES AN INSPECTION FIGURE IN THE PURCHASE OF A HOME? An inspector checks the safety of your potential new home. Home Inspectors focus especially on the structure, construction, and mechanical systems of the house and will make you aware of only repairs,that are needed. The Inspector does not evaluate whether or not you're getting good value for your money. Generally, an inspector checks (and gives prices for repairs on): the electrical system, plumbing and waste disposal, the water heater, insulation and Ventilation, the HVAC system, water source and quality, the potential presence of pests, the foundation, doors, windows, ceilings, walls, floors, and roof. Be sure to hire a home inspector that is qualified and experienced. It's a good idea to have an inspection before you sign a written offer since, once the deal is closed, you've bought the house as is." Or, you may want to include an inspection clause in the offer when negotiating for a home. An inspection t clause gives you an 'out" on buying the house if serious problems are found,or gives you the ability to renegotiate the purchase price if repairs are needed. An inspection clause can also specify that the seller must fix the problem(s) before you purchase the house. 20. DO I NEED TO BE THERE FOR THE INSPECTION? It's not required, but it's a good idea. Following the inspection, the home inspector will be able to answer questions about the report and any problem areas. This is also an opportunity to hear an objective opinion on the home you'd I like to purchase and it is a good time to ask general, maintenance questions.

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21. ARE OTHER TYPES OF INSPECTIONS REQUIRED? If your home inspector discovers a serious problem a more specific Inspection may be recommended. It's a good idea to consider having your home inspected for the presence of a variety of health-related risks like radon gas asbestos, or possible problems with the water or waste disposal system. 22. HOW CAN I PROTECT MY FAMILY FROM LEAD IN THE HOME? If the house you're considering was built before 1978 and you have children under the age of seven, you will want to have an inspection for lead-based point. It's important to know that lead flakes from paint can be present in both the home and in the soil surrounding the house. The problem can be fixed temporarily by repairing damaged paint surfaces or planting grass over effected soil. Hiring a lead abatement contractor to remove paint chips and seal damaged areas will fix the problem permanently. 23. ARE POWER LINES A HEALTH HAZARD? There are no definitive research findings that indicate exposure to power lines results in greater instances of disease or illness. 24. DO I NEED A LAWYER TO BUY A HOME? Laws vary by state. Some states require a lawyer to assist in several aspects of the home buying process while other states do not, as long as a qualified real estate professional is involved. Even if your state doesn't require one, you may want to hire a lawyer to help with the complex paperwork and legal contracts. A lawyer can review contracts, make you aware of special considerations, and assist you with the closing process. Your real estate agent may be able to recommend a lawyer. If not, shop around. Find out what services are provided for what fee, and whether the attorney is experienced at representing homebuyers. 25. DO I REALLY NEED HOMEOWNER'S INSURANCE? Yes. A paid homeowner's insurance policy (or a paid receipt for one) is required at closing, so arrangements will have to be made prior to that day. Plus, involving the insurance agent early in the home buying process can save you money. Insurance agents are a great resource for information on home safety and they can give tips on how to keep insurance premiums low. 26. WHAT STEPS COULD I TAKE TO LOWER MY HOMEOWNER'S INSURANCE COSTS? Be sure to shop around among several insurance companies. Also, consider the cost of insurance when you look at homes. Newer homes and homes constructed with materials like brick tend to have lower premiums. Think about avoiding areas prone to natural disasters, like flooding. Choose a home with a fire hydrant or a fire department nearby.


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27. IS THE HOME LOCATED IN A FLOOD PLAIN? Your real estate agent or lender can help you answer this question. If you live in a flood plain, the lender will require that you have flood insurance before lending any money to you. But if you live near a flood plain, you may choose whether or not to get flood insurance coverage for your home. Work with an insurance agent to construct a policy that fits your needs. 28. WHAT OTHER ISSUES SHOULD I CONSIDER BEFORE I BUY MY HOME? Always check to see if the house is in a low-lying area, in a high-risk area for natural disasters (like earthquakes, hurricanes, tornadoes, etc.), or in a hazardous materials area. Be sure the house meets building codes. Also consider local zoning laws, which could affect remodeling or making an addition in the future. Your real estate agent should be able to help you with these questions. 29. HOW DO I MAKE AN OFFER? Your real estate agent will assist you in making an offer, which will include the following information: • • • • • • • •

Complete legal description of the property Amount of earnest money Down payment and financing details Proposed move-in date Price you are offering Proposed closing date Length of time the offer is valid Details of the deal

Remember that a sale commitment depends on negotiating a satisfactory contract with the seller, not just Making an offer. Other ways to lower ins-insurance costs include insuring your home and car(s) with the same company, increasing home security, and seeking group coverage through alumni or business associations. Insurance costs are always lowered by raising your deductibles, but this exposes you to a higher out-of-pocket cost if you have to file a claim. 30. HOW DO I DETERMINE THE INITIAL OFFER? Unless you have a buyer's agent, remember that the agent works for the seller. Make a point of asking him or her to keep your discussions and information confidential. Listen to your real estate agent's advice, but follow your own instincts on deciding a fair price. Calculating your offer should involve several factors: what homes sell for in the area, the home's condition, how long it's been on the market, financing terms, and the seller's situation. By the time you're ready to make an offer, you should have a good idea of what the home is

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worth and what you can afford. And, be prepared for give-and-take negotiation, which is very common when buying a home. The buyer and seller may often go back and forth until they can agree on a price. 31. WHAT IS EARNEST MONEY? HOW MUCH SHOULD I SET ASIDE? Earnest money is money put down to demonstrate your seriousness about buying a home. It must be substantial enough to demonstrate good faith and is usually between 1-5% of the purchase price (though the amount can vary with local customs and conditions). If your offer is accepted, the earnest money becomes part of your down payment or closing costs. If the offer is rejected, your money is returned to you. If you back out of a deal, you may forfeit the entire amount. 32. WHAT ARE "HOME WARRANTIES", AND SHOULD I CONSIDER THEM? Home warranties offer you protection for a specific period of time (e.g., one year) against potentially costly problems, like unexpected repairs on appliances or home systems, which are not covered by homeowner's insurance. Warranties are becoming more popular because they offer protection during the time immediately following the purchase of a home, a time when many people find themselves cash-strapped.

GENERAL FINANCING QUESTIONS:THE BASICS 33. WHAT IS A MORTGAGE? Generally speaking, a mortgage is a loan obtained to purchase real estate. The "mortgage" itself is a lien (a legal claim) on the home or property that secures the promise to pay the debt. All mortgages have two features in common: principal and interest. 34. WHAT IS A LOAN TO VALUE (LTV) HOW DOES IT DETERMINE THE SIZE OF MY LOAN? The loan to value ratio is the amount of money you borrow compared with the price or appraised value of the home you are purchasing. Each loan has a specific LTV limit. For example: With a 95% LTV loan on a home priced at $50,000, you could borrow up to $47,500 (95% of $50,000), and would have to pay,$2,500 as a down payment. The LTV ratio reflects the amount of equity borrowers have in their homes. The higher the LTV the less cash homebuyers are required to pay out of their own funds. So, to protect lenders against potential loss in case of default, higher LTV loans (80% or more) usually require mortgage insurance policy.


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35. WHAT TYPES OF LOANS ARE AVAILABLE AND WHAT ARE THE ADVANTAGES OF EACH? Fixed Rate Mortgages: Payments remain the same for the the life of the loan Types • 15-year • 30-year Advantages • Predictable • Housing cost remains unaffected by interest rate changes and inflation. Adjustable Rate Mortgages (ARMS): Payments increase or decrease on a regular schedule with changes in interest rates; increases subject to limits Types • Balloon Mortgage- Offers very low rates for an Initial period of time (usually 5, 7, or 10 years); when time has elapsed, the balance is clue or refinanced (though not automatically) • Two-Step Mortgage- Interest rate adjusts only once and remains the same for the life of the loan • ARMS linked to a specific index or margin Advantages • Generally offer lower initial interest rates • Monthly payments can be lower • May allow borrower to qualify for a larger loan amount 36. WHEN DO ARMS MAKE SENSE? An ARM may make sense If you are confident that your income will increase steadily over the years or if you anticipate a move in the near future and aren't concerned about potential increases in interest rates. 37. WHAT ARE THE ADVANTAGES OF 15- AND 30-YEAR LOAN TERMS? 30-Year: • In the first 23 years of the loan, more interest is paid off than principal, meaning larger tax deductions. • As inflation and costs of living increase, mortgage payments become a smaller part of overall expenses.

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United States Department of Housing and Urban Development 15-year: • Loan is usually made at a lower interest rate. • Equity is built faster because early payments pay more principal.

38. CAN I PAY OFF MY LOAN AHEAD OF SCHEDULE? Yes. By sending in extra money each month or making an extra payment at the end of the year, you can accelerate the process of paying off the loan. When you send extra money, be sure to indicate that the excess payment is to be applied to the principal. Most lenders allow loan prepayment, though you may have to pay a prepayment penalty to do so. Ask your lender for details. 39. ARE THERE SPECIAL MORTGAGES FOR FIRST-TIME HOMEBUYERS? Yes. Lenders now offer several affordable mortgage options which can help first-time homebuyers overcome obstacles that made purchasing a home difficult in the past. Lenders may now be able to help borrowers who don't have a lot of money saved for the down payment and closing costs, have no or a poor credit history, have quite a bit of long-term debt, or have experienced income irregularities. 40. HOW LARGE OF A DOWN PAYMENT DO I NEED? There are mortgage options now available that only require a down payment of 5% or less of the purchase price. But the larger the down payment, the less you have to borrow, and the more equity you'll have. Mortgages with less than a 20% down payment generally require a mortgage insurance policy to secure the loan. When considering the size of your down payment, consider that you'll also need money for closing costs, moving expenses, and possibly -repairs and decorating. 41. WHAT IS INCLUDED IN A MONTHLY MORTGAGE PAYMENT? The monthly mortgage payment mainly pays off principal and interest. But most lenders also include local real estate taxes, homeowner's insurance, and mortgage insurance (if applicable). 42. WHAT FACTORS AFFECT MORTGAGE PAYMENTS? The amount of the down payment, the size of the mortgage loan, the interest rate, the length of the repayment term and payment schedule will all affect the size of your mortgage payment. 43. HOW DOES THE INTEREST RATE FACTOR IN SECURING A MORTGAGE LOAN? A lower interest rate allows you to borrow more money than a high rate with the some monthly payment. Interest rates can fluctuate as you shop for a loan, so ask-lenders if they


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offer a rate "lock-in"which guarantees a specific interest rate for a certain period of time. Remember that a lender must disclose the Annual Percentage Rate (APR) of a loan to you. The APR shows the cost of a mortgage loan by expressing it in terms of a yearly interest rate. It is generally higher than the interest rate because it also includes the cost of points, mortgage insurance, and other fees included in the loan. 44. WHAT HAPPENS IF INTEREST RATES DECREASE AND I HAVE A FIXED RATE LOAN? If interest rates drop significantly, you may want to investigate refinancing. Most experts agree that if you plan to be in your house for at least 18 months and you can get a rate 2% less than your current one, refinancing is smart. Refinancing may, however, involve paying many of the same fees paid at the original closing, plus origination and application fees. 45. WHAT ARE DISCOUNT POINTS? Discount points allow you to lower your interest rate. They are essentially prepaid interest, With each point equaling 1% of the total loan amount. Generally, for each point paid on a 30-year mortgage, the interest rate is reduced by 1/8 (or.125) of a percentage point. When shopping for loans, ask lenders for an interest rate with 0 points and then see how much the rate decreases With each point paid. Discount points are smart if you plan to stay in a home for some time since they can lower the monthly loan payment. Points are tax deductible when you purchase a home and you may be able to negotiate for the seller to pay for some of them. 46. WHAT IS AN ESCROW ACCOUNT? DO I NEED ONE? Established by your lender, an escrow account is a place to set aside a portion of your monthly mortgage payment to cover annual charges for homeowner's insurance, mortgage insurance (if applicable), and property taxes. Escrow accounts are a good idea because they assure money will always be available for these payments. If you use an escrow account to pay property tax or homeowner's insurance, make sure you are not penalized for late payments since it is the lender's responsibility to make those payments.

FIRST STEPS 47. WHAT STEPS NEED TO BE TAKEN TO SECURE A LOAN? The first step in securing a loan is to complete a loan application. To do so, you'll need the following information. • • •

Pay stubs for the past 2-3 months W-2 forms for the past 2 years Information on long-term debts

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United States Department of Housing and Urban Development • • • • •

Recent bank statements tax returns for the past 2 years Proof of any other income Address and description of the property you wish to buy Sales contract

During the application process, the lender will order a report on your credit history and a professional appraisal of the property you want to purchase. The application process typically takes between 1-6 weeks. 48. HOW DO I CHOOSE THE RIGHT LENDER FOR ME? Choose your lender carefully. Look for financial stability and a reputation for customer satisfaction. Be sure to choose a company that gives helpful advice and that makes you feel comfortable. A lender that has the authority to approve and process your loan locally is preferable, since it will be easier for you to monitor the status of your application and ask questions. Plus, it's beneficial when the lender knows home values and conditions in the local area. Do research and ask family, friends, and your real estate agent for recommendations. 49. HOW ARE PRE-QUALIFYING AND PRE-APPROVAL DIFFERENT? Pre-qualification is an informal way to see how much you maybe able to borrow. You can be 'pre-qualified' over the phone with no paperwork by telling a lender your income, your long-term debts, and how large a down payment you can afford. Without any obligation, this helps you arrive at a ballpark figure of the amount you may have available to spend on a house. Pre-approval is a lender's actual commitment to lend to you. It involves assembling the financial records mentioned in Question 47 (Without the property description and sales contract) and going through a preliminary approval process. Pre-approval gives you a definite idea of what you can afford and shows sellers that you are serious about buying. 50. HOW CAN I FIND OUT INFORMATION ABOUT MY CREDIT HISTORY? There are three major credit reporting companies: Equifax, Experian, and Trans Union. Obtaining your credit report is as easy as calling and requesting one. Once you receive the report, it's important to verify its accuracy. Double check the "high credit limit,"'total loan," and 'past due" columns. It's a good idea to get copies from all three companies to assure there are no mistakes since any of the three could be providing a report to your lender. Fees, ranging from $5-$20, are usually charged to issue credit reports but some states permit citizens to acquire a free one. Contact the reporting companies at the numbers listed for more information. Credit Reporting Companies Company Name Phone Number Experian 1-888-524-3666

One Hundred Questions and Answers about Buying a New Home Equifax Trans Union

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1-800-685-1111 1-800-916-8800

51. WHAT IF I FIND A MISTAKE IN MY CREDIT HISTORY? Simple mistakes are easily corrected by writing to the reporting company, pointing out the error, and providing proof of the mistake. You can also request to have your own comments added to explain problems. For example, if you made a payment late due to illness, explain that for the record. Lenders are usually understanding about legitimate problems. 52. WHAT IS A CREDIT BUREAU SCORE AND HOW DO LENDERS USE THEM? A credit bureau score is a number, based upon your credit history, that represents the possibility that you will be unable to repay a loan. Lenders use it to determine your ability to qualify for a mortgage loan. The better the score, the better your chances are of getting a loan. Ask your lender for details. 53. HOW CAN I IMPROVE MY SCORE? There are no easy ways to improve your credit score, but you can work to keep it acceptable by maintaining a good credit history. This means paying your bills on time and not overextending yourself by buying more than you can afford.

FINDING THE RIGHT LOAN FOR YOU 54. HOW DO I CHOOSE THE BEST LOAN - PROGRAM FOR ME? Your personal situation will determine the best kind of loan for you. By asking yourself a few questions, you can help narrow your search among the many options available and discover which loan suits you best. • • • •

Do you expect your finances to changeover the next few years? Are you planning to live in this home for a long period of time? Are you comfortable with the idea of a changing mortgage payment amount? Do you wish to be free of mortgage debt as your children approach college age or as you prepare for retirement?

Your lender can help you use your answers to questions such as these to decide which loan best fits your needs. 55. WHAT IS THE BEST WAY TO COMPARE LOAN TERMS BETWEEN LENDERS? First, devise a checklist for the information from each lending institution. You should include the company's name and basic information, the type of mortgage, minimum down

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payment required, interest rate and points, closing costs, loan processing time, and whether prepayment is allowed. Speak with companies by phone or in person. Be sure to call every lender on the list the same day, as interest rates can fluctuate daily. In addition to doing your own research, your real estate agent may have access to a database of lender and mortgage options. Though your agent may primarily be affiliated with a particular lending institution, he or she may also be able to suggest a variety of different lender options to you. 56. ARE THERE ANY COSTS OR FEES ASSOCIATED WITH THE LOAN ORIGINATION PROCESS? Yes. When you turn in your application, you'll be required to pay a loan application fee to cover the costs of underwriting the loan. This fee pays for the home appraisal, a copy of your credit report, and any additional charges that may be necessary. The application fee is generally non-refundable. 57. WHAT IS RESPA? RESPA stands for Real Estate Settlement Procedures Act. It requires lenders to disclose information to potential customers throughout the mortgage process, By doing so, it protects borrowers from abuses by lending institutions. RESPA mandates that lenders fully inform borrowers about all closing costs, lender servicing and escrow account practices, and business relationships between closing service providers and other parties to the transaction. For more information on RESPA, or call 1-800-569-4287 for a local counseling referral. 58. WHAT IS A GOOD FAITH ESTIMATE, AND HOW DOES IT HELP ME? It's an estimate that lists all fees paid before closing, all closing costs, and any escrow costs you will encounter when purchasing a home. The lender must supply it within three days of your application so that you can make accurate judgments when shopping for a loan. 59. BESIDES RESPA, RESPONSIBILITIES?

DOES

THE

LENDER

HAVE

ANY

ADDITIONAL

Lenders are not allowed to discriminate in any way against potential borrowers. If you believe a lender is refusing to provide his or her services to you on the basis of race, color, nationality, religion, sex, familial status, or disability, contact HUD's Office of Fair Housing at 1-800-669-9777 (or 1-800-927-9275 for the hearing impaired). 60. WHAT RESPONSIBILITIES DO I HAVE DURING THE LENDING PROCESS? To ensure you won't fall victim to loan fraud, be sure to follow all of these steps as you apply for a loan: • •

Be sure to read and understand everything before you sign. Refuse to sign any blank documents.

One Hundred Questions and Answers about Buying a New Home • • • • • • • • •

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Do not buy property for someone else. Do not overstate your income. Do not overstate how long you have been employed. Do not overstate your assets. Accurately report your debts. Do not change your income tax returns for any reason. Tell the whole truth about gifts. Do not list fake co-borrowers on your loan application. Be truthful about your credit problems, past and present. Be honest about your intention to occupy the house Do not provide false supporting documents.

CLOSING 61. WHAT HAPPENS AFTER I'VE APPLIED FOR MY LOAN? It usually takes a lender between 1-6 weeks to complete the evaluation of your application. Its not unusual for the lender to ask for more information once the application has been submitted. The sooner you can provide the information, the faster your application will be processed. Once all the information has been verified the lender will call you to let you know the outcome of your application. If the loan is approved, a closing date is set up and the lender will review the closing with you. And after closing, you'll be able to move into your new home. 62. WHAT SHOULD I LOOK OUT FOR DURING THE FINAL WALK-THROUGH? This will likely be the first opportunity to examine the house without furniture, giving you a clear view of everything. Check the walls and ceilings carefully, as well as any work the seller agreed to do in response to the inspection. Any problems discovered previously that you find uncorrected should be brought up prior to closing. It is the seller's responsibility to fix them. 63. WHAT MAKES UP CLOSING COST? There may be closing cost customary or unique to a certain locality, but closing cost are usually made up of the following: • • • • • • •

Attorney's or escrow fees (Yours and your lender's if applicable) Property taxes (to cover tax period to date) Interest (paid from date of closing to 30 days before first monthly payment) Loan Origination fee (covers lenders administrative cost) Recording fees Survey fee First premium of mortgage Insurance (if applicable)

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United States Department of Housing and Urban Development • • • • •

Title Insurance (yours and lender's) Loan discount points First payment to escrow account for future real estate taxes and insurance Paid receipt for homeowner's insurance policy (and fire and flood insurance if applicable) Any documentation preparation fees

64. WHAT CAN I EXPECT TO HAPPEN ON CLOSING DAY? You'll present your paid homeowner's insurance policy or a binder and receipt showing that the premium has been paid. The closing agent will then list the money you owe the seller (remainder of down payment, prepaid taxes, etc.) and then the money the seller owes you (unpaid taxes and prepaid rent, if applicable). The seller will provide proofs of any inspection, warranties, etc. Once you're sure you understand all the documentation, you'll sign the mortgage, agreeing that if you don't make payments the lender is entitled to sell your property and apply the sale price against the amount you owe plus expenses. You'll also sign a mortgage note, promising to repay the loan. The seller will give you the title to the house in the form of a signed deed. You'll pay the lender's agent all closing costs and, in turn,he or she will provide you with a settlement statement of all the items for which you have paid. The deed and mortgage will then be recorded in the state Registry of Deeds, and you will be a homeowner. 65. WHAT DO I GET AT CLOSING? •

• • • • •

Settlement Statement, HUD-1 Form (itemizes services provided and the fees charged; it is filled out by the closing agent and must be given to you at or before closing) Truth-in-Lending Statement Mortgage Note Mortgage or Deed of Trust Binding Sales Contract (prepared by the seller; your lawyer should review it) Keys to your new home

HOW CAN HUD AND THE FHA HELP ME BECOME A HOMEOWNER 66. WHAT IS THE U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT? Also known as HUD, the U.S. Department of Housing and Urban Development was established in 1965 to develop national policies and programs to address housing needs in the U.S. One of HUD's primary missions is to create a suitable living environment for all Americans by developing and improving the country's communities and enforcing fair housing laws


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67. HOW DOES HUD HELP HOMEBUYERS AND HOMEOWNERS? HUD helps people by administering a variety of programs that develop and support affordable housing. Specifically, HUD plays a large role in homeownership by making loans available for lower- and moderate-income families through its FHA mortgage insurance program and its HUD Homes program. HUD owns homes in many communities throughout the U.S. and offers them for sale at attractive prices and economical terms. HUD also seeks to protect consumers through education, Fair Housing Laws, and housing rehabilitation initiatives. 68. WHAT IS THE FHA? Now an agency within HUD, the Federal Housing Administration was established in 1934 to advance opportunities for Americans to own homes. By providing private lenders with mortgage insurance, the FHA gives them the security they need to lend to first-time buyers who might not be able to qualify for conventional loans. The FHA has helped more than 26 million Americans buy a home. 69. HOW CAN THE FHA ASSIST ME IN BUYING A HOME? The FHA works to make homeownership a possibility for more Americans. With the FHA, you don't need perfect credit or a high-paying job to qualify for a loan. The FHA also makes loans more accessible by requiring smaller down payments than conventional loans. In fact, an FHA down payment could be as little as a few months rent. And your monthly payments may not be much more than rent. 70. HOW IS THE FHA FUNDED? Lender claims paid by the FHA mortgage insurance program are drawn from the Mutual Mortgage Insurance fund. This fund is made up of premiums paid by FHA-insured loan borrowers. No tax dollars are used to fund the program. 71. WHO CAN QUALIFY FOR FHA LOANS? Anyone who meets the credit requirements, can afford the mortgage payments and cash investment, and who plans to use the mortgaged property as a primary residence may apply for an FHA-insured loan. 72. WHAT IS THE FHA LOAN LIMIT? FHA loan limits vary throughout the country, from $115,200 in low-cost areas to $208,800 in high-cost areas. The loan maximums for multi-unit homes are higher than those for single units and also vary by area. Because these maximums are linked to the conforming loan limit and average area home prices, FHA loan limits are periodically subject to change. Ask your lender for details and confirmation of current limits.

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73. WHAT ARE THE STEPS INVOLVED IN THE FHA LOAN PROCESS? With the exception of a few additional forms, the FHA loan application process is similar to that of a conventional loan (see Question 47). With new automation measures, FHA loans may be originated more quickly than before. And, if you don't prefer a face-to-face meeting, you can apply for an FHA loan via mail, telephone, the Internet, or video conference. 74. HOW MUCH INCOME DO I NEED TO HAVE TO QUALIFY FOR AN FHA LOAN? There is no minimum income requirement. But you must prove steady income for at least three years, and demonstrate that you've consistently paid your bills on time. 75. WHAT QUALIFIES AS AN INCOME SOURCE FOR THE FHA? Seasonal pay, child support, retirement pension payments, unemployment compensation, VA benefits, military pay, Social Security income, alimony, and rent paid by family all qualify as income sources. Part-time pay, overtime, and bonus pay also count as long as they are steady. Special savings plans-such as those set up by a church or community association qualify, too. Income type is not as important as income steadiness with the FHA. 76. CAN I CARRY DEBT AND STILL QUALIFY FOR FHA LOANS? Yes. Short-term debt doesn't count as long as it can be paid off within 10 months. And some regular expenses, like child care costs, are not considered debt. Talk to your lender or real estate agent about meeting the FHA debt-to-income ratio. 77. WHAT IS THE DEBT-TO-INCOME RATIO FOR FHA LOANS? The FHA allows you to use 29% of your income towards housing costs and 41% towards housing expenses and other long-term debt. With a conventional loan, this qualifying ratio allows only 28% toward housing and 36% towards housing and other debt 78. CAN I EXCEED THIS RATIO? You may qualify to exceed if you have: • • • • • • • •

a large down payment a demonstrated ability to pay more toward your housing expenses substantial cash reserves net worth enough to repay the mortgage regardless of income evidence of acceptable credit history or limited credit use less-than-maximum mortgage terms funds provided by an organization a decrease in monthly housing expenses


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79. HOW LARGE A DOWN PAYMENT DO I NEED WITH AN FHA LOAN? You must have a down payment of at least 3% of the purchase price of the home. Most affordable loan programs offered by private lenders require between a 3%-5% down payment, with a minimum of 3% coming directly from the borrower's own funds. 80. WHAT CAN I USE TO PAY THE DOWN PAYMENT AND CLOSING COSTS OF AN FHA LOAN? Besides your own funds, you may use cash gifts or money from a private savings club. If you can do certain repairs and improvements yourself, your labor may be used as part of a down 8 payment (called -sweat equity"). If you are doing a lease purchase, paying extra rent to the seller may also be considered the same as accumulating cash. 81. HOW DOES MY CREDIT HISTORY IMPACT MY ABILITY TO QUALIFY? The FHA is generally more flexible than conventional lenders in its qualifying guidelines. In fact, the FHA allows you to re-establish credit if: • • • •

two years have passed since a bankruptcy has been discharged all judgments have been paid any outstanding tax liens have been satisfied or appropriate arrangements have been made to establish a repayment plan with the IRS or state Department of Revenue three years have passed since a foreclosure or a deed-in-lieu has been resolved

82. CAN I QUALIFY FOR AN FHA LOAN WITHOUT A CREDIT HISTORY? Yes. If you prefer to pay debts in cash or are too young to have established credit, there are other ways to prove your eligibility. Talk to your lender for details. 83. WHAT TYPES OF CLOSING COSTS ARE ASSOCIATED WITH FHA-INSURED LOANS? Except for the addition of an FHA mortgage insurance premium, FHA closing costs are similar to those of a conventional loan outlined in Question 63. The FHA requires a single, upfront mortgage insurance premium equal to 2.25% of the mortgage to be paid at closing (or 1.75% if you complete the HELP program- see Question 91). This initial premium may be partially refunded if the loan is paid in full during the first seven years of the loan term. After closing, you will then be responsible for an annual premium - paid monthly - if your mortgage is over 15 years or if you have a 15-year loan with an LTV greater than 90%. 84. CAN I ROLL CLOSING COSTS INTO my FHA LOAN? No. Though you can't roll closing costs into your FHA loan, you may be able to use the amount you pay for them to help satisfy the down payment requirement. Ask your lender for details.

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85. ARE FHA LOANS ASSUMABLE? Yes. You can assume an existing FHA-insured loan, or, if you are the one deciding to sell, allow a buyer to assume yours. Assuming a loan can be very beneficial, since the process is streamlined and less expensive compared to that for a new loan. Also, assuming a loan can often result in a lower interest rate. The application process consists basically of a credit check and no property appraisal is required. And you must demonstrate that you have enough income to support the mortgage loan. In this way, qualifying to assume a loan is similar to the qualification requirements for a new one. 86. WHAT SHOULD I DO IF I CAN'T MAKE A PAYMENT ON LOAN? Call or, write to your lender as soon as possible. Clearly explain the situation and be prepared to provide him or her with financial information. 87. ARE THERE ANY OPTIONS IF I FALL BEHIND ON MY LOAN PAYMENTS? Yes. Talk to your lender or a HUD-approved counseling agency for details. Listed below are a few options that may help you get back on track. For FHA loans: Keep living in your home to qualify for assistance. Contact a HUD-approved housing counseling agency (1-800-569-4287 or TDD: 1-800483-2209) and cooperate with the counselor/lender trying to help you. HUD has a number of special loss mitigation programs available to help you: Special Forbearance: Your lender will arrange for a revised repayment plan which may Include temporary reduction or suspension of payments; you can qualify by having an Involuntary reduction in your Income or Increase In living expenses. Mortgage Modification: Allows refinance debt and/or extend the term of the your mortgage loan which may reduce your monthly payments; you can qualify if you have recovered from financial problems, but net Income Is less than before. Partial Claim: Your lender maybe able to help you obtain an interest-free loan from HUD to bring your mortgage current. Pre-foreclosure Sale: Allows you to sell your property and pay off your mortgage loan ,to avoid foreclosure. Deed-in lieu of Foreclosure: Lets you voluntarily "give back" your property to the lender; it won't save your house but will help you avoid the costs, time, and effort of the foreclosure process. If you are having difficulty with an-uncooperative lender or feel your loan servicer is not providing you with the most effective loss mitigation options, call the FHA Loss Mitigation Center at 1-888-297-8685 for additional help. For Conventional Loans: Talk to your lender about specific loss mitigation options. Work directly with him or her to request a "workout packet." A secondary lender, like Fannie Mae or Freddie Mac, may


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have purchased your loan. Your lender can follow the appropriate guidelines set by Fannie or Freddie to determine the best option for your situation. Fannie Mae does not deal directly with the borrower. They work with the lender to determine the loss mitigation program that best fits your needs. Freddie Mac, like Fannie Mae, will usually only work with the loan servicer. However, if you encounter problems with your lender during the loss mitigation process, you can coil customer service for help at 1-800-FREDDIE (1-800-373-3343). In any loss mitigation situation, it is important to remember a few helpful hints: Explore every reasonable alternative to avoid losing your home, but beware of scams. For example, watch out for: Equity skimming: a buyer offers to repay the mortgage or sell the property if you sign over the deed and move out. Phony counseling agencies: offer counseling for a fee when it is often given at no charge. Don't sign anything you don't understand.

MORTGAGE INSURANCE 88. WHAT IS MORTGAGE INSURANCE? Mortgage insurance is a policy that protects lenders against some or most of the losses that result from defaults on home mortgages. It's required primarily for borrowers making a down payment of less than 20%. 89. HOW DOES MORTGAGE INSURANCE WORK? IS IT LIKE HOME OR AUTO INSURANCE? Like home or auto insurance, mortgage insurance requires payment of a premium, is for protection against loss, and is used in the event of an emergency. If a borrower can't repay an insured mortgage loan as agreed, the lender may foreclose on the property and file a claim with the mortgage insurer for some or most of the total losses. 90. DO I NEED MORTGAGE INSURANCE? HOW DO I GET IT? You need mortgage insurance only if you plan to make a down payment of less than 20% of the purchase price of the home. The FHA offers several loan programs that may meet your needs. Ask your lender for details. 91. HOW CAN I RECEIVE A DISCOUNT ON THE FHA INITIAL MORTGAGE INSURANCE PREMIUM? Ask your real estate agent or lender for information on the HELP program from the FHA. HELP - Homebuyer Education Learning Program - is structured to help people like you begin the homebuying process. It covers such topics as budgeting, finding a home, getting a loan, and home maintenance. In most cases, completion of this program may entitle you to a

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reduction in the initial FHA mortgage insurance premium from 2.25% to 1.75% of the purchase price of your new home. 92. WHAT IS PMI? PMI stands for Private Mortgage Insurance or Insurer. These are privately-owned companies that provide mortgage insurance. They offer both standard and special affordable programs for borrowers. These companies provide guidelines to lenders that detail the types of loans they will insure. Lenders use these guidelines to determine borrower eligibility. PMI's usually have stricter qualifying ratios and larger down payment requirements than the FHA, but their premiums are often lower and they insure loans that exceed the FHA limit.

FHA PRODUCTS 93. WHAT IS A 203(b) LOAN? This is the most commonly used FHA program. It offers a low down payment, flexible qualifying guidelines, limited lender's fees, and a maximum loan amount. 94. WHAT IS A 203(k) LOAN? This is a loan that enables the homebuyer to finance both the purchase and rehabilitation of a home through a single mortgage. A portion of the loan is used to pay off the seller's existing mortgage and the remainder is placed in an escrow account and released as rehabilitation is completed. Basic guidelines for 203(k) loans are as follows: • • • •

The home must be at least one year old. The cost of rehabilitation must be at least $5,000, but the total property value including the cost of repairs - must fall within the FHA maximum mortgage limit. The 203(k) loan must follow many of the 203(b) eligibility requirements. Talk to your lender about specific improvement, energy efficiency, and structural guidelines.

95. WHAT IS AN ENERGY EFFICIENT MORTGAGE (EEM)? The Energy Efficient Mortgage allows a homebuyer to save future money on utility bills. This is done by financing the cost of adding energy-efficiency features to a new or existing home as part of an FHA-insured home purchase. The EEM can be used with both 203(b) and 203(k) loans. Basic guidelines for EEMs are as follows: The cost of improvements must be determined by a Home Energy Rating System or by an energy consultant. This cost must be less than the anticipated savings from the improvements. One- and two-unit new or existing homes are eligible; condos are not.


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The improvements financed may be 5% of property value or $4,000, whichever is greater. The total must fall within the FHA loan limit. 96. DELETED. 97. WHAT IS A TITLE I LOAN? Given by a Lender and insured by the FHA, a Title I loan is used to make non-luxury renovations and repairs to a home. It offers a manageable interest rate and repayment schedule. Loans are limited to between $5,000 and 20,000. If the loan amount is under 7,500, no lien is required against your home. Ask your lender for details. 98. WHAT OTHER LOAN PRODUCTS OR PROGRAMS DOES THE FHA OFFER? The FHA also insures loans for the purchase or rehabilitation of manufactured housing, condominiums, and cooperatives. It also has special programs for urban areas, disaster victims, and members of the armed forces. Insurance for ARMS is also available from the FHA. 99. HOW CAN I OBTAIN AN FHA-INSURED LOAN? Contact an FHA-approved lender such as a participating mortgage company, bank, savings and loan association, or thrift. For more information on the FHA and how you can obtain an FHA loan, visit the HUD web site at http://www.hud.gov or call a HUD-approved counseling agency at 1-800-569-4287 or TDD: 1-800-877-8339. 100. HOW CAN I CONTACT HUD? Visit the web site at http://www.hud.gov or look in the phone book "blue pages" for a listing of the HUD office near you.


Chapter 4

ALTERNATIVE MORTGAGES: RISKS TO CONSUMERS * AND LENDERS IN THE CURRENT HOUSING CYCLE Edward Vincent Murphy ABSTRACT Borrowers increasingly turned to alternative mortgages to purchase homes in 20012005, when mortgage rates remained historically low and homes appreciated rapidly in many markets. Signs of rising interest rates and slowing home sales raise concerns that the use of some types of alternative mortgages may exacerbate price declines and threaten the finances of consumers and lenders. The use of mortgages with adjustable rates, zero down payment, interest-only, or negative amortization features raise economic risk compared to traditional mortgages. If borrowers and lenders have not adequately evaluated these risks, then the financial system may be hit with unexpected losses. Alternative mortgages offer some combination of adjustable rates, extremely low down payments, negative amortization, and/or optional monthly payments. The prudent use of alternative mortgages offers benefits. Buyers planning to move frequently could place less value on ensuring fixed payments in later years of a loan. During periods of exceptionally high interest rates, adjustable rates may suit consumers expecting rates to fall. People whose incomes depend on commission or bonuses may be attracted to mortgages with flexible monthly payments. These benefits come with potential costs for the borrower and for the financial system. Adjustable rates shift the risk of rising interest rates from banks to borrowers. Low down payments increase the risk that borrowers will owe more than their house is worth if prices fall. A borrower owing more than the house is worth may be unable to sell or refinance the house. Some measures of interest rate risk and negative appreciation risk show geographic concentration. The use of alternative mortgages in these areas could make home prices more volatile and increase defaults. These risks are relevant because more than a trillion dollars of mortgages originated during the boom will reset their monthly payments in the next two years. Federal regulatory agencies issued new guidance on alternative mortgages in October 2006. The guidance recognized that these products expose financial institutions to increased risk because the products have not been tested in a stressed environment. *

Excerpted from CRS Report RL33775, dated December 27, 2006.

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Edward Vincent Murphy The agencies directed financial institutions to tighten lending standards and to improve disclosure to consumers. This report describes alternative mortgages, summarizes recent regulatory actions, and provides an estimate of the geographic concentration of interest rate risk and negative appreciation risk.

BACKGROUND More than a trillion dollars of mortgages will have payment resets in 2007.[1] A newspaper account of one resident of Garden Grove, California, illustrates the potential problem. His monthly mortgage payment is scheduled to double and he just learned that he owes more than his house is worth because prices of neighboring houses fell by $140,000.[2] It will be a struggle to maintain the higher payments on his resetting mortgage and it is difficult to refinance while he is upside down.[3] Federal banking agencies issued new guidance in October 2006 to help potential home buyers understand the risks in alternative mortgages and to ensure that lenders follow safe and sound practices. Alternative mortgages are sometimes called nontraditional mortgages or exotic mortgages. Alternative mortgages have some combination of variable interest rates, extremely low down payments, interest-only periods, and/or negative amortization. (Amortization refers to the gradual payment of the loan’s principal.) In many cases, borrowers intend to refinance these loans or sell the houses relatively quickly. The potential advantages of alternative features for these buyers often depend on the expected path of interest rates and home appreciation. Similarly, significant disadvantages can arise if interest rates and appreciation take an unexpected turn. House prices boomed from 2000 to 2005 in many parts of the country and then suddenly ground to a halt in 2006. Although adjustable rate mortgages are not new, their increased use during the boom was counterintuitive to many economists because mortgage rates were already low by historic standards. Other alternative features were not new but their use by the general public increased during the boom. The increased use of alternative mortgages by unsophisticated borrowers may lead to increased delinquency and foreclosures. This report presents salient features of alternative mortgages, summarizes recent federal agency guidance, places the potential benefits and risks to consumers and financial systems in the context of economic conditions, and estimates geographic concentration of risk.

FEATURES OF NONTRADITIONAL MORTGAGES Discussions of alternative mortgages often focus on some combination of four differences from traditional mortgages. Borrowers have increasingly chosen one or more of the following features. • • • •

Adjustable rates Extremely low or zero down payment Interest-only payments Negative amortization

Alternative Mortgages

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Adjustable Rates There are many varieties of adjustable rate mortgages (ARMs). One of the simplest forms offers an initial low rate, called a teaser, at the beginning of the loan and then resets after an introductory period. The teaser rate may apply for one year or for as little as one month. The mortgage contract may specify a reset interest rate or may tie the rate to another interest rate by formula. The resulting interest rate may itself be fixed or variable. Teaser rates should be distinguished from fully adjustable rate mortgages. In principle, a 30-year fixed rate mortgage could have a one-month teaser rate without materially affecting the costs and benefits of the mortgage product. Excluding teaser rates, variable rate mortgages tie the loan to the economy. The future mortgage rate on these loans typically depends on another future interest rate observed in financial markets. The rate might reset each month, each year, or only after several years. The home buyer’s mortgage payment would drop if the interest rate dropped but would rise if the interest rate rose. Many adjustable rate mortgages provide for a cap on the amount a rate can rise in any period or over the life of the loan. Adjustable rate mortgages can be tied to a variety of market interest rates. One common reference rate is the London Interbank Offered Rate (LIBOR). LIBOR rates are determined in the London market for unsecured bank loans. It is a rate that banks charge each other for short term loans (less than 12 months). Typical adjustable rate mortgages will specify a reset date at which time the mortgage rate will adjust to the LIBOR or similar rate plus a predetermined markup.

Extremely Low or Zero Down Payment Saving enough funds to meet the traditional 20% down payment can be a significant barrier to otherwise credit-worthy potential home buyers. Furthermore, the required down payment grows with the appreciation rate. If home appreciation is growing faster than household income, then it will be difficult for first time home buyers to save sufficiently. Lending programs gradually reduced the required down payment options to 10%, 5%, and eventually 3% of the purchase price. There are mortgages that take this process to its logical conclusion and allow buyers to purchase with no money down. Some programs even roll in closing and other acquisition costs for greater-than-100% financing. A related practice is using a second mortgage to finance the down payment. Sometimes called piggy back loans or silent seconds, the home buyer uses the second loan to borrow the funds for a 20% down payment. This down payment is enough to improve the interest rate and other terms of the first mortgage. However, the second mortgage carries a higher interest rate and other less desirable features because the first mortgage has prior claim on the collateral. Although the original first-mortgage lender may be aware of the piggy back loan (and may have helped arrange it), subsequent holders of the first mortgage may not be aware of the piggy back loan because lenders often sell the loans they originate to the secondary mortgage market.

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Interest Only An interest-only mortgage allows the home buyer to carry the loan balance for a period of time without having to pay back any principal. The current mortgage payment covers only the monthly interest due on the existing balance. Eventually, the monthly payment must also cover the principal. If the duration of the mortgage is not extended, then the payments will have to amortize the remaining balance over a shorter period of time. Therefore, a homeowner choosing to pay only the interest for a few months increases the monthly payment for later months.

Negative Amortization Unlike interest-only mortgages which leave the loan balance unchanged, a mortgage with negative amortization allows the borrower to increase the loan’s principal by paying less than the current interest due. The remaining interest is added to the loan balance. Future payments are then recalculated based on the increased principal. The homeowner gets lower current payments but at the cost of greater debt and higher future payments. These four features of alternative mortgages are not mutually exclusive. There are option mortgages which allow borrowers to choose each month to pay a fully amortizing amount, an interest-only amount, or a negatively amortizing amount. Interest-only mortgages that use an adjustable rate when the introductory period ends are also common. The increased use of these mortgages and innovative combination of features has drawn the attention of federal regulators.

FEDERAL AGENCY ACTIONS ON ALTERNATIVE MORTGAGES Several federal banking agencies, including the Federal Reserve, the Office of Thrift Supervision (OTS), the National Credit Union Agency (NCUA), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC), oversee mortgage originations by financial institutions. These agencies issued a joint guidance statement (the 10/06 Guidance) for alternative mortgages on October 4, 2006.[4]

Issues and Comments The aforementioned agencies are responsible for overseeing both the consumer protection mandates of the Truth in Lending Act (TILA) and the safety and soundness of their regulated institutions. The agencies recognized that alternative mortgages have existed for some time but were concerned that products with possible negative amortization were being offered to a wider spectrum of borrowers by greater numbers of lenders. The 10/06 Guidance addressed three areas of concern: underwriting standards, risk management, and consumer protection. The 10/06 Guidance specified that lenders must tighten underwriting standards to manage


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risk. Lenders must also provide clear information to consumers to ensure consumer protection, but the guidance explicitly rejected imposing the doctrine of suitability.[5] The comment period drew a range of views on the proposal that became the 10/06 Guidance. Some depository institutions and industry groups argued against additional restrictions on alternative mortgages. They pointed out that alternatives to the traditional 30year fixed rate mortgage have been successfully used for many years. Some argued that alternative mortgages contribute to market flexibility in a changing economy. Some also argued that lenders had the incentive and the capability to appropriately manage the risks. Critics of alternative mortgages encouraged more stringent limitations. Some argued that an agency guidance would not be effective enough because it would not apply to lenders regulated at the state level. These critics argued for new federal legislation. Some consumer groups argued that alternative mortgages were too complex for unsophisticated borrowers to fully understand. Others argued that expanded use of nontraditional mortgages could encourage speculation in real estate and destabilize house prices.

Consumer Disclosure The 10/06 Guidance addressed some of the commenters’ consumer protection concerns. Lenders are to provide full disclosure in plain language. Lenders were already required to give consumers considering adjustable rate mortgages an information booklet published by the Federal Reserve.[6] The 10/06 Guidance now requires that consumers considering other nontraditional mortgages be given similar information including examples of payment comparisons. As of the end of 2006, the Federal Reserve had not issued its own interest-only or negative-amortization counterpart to the adjustable rate booklet. The Government Accountability Office (GAO) also made recommendations for alternative mortgages. On disclosures, GAO found that “although federal banking regulators have taken a range of proactive steps to address AMP [alternative mortgage product] lending, current federal standards for disclosures do not require information on AMP specific risks.”[7] GAO recommended that the Federal Reserve improve its regulations governing disclosures by requiring language that explains the specific risks and features of alternative mortgages.

Prudent Practices In addition to consumer disclosure, the 10/06 Guidance addresses a number of lending practices that some commenters considered unsafe or unsound. The use of alternative mortgages by less affluent borrowers raised concerns that some home buyers would not be able to sustain payments if housing market conditions changed. The 10/06 Guidance specifically addresses collateral-dependent loans, risk layering, and third-party relationships. The 10/06 Guidance stated that collateral dependent loans are an unsafe and unsound lending practice. Collateral-dependent loans refers to the practice of lenders to rely solely on the borrower’s ability to sell or refinance the property to approve the loan. An example of this practice would be an interest-only loan to a person with no down payment that resets after three or five years. In the first few years of the loan, the borrower is expected to pay a high

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interest rate. When the loan resets, the buyer is expected to refinance the loan, by which time appreciation could have provided a down payment which would reduce the interest rate the buyer would be expected to pay. The 10/06 Guidance requires loans to be underwritten for full risk layering. To understand risk layering, consider a mortgage with an optional negative amotization feature. This option is the equivalent of extending the borrower additional credit without additional underwriting. If the borrower chooses to pay less than current interest in the current month, then the remaining interest is added to the loan balance. For example, a borrower may be extended a $200,000 loan that could rise to a $250,000 balance if the borrower pays the minimum each period. The 10/06 Guidance specifies that lenders consider a borrower’s ability to repay the maximum loan balance assuming the borrower pays only the minimum monthly payment each period. In the example, the lender would have to qualify the borrower for a $250,000 loan, not a $200,000 loan. The 10/06 Guidance also addresses third-party relationships and risk management. Banks and financial institutions often do not originate or hold their loans. Mortgage brokers may market the loans to consumers. Once originated, the loans may be sold to investors in the secondary mortgage market. The guidance requires covered institutions to have strong systems and controls for establishing and maintaining third party relationships. While the industry worried that this would require institutions to oversee the marketing practices of third-parties, the agencies responded that an institution’s risk management system should address the overall level of risk that third-party relationships create for the institution.

ANALYSIS OF NONTRADITIONAL MORTGAGES GAO estimates that interest-only and other alternative mortgages approached 30% of the mortgage market by 2005.[8] Payments on these mortgages will reset to higher levels in the next few years. Although such products were sometimes used in the past by sophisticated borrowers as cash management tools, the recent housing boom saw alternative mortgages offered as affordability products to less sophisticated borrowers. Alternative mortgages were used by less wealthy borrowers in areas of high expected appreciation. The concentration of mortgage resets in time and in location can cause concerns for individual borrowers, for local real estate markets, and for financial institutions.

Payment Resets, Affordability Products, and Planned Refinances The expanded use of alternative mortgages during the housing boom has created a wave of mortgage resets due in the next few years as the introductory periods expire. Not only will adjustable rate mortgages change their payments as interest rates change, but interest-only mortgages will increase their payments when the full amortization period begins. Even if interest rates do not increase much further, the increase in monthly payments will be substantial for many borrowers. Consider a $200,000 interest-only loan originated at a time when the prevailing mortgage rate is 6.5%. The interest-only period lasts four years then the loan amortizes over the final 26


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years at the 6.5 percent rate. The monthly payments during the interest-only period will be $1,083. The monthly payments increase to $1,328 after four years. Even though the borrower will not be affected if interest rates rise above 6.5 percent, monthly payments will still rise $245 per month. Table 1 compares this hypothetical interest-only loan to a similar fully amortizing fixed rate mortgage. Although the early payments of the interest-only mortgage are lower than the traditional mortgage, the later payments are higher. Table 1. Payment Reset for Interest-Only Mortgages Interest Only (I/O) Feature and Payment Increases For $200,000 Loan at 6.5% Interest Initial Payments Reset Payments Change Percent Increase Traditional 30 Yr Fixed $1,264 $1,264 $0 0% I/O, Reset Year 5 $1,083 $1,328 $245 23%

Source: Table prepared by the Congressional Research Service (CRS).

Unlike interest-only mortgages, adjustable rate mortgages could have declining payments as well as rising payments. Adjustable rate mortgages were very common in the 1980s when interest rates were high and people expected mortgage rates to fall. The concern with morerecent adjustable rate mortgages is that their original rate was near historic lows so it is probable that the prevailing interest rate will be higher when they reset.[9] (Interest rate risk will be discussed in greater detail below.) Table 2 presents sample payment resets after three years for a $200,000 mortgage if interest rates rise or fall by a few percentage points. If the interest rate was originally 6%, then the monthly mortgage payment is $1199. If interest rates rise to 8%, then the monthly mortgage payment rises to $1449. On the other hand, if interest rates fall to 4%, then the monthly payment would drop to $971. Table 2. Payment Reset for Adjustable Rates Mortgages Interest Rates and Monthly Payments Fully Amortizing $200,000 Loan, 30 Years Rate Resets After 3 Years Interest Rate Monthly Payment 4% $971 5% $1,082 Base Rate 6% $1199 7% $1322 8% $1449 9% $1582 10% $1718


Sophisticated borrowers have used alternative mortgages to manage their cash flow for a long time. Consider a person who can qualify for any type of loan and has plenty of savings for contingencies. If the person must move frequently for work, then the person might not care much about the size of later payments because the loan will not extend that long. If a couple starts in a one-bedroom condominium but expects to move when they have children, then they might not want a traditional mortgage. If the person has other interest-rate-sensitive investments, then the person might use the mortgage as a hedge. For example, the holder of

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adjustable rate bonds would lose if interest rates fell but could offset part of that loss through an adjustable rate mortgage. Alternative mortgages were marketed as affordability products to lower income and less sophisticated borrowers during the housing boom. This raises concerns that some home buyers applied for more debt than they could qualify for using traditional underwriting standards. Lenders may have qualified them for the greater debt through these alternative products. Underwriting standards could become more lax even using traditional qualifying ratios if the process was based on the early years of an alternative mortgage product’s payments. Consider again the $200,000 loan at 6.5% presented in table 1. Traditionally, lenders presumed that there was a cap on the percentage of household income borrowers could devote to housing costs. If that cap was 28%, and the traditional 30-year fixed rate mortgage had monthly payments of $1,264, then a borrower would need an income of $54,177 to qualify for the traditional loan. A borrower with a lower income could not qualify for that loan and presumably could not buy the house. The interest-only loan presents an interesting qualifying issue. If households can devote 28% of income to housing costs, then an income of $46,428 qualifies for the early years of the loan. However, an income of $56,950 would be required for the later years of the interestonly loan. Table 3 compares the income required to support the monthly payment assuming that households can devote 28% to housing costs. A borrower with only $46,428 might be tempted to take out a $200,000 loan using the interest-only product and then refinance the house when the payment reset. Table 3. Payment Driven Loan Qualification $200,000 Loan Using 28% Qualifying Ratio Loan Type Payment Qualifying Income I/O Years 1-5 $1,083 $46,428 FRM 30 Years $1,264 $54,177 I/O Years 6-30 $1,328 $56,950


A cash-constrained borrower’s ability to successfully execute the planned refinancing would depend on the housing market. The borrower is relying on the expected appreciation of the house itself to help pay for the house. This is an example of a collateral-dependent loan which the 10/06 Guidance designates unsafe and unsound. It is not known how many of the loans due to reset in the next two years are collateral-dependent loans. The performance of these loans will depend on the housing market.

Booming House Prices and the Attraction of Alternative Mortgages U.S. house prices appreciated rapidly in many regions during 2001-2005. Nationally, the Office of Federal Housing Enterprise Oversight (OFHEO) house price index (HPI) rose 51% over the five-year period. Table 4 compares appreciation during the recent boom to appreciation in other five-year periods. The recent housing boom saw the fastest appreciation


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since 1980. The boom stands out even more when it is adjusted for inflation. Real house prices rose 34% between 2000 and 2005. Table 4. U.S. House Price Appreciation 1980-2005 Nominal and Real Change in OFHEO House Price Index (HPI) 5-Year Increments 1980-85 1985-90 1990-95 1995-00 Nominal HPI 25% 37% 8% 26% Real HPI -8% 14% -9% 12%

2000-05 51% 34%

Source: Office of Federal Housing Enterprise Oversight (OFHEO)

The distinction between nominal and real house prices is important. Mortgage contracts are almost always specified in nominal terms. This means that a fall in the real price might not cause a borrower to be upside down on the mortgage if inflation is high enough to counteract the real price decline. This scenario occurred in the early 1980s and the early 1990s. On the other hand, analysts considering the return to housing as an investment often focus on real prices.[10] Although real prices can be important for long term trends in the composition of household savings, nominal prices are more important for determining the stress on borrowers as their payment reset date nears. Prices rose even more rapidly in some markets. Table 5 compares the annual appreciation rate of some U.S. cities during 2000-2006. The extremely rapid rise in certain markets led to concerns that the 1990s stock bubble had been replaced with a housing bubble.[11] For example, Las Vegas house prices rose 34.9% in a single year, 2004. Orlando’s house prices rose 32.7% in 2005. Seven of the cities listed in table 5 experienced five consecutive years of appreciation rates exceeding 10% per year. Then in 2006 the housing market slowed dramatically, as shown by the significant decline in the appreciation rate in each of the 31 cities listed in table 5. Markets with rapid appreciation reduce the ability of first-time buyers to save for down payments. A 20% down payment on a $200,000 house is $40,000. If prices rise 10%, then the 20% down payment rises to $44,000. The down payment becomes a moving target. In areas with rapid home price appreciation, the required down payment may be growing faster than household income. Potential first time buyers may fear being permanently priced out of the market if they do not enter the market as soon as possible. While rapid home price appreciation may outstrip the savings of renters, an owner’s home price appreciation actually increases household savings. Home equity is a form of savings for home owners. Including the growth in home equity, savings rise faster if the household is an owner in a rapidly appreciating market but the household can’t become an owner until it has accumulated sufficient savings for a down payment. A mortgage with a low down payment that is designed to be refinanced after a few years could allow the prospective first-time home buyer to get in to the market and take advantage of the house’s growing equity.

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Edward Vincent Murphy Table 5. Annual House Price Appreciation 2000-2006, by Metro Area

US National West Palm Beach Los Angeles Miami Washington San Diego Las Vegas Orlando Phoenix New York San Francisco Philadelphia Boston Richmond Minneapolis Portland Chicago New Orleans St. Louis Birmingham Pittsburgh Denver Kansas City Atlanta Buffalo Nashville Houston Cincinnati Detroit Dallas Charlotte Cleveland

2000

2001

2002

2003

2004

2005

2006

8.1% 8.7 8.9 9.1 11.7 13.4 6.6 8.7 6.5 10.8 19.2 7.1 13.6 5.5 11.0 5.0 6.7 5.9 6.4 6.4 7.4 12.2 6.5 8.4 6.0 5.2 7.1 5.7 7.4 7.1 5.9 5.6

6.5% 11.2 10.5 13.0 11.3 11.9 5.9 6.9 5.4 10.9 2.9 8.5 12.5 5.3 10.2 4.0 7.4 3.8 6.3 3.2 4.8 6.2 5.6 5.0 3.8 2.8 4.0 3.8 5.4 4.1 2.4 3.3

7.1% 13.6 14.3 14.1 10.9 16.6 5.9 7.9 4.9 11.3 6.6 9.6 12.2 6.5 8.3 4.0 6.3 6.0 5.2 4.7 4.5 3.3 4.6 4.4 4.2 2.6 4.6 3.5 3.6 3.7 2.9 3.6

8.2% 17.0 19.3 15.2 14.0 17.7 18.3 9.1 6.9 11.8 6.3 11.3 10.3 8.2 8.7 6.0 7.7 6.4 6.6 4.7 5.0 2.7 4.0 3.6 5.0 3.7 3.4 3.4 3.4 2.1 2.2 3.8

13.0% 27.1 27.0 22.7 24.2 25.9 34.9 20.4 22.2 16.3 18.9 15.9 11.6 13.6 9.5 12.7 11.1 8.3 8.6 6.0 5.3 3.9 5.7 4.9 6.5 6.2 4.7 5.2 3.4 3.1 4.2 4.0

12.9% 28.7 23.6 28.7 22.3 8.7 16.6 32.7 37.0 16.6 15.1 14.2 5.9 17.8 6.7 12.6 10.8 14.9 7.6 8.9 5.6 3.5 5.5 5.1 5.4 9.2 5.8 4.2 1.8 4.1 6.1 2.6

2.1% 0.2 4.4 8.4 2.7 -0.1 1.3 5.5 3.8 1.9 1.2 3.0 -1.2 4.3 0.3 7.5 2.9 5.4 1.9 2.3 0.3 1.0 0.5 1.6 2.4 4.8 2.8 0.9 -3.0 1.9 4.4 -0.8

AVG 00-05 9.3% 17.7 17.3 17.1 15.7 15.7 14.7 14.3 13.8 13.0 11.5 11.1 11.0 9.5 9.1 8.9 8.3 7.6 6.8 5.6 5.4 5.3 5.3 5.2 5.1 5.0 4.9 4.3 4.2 4.0 3.9 3.8

Source: OFHEO HPI, calculated 1st Quarter to 1st Quarter

Rapid appreciation can reduce the time needed for credit enhancement. Lenders typically require some form of credit enhancement if the value of the loan is more than 80% of the value of the property. This loan-to-value ratio (LTV) of 0.8 corresponds with the traditional 20% down payment. One way that buyers with less than 20% down enhanced their credit was through private mortgage insurance (PMI). However, the PMI monthly premium counted towards the funds that underwriters assumed households could devote to housing costs. The more quickly that a household can lower LTV and eliminate the need for PMI, the greater the percentage of the household’s total monthly payment can be devoted to paying off the loan. In rapidly appreciating markets, the effect of growing equity on potential savings and on the need for PMI made alternative mortgages with planned refinances a potential affordability product. If first time buyers could just get into the rising market, then the growing equity


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would provide sufficient savings to lower LTV and eliminate the need for PMI by the time they had to refinance. Similar logic applies if buyers replace PMI with a piggy back loan at a higher interest rate because the need for the second loan at a higher rate is eliminated when equity rises. Table 6 presents the growth of equity and reduction in LTV for a $200,000 interest-only loan for various appreciation rates. If appreciation rises 10%, then by the beginning of year three the equity increases to $42,000 and the LTV falls to 0.79. In this case, the buyer who put zero down and paid only interest would be able to refinance into a loan without credit enhancement because the drop in LTV is the equivalent of the 20% down payment. The time required to reduce LTV enough to eliminate credit enhancement decreases as the appreciation rate rises. The preceding discussion showed two ways that zero down payment and interest-only mortgages could have been used as affordability products. First, if qualification is payment driven, then lower-income borrowers could be qualified based on the payments required during the introductory period of interest-only mortgages. Table 3 showed that a household With $46,428 Income Could Qualify For The Early Payments Of A $200,000 Loan At 6.5% interest, even though that loan would have traditionally required an income of $54,177 to qualify. Second, price appreciation during the introductory period could lower LTV, eliminate the need for credit enhancement, and allow the household to devote more funds to the house payment. Table 6 showed that 10% annual appreciation can eliminate the need for PMI by the beginning of the third year of payments. Problems could arise if the housing market weakens further. Some of these borrowers may not be able to refinance prior to their payment reset dates if their houses fail to appreciate at the expected rate.

Negative Appreciation Risk Borrowers using alternative mortgages to take advantage of appreciation are exposed to the risk that house prices will fail to appreciate or even decline in price. Recall that table 5 showed that the rate of appreciation slowed across the country in 2006. In some formerly hot markets, prices declined for the first three quarters of 2006. As payment reset dates approach, many borrowers who used alternative mortgages as affordability products will wish to refinance. Their ability to refinance will depend in many cases on home equity gained through price appreciation and the health of their local market. Local factors usually play a dominant role in determining regional house prices. Because of the role the job market plays in household income, analysts assume the local unemployment rate is important even in the absence of other information. For example, David Lereah, chief economist for the National Association of Realtors, emphasized the labor market in a presentation to residents of Charleston, SC. “Your unemployment situation is very positive ... I really don’t know the local industries in Charleston other than tourism, but whatever it is, it’s doing a good job.”[12] Although Lereah went on to discuss migration patterns and other factors, the stress on labor markets is unmistakable.

Table 6. Appreciation, Home Equity, and Loan to Value (LTV) Appreciation Contribution to Home Equity $200,000 House, Zero Down, I/O Loan Reset Year Appreciation Rate (Annual Percent) Beginning 0% LTV 5% Equity LTV 10% LTV 15% LTV 20% Year Equity Equity Equity Equity 1 0 1 $0 1.00 $0 1.00 $0 1.00 $0 2 0 1 $10,000 0.95 $20,000 0.90 $30,000 0.85 $40,000 3 0 1 $20,000 0.90 $42,000 0.79 $64,500 0.68 $88,000 4 0 1 $31,525 0.84 $66,200 0.67 $104,175 0.48 $145,600 5 0 1 $43,101 0.78 $92,820 0.54 $149,801 0.25 $214,720

Source: CRS Calculations.

LTV 1.00 0.80 0.56 0.27 -0.07


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Because local economies often play such a crucial role in house prices, one might think that the price risks embodied in low down payment mortgages will only be a problem if an area’s unemployment rises. While it is true that an increase in local unemployment can help drive down house prices, it is important to note that prices can fall even if the local labor market is healthy. The next sections show how different metro areas can have divergent price trends but that the recent house price slowdown is widespread and independent of local unemployment. House prices in different metro areas do not always follow the national trend or move in the same direction. Recall again the wide range of appreciation rates for the cities presented in table 5. San Diego’s houses appreciated over 15% per year during 2000-2005, but Denver and Buffalo were closer to 5% per year. Figure 1 tracks house prices for San Diego, Buffalo, and Denver from 1980 to 2005. They do not follow the national average nor do they follow similar patterns. Denver’s prices rose more quickly in the early 1980s, when San Diego and Buffalo stagnated. San Diego boomed in the late 1980s but then fell in the 1990s. Buffalo’s prices followed a more stable trajectory. Differences in the local economies of the three cities contributed to the divergent paths of home prices. Many of the biggest house price slowdowns in 2006 cannot be attributed to shocks to local job markets. For example, Boston’s appreciation rate dropped during 2004-2006 even though the Massachusetts labor market remained stable. Boston’s appreciation rate fell from 11.6% in 2004, to 5.9% in 2005, and finally fell 1.2% in the first three quarters of 2006. Yet the Massachusetts unemployment rate remained close to 5% in all three years.[13] Despite a relatively stable labor market, Boston’s house prices stopped appreciating.

Figure 1. Comparison of Appreciation for 3 Cities, 1980-2005.

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The slowdowns in house price appreciation were widespread and occurred in areas with healthy job markets. Table 7 compares local unemployment rate changes to the slowdown in appreciation for several of the formerly hot housing markets. Notice that the local unemployment rates were relatively unchanged in October 2006 compared to October 2005. Yet the rate of home price appreciation fell precipitously in each market. Table 7 shows that the rate of appreciation experienced by home buyers while they are choosing their mortgage can decline drastically even if the local economy remains healthy. The possibility of zero or negative appreciation in an otherwise healthy economy is a risk for borrowers who made very low down payments. If they used a piggy back loan to avoid PMI or used an interest-only loan and planned to refinance when they reached an LTV of 0.8, then they could become upside down on the mortgage. Borrowers with little savings may find it difficult to refinance or sell a house before the reset date if their LTV has not improved (i.e., declined). Table 8 shows how declines in house prices affect the LTV of zero-down borrowers for a $200,000 interest-only loan. Table 7. Local Unemployment and Slowing Appreciation Local Unemployment and Slowing Appreciation Unemployment Appreciation 10/05 10/06 2005 4.2% 3.4% 37.0% 4.2 3.6 8.7 4.5 3.9 23.6 5.8 4.1 16.6 3.7 3.5 28.7 3.0 2.9 22.3 3.7 4.0 16.6 3.1 2.8 32.7

Market Phoenix San Diego Los Angeles New York Miami Washington Las Vegas Orlando

2006 3.8% -0.1 4.4 1.9 8.4 2.7 1.3 5.5

Source: OFHEO and BLS

Table 8. Negative Appreciation, Equity, and Loan to Value (LTV) Negative Appreciation and Increasing Debt Burdens $200,000 House, Zero Down, I/O Loan Reset Year 5 0% -1% -2% -3% Begin Equity LTV Equity LTV Equity Year 1 $0 1.00 $0 1.00 $0 1.00 $0 2 $0 1.00 $-2,000 1.01 $-4,000 1.02 $-6,000 3 $0 1.00 $-3,980 1.02 $-7,920 1.04 $-11,820 4 $0 1.00 $-5,940 1.03 $-11,762 1.06 $-17,465 5 $0 1.00 $-7,881 1.04 $-15,526 1.08 $-22,941

LTV

-4% Equity

LTV

1.00 1.03 1.06 1.09 1.11

$0 $-8,000 $-15,680 $-23,053 $-30,131

1.00 1.04 1.08 1.12 1.15

Source: CRS Calculations.

If house prices depreciate 3% per year for two years, then the zero-down, interest-only borrower presented in table 8 will owe $11,820 more than the house is worth. Recall that one reason a borrower might have been attracted to the interest-only loan was because the borrower did not have the savings for a down payment. When the introductory period ends


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and the reset date arrives, the borrower’s payments will rise. In this hypothetical example of a $200,000 interest-only loan in a period of 6.5% interest rates, table 1 shows that the reset payment would rise $245 per month after four years. The borrower must either find an additional $245 per month to maintain the current mortgage or $11,820 to cover the reduction in equity and try to refinance even if interest rates do not rise.

Interest Rate Risk A common form of alternative mortgage employs adjustable interest rates. Adjustable rate mortgages shift the risk of rising interest rates from the lenders to the borrowers. Table 2 showed how a rise in interest rates could increase the payment on an adjustable rate mortgage. However, adjustable rate mortgages allow borrowers to benefit when interest rates fall. The availability and popularity of adjustable rate mortgages have changed with changing macroeconomic conditions. When lenders held most of their loans in their own portfolio, fixed rate mortgages imposed significant costs when interest rates rose. The lenders’ own costs of funds depended on the short-term interest rates prevalent as time progressed.[14] However, the lenders’ income from their mortgages depended on the interest rates prevalent at the time the mortgages were originated. This is called borrowing short and lending long. Rising interest rates increase the lenders’ cost of funds but the lenders’ incomes do not rise. In response to strains on the banking sector as interest rates rose in the late 1970s and early 1980s, Congress encouraged wider use of adjustable rate mortgages.[15] Mortgage rates are affected by conditions in the macroeconomy. Although the Federal Reserve does not directly set long term interest rates such as mortgage rates, Federal Reserve policy can determine short term interest rates and influence inflation. The mortgage rate incorporates expectations of future inflation because mortgages are repaid over long periods. Figure 2 compares inflation, mortgage rates, and the Federal Reserve discount rate since 1972. The three are related but notice that the steep rise in the discount rate after 2003 has resulted in only a minor rise in mortgage rates during the same period. The 1980s exemplify an environment conducive to adjustable rate mortgages. Mortgage rates began to decline as the fear of inflation subsided. Expecting mortgage rates to fall, more people turned to adjustable rates. For example, 61% of the conventional mortgages originated in 1984 were adjustable.[16] Mortgage rates then declined from over 13% in 1984 to under 8% by 1993. Once mortgage rates stabilized, the popularity of adjustable rate mortgages declined. For example, only 12% of mortgages originated in 2001 were adjustable rates. This relatively longstanding response of borrowers to changing macroeconomic conditions distinguishes adjustable rate mortgages from the use of interest-only mortgages as affordability products described earlier. The pattern of adjustable rate mortgages during the recent boom causes some concern. Figure 2 showed that the mortgage rates prevailing in 2003-2005 represented 30-year lows. Consumers hedging against interest rate changes would be expected to lock in the historic low rates by borrowing at fixed rates. Yet the share of adjustable rates rose from 12% in 2001 to 34% in 2004. Although still well below the 61% share in 1984, the rising number of ARMs during a period of exceptionally low interest rates means that consumers shouldered

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additional interest rate risk as the boom progressed. There is evidence that this interest rate risk is concentrated in the formerly hot markets.

Figure 2. Mortgage Rate, Discount Rate, and Inflation, 1980-2005.

Geographic Correlation of Falling-House-Price Risk and Interest Rate Risk Concentrated risk is important for cities as well as for financial institutions. The presence of distressed neighbors affects the price that other sellers can get for their houses. If an area becomes concentrated with borrowers who are unprepared for payment shock and at the same time become upside down on their loans, then downward pressure can be put on housing prices. If this happens, then more homeowners will become upside down on their loans, reinforcing the problem. Exposure to the risk of rising interest rates is geographically concentrated in the areas that may be exposed to the risk of falling house prices. The Federal Home Finance Board (FHFB) conducts a survey of the use of adjustable rate mortgages. The sample used for the survey excludes many important categories of nontraditional mortgages such as negatively amortizing loans. However, the survey can give


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some indication of the geographical concentration of some types of alternative mortgages and the exposure of some areas to the risk that inflation and interest rates will increase. Table 9 uses FHFB data to show the use of adjustable rate mortgages and the recent slowdown in appreciation for 12 metropolitan areas from different parts of the country. The rates reported in table 9 are unweighted averages of the five most recent quarters in the FHFB survey.[17] An area is more immediately exposed to rising interest rates if a higher percentage of its loans will reset interest rates in the near future. By this measure, Dallas and Houston are probably less exposed to the risk that interest rates might rise in the near future while California cities appear more exposed to interest rate risk. In addition to a rise in interest rates for adjustable rate mortgages, regions could suffer if their lenders and home buyers used low down payments and overestimated the rate at which their houses would appreciate. Prior to the issuance of the 10/06 Guidance, some borrowers may have been using expected appreciation to get into larger houses than they could have otherwise afforded. Table 9 shows the decline in the rate of appreciation from 2005 to the first three quarters of 2006. To the extent that some borrowers counted on the rate of appreciation prevailing at the time they originated their loan to continue, a sudden deceleration in the rate of growth of prices will delay the time that they can achieve an LTV of 0.8 and get better terms when they attempt to refinance. Miami, California, and New York had comparatively large drops in appreciation and could have home buyers who made large mistakes when projecting appreciation rates. Even though the appreciation rate might still be comparatively rapid, an unexpected drop in appreciation could still foil the plans of a low down payment buyer. For example, Miami’s 2006 appreciation rate is still relatively high at 8%. However, if a zero-down Miami buyer in 2005 planned on appreciation of 20% per year and chose a mortgage that reset after one year, the 8% appreciation rate would not achieve the LTV of 0.8 to allow an improved refinance. The buyer wouldn’t be upside down but would still pay more than expected costs because the loan might have to be refinanced more than once. Fees are paid each time a loan is refinanced. Table 9. Adjustable Rate Mortgages and Price Slowdowns Loan Resets and Price Slowdown By Metro Share of Adjustable Rates ‘06 Atlanta 31% Boston 29% Chicago 40% Dallas-Ft. Worth 11% Denver 36% Houston 9% Kansas City 16% Los Angeles 57% Miami 36% New York 30% San Diego 62% San Francisco 65% Source: FHFB and OFHEO.

Appreciation Rate ‘05 ‘06 5% 2% 6% -1% 11% 3% 4% 2% 4% 1% 6% 3% 5% 1% 24% 4% 29% 8% 17% 2% 9% 0% 15% 1%

Falling Appreciation ‘05-‘06 -3% -7% -8% -2% -3% -3% -4% -20% -21% -15% -9% -14%

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Table 9 does not purport to measure the probability that a particular housing market will suffer severe stress. Instead, it is a very simple indication of a region’s exposure to interest rate and falling-house-price risk. Industry analysts use more sophisticated methods to predict the probability that housing prices might fall in a particular market. The United States Market Risk index (USMR) is one such measure.[18] The USMR index takes into account the local job market, recent price acceleration, and the affordability index. Weak job markets and low affordability tend to increase the risk of falling house prices. Stable recent appreciation tends to reduce the risk of falling house prices. Table 10 presents the market risk index for selected cities. A value of 100 implies a 10% chance that house prices in the area will fall within two years. Table 10. Adjustable Rate Mortgages and the Market Risk Index Metropolitan Area San Francisco San Diego Los Angeles Las Vegas Sacramento Phoenix Chicago Seattle Miami Denver Orlando Tampa Portland Atlanta Milwaukee New York Boston Virginia Beach Minneapolis Detroit Columbus Washington St. Louis Indianapolis San Antonio Kansas City Philadelphia Dallas Cincinnati Houston Pittsburgh Cleveland

Source: FHFB and PMI Group.

Share of Adjustable Rates 06 65% 62% 57% 51% 48% 41% 40% 39% 39% 36% 34% 34% 32% 31% 31% 30% 30% 29% 27% 25% 24% 22% 21% 19% 17% 16% 13% 11% 9% 9% 6% 3%

PMI Risk Index 587 603 590 540 601 353 147 153 471 187 313 404 158 201 140 543 596 413 393 379 74 540 133 63 78 109 179 89 72 88 61 74


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Table 10 shows that areas with lower risk of falling house prices as measured by the PMI Group’s USMR index tend to have fewer adjustable rate mortgages. The markets with a high percentage of adjustable rate mortgages are correlated with higher risk of falling house prices. Statistical analysis shows that the relationship of the risk of rising interest rates and the risk of falling house prices is positive.[19] There is a geographic concentration of mortgages vulnerable to rising interest rates and risks to any borrowers who made low down payments. Washington, DC, and Chicago are notable exceptions. Chicago has a relatively high level of interest rate risk as measured by the share of adjustable rate loans but a low level of fallinghouse-price risk as measured by the USMR. Washington has a high risk of falling house prices but less interest rate risk. A correlation of ARM share and the risk index does not imply causation. Nor is this a test of a formal model of the determination of regional ARM shares. Table 10 merely shows that the interest rate risk inherent in adjustable rate mortgages is correlated with the risk of falling house prices identified by PMI’s market risk index. The regions using ARMs tend to be the regions most susceptible to changes in macroeconomic conditions such as interest rate changes.

Recent Slowdown in Price To say that some regions face significant risks is not to say that a bubble has burst. According to OFHEO Chief Economist Patrick Lawler, “House prices continued to rise through the third quarter in most of the country, but generally at only low or moderate rates. The transition from sizzling markets to normal or weak markets has been orderly so far, and recent drops in interest rates lessen the likelihood that precipitous changes will occur.”[20] A study by the FDIC reinforces the view that a slowdown in housing does not have to result in collapsing local markets. Of 46 instances of housing booms in U.S. cities since 1978, 21 experienced a subsequent housing bust. In other words, more than half of the observations of housing booms were not followed by housing busts.[21] The housing busts that did occur were often associated with declines in the local area’s predominant industries.

CONCLUSION Mortgages with adjustable rates and interest-only options have been more widely used in recent years. Once only used by the financially sophisticated, products with significant payment adjustments have been marketed to low-income borrowers as affordable products. The performance of these products among lower-income borrowers has not been tested in a stressed environment. Federal agencies have issued new guidance covering alternative mortgages. Lenders must disclose adequate information to consumers in plain English. Lenders must take steps to manage the risks of alternative mortgages. These steps include assessing borrowers’ capacity to pay the entire potential balance of negative amortization loans and establishing risk management procedures for third party loan partners. Lenders may not rely solely on the ability to sell the property to qualify borrowers for a loan.

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By choosing interest-only products, some consumers have assumed the risk of falling house prices as their reset period approaches. By choosing adjustable rate mortgages, some consumers have shifted interest rate risk from lenders to themselves. The geographical distribution of alternative mortgages suggests that falling-house-price risk and interest rate risk are concentrated in the same regions. It remains to be seen if interest rates will remain low and if consumers have prepared for the risks they have assumed. The impact of these mortgages may be tested if housing markets continue to slow down.

REFERENCES [1] [2] [3] [4] [5] [6]

[7]

[8] [9]

[10]

[11]

[12] [13] [14] [15] [16]

“Facing the Fallout from Foreclosures,” Community Banker, Nov. 2006. p. 40. “Falling Prices Trap New Home Buyers,” Orange County Register, Dec. 13, 2006. When a borrower owes more than the collateral is worth, the borrower is said to be upside down. “Interagency Guidance on Nontraditional Mortgage Product Risks,” Federal Register, vol. 71, Oct. 4, 2006, p. 58613. The doctrine of suitability would impose a duty on lenders to ensure that a chosen mortgage product was suitable to the borrower’s financial circumstances and goals. The Federal Reserve publishes the Consumer Handbook for Adjustable Rate Mortgages (CHARM Booklets). Regulation Z requires that consumers be given CHARM booklets in the shopping phase if they ask for, or are offered, adjustable rate mortgages. U.S. Government Accountability Office, Alternative Mortgage Products: Impact on Defaults Remains Unclear, But Disclosure of Risks to Borrowers Could be Improved, GAO-06-1112T, Sept. 20, 2006. p.2. Alternative Mortgage Products, Sept. 20, 2006. Some adjustable rates are tied to short-term interest rates while traditional mortgages are long term. Some sophisticated borrowers choose adjustable or fixed rate mortgages based on the difference between short- and long-term rates, called the yield curve. For these borrowers, the steepness of the yield curve, not the relation of current mortgage rates to their long-term trend, would be the important consideration. Robert Schiller’s critique of the housing market uses real prices and attempts to adjust for changes in housing quality. See “Be Warned: Mr. Bubble is Worried Again,” New York Times, Aug. 21, 2005. When asked about a national housing bubble, former Federal Reserve Chairman Alan Greenspan replied that there was no national bubble but that some markets showed signs of froth. Testimony before the Joint Economic Committee, June 9, 2005. “Realtors’ economist rates area ‘very healthy’” The Post and Courier, July 18, 2005, p.F8. Bureau of Labor Statistics, Series ID LASST25000003. Many lenders now sell their mortgages to investors in the secondary market reducing exposure to rising interest rates. Alternative Mortgages Parity Act, 1982. 12 U.S.C. sec. 3801. Federal Housing Finance Board, 2006 Mortgage Market Statistical Annual - Volume 1, p. 17.


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[17] The FHFB combines some MSAs for reporting purposes so there is not an exact match with the OFHEO price index. [18] Economic Real Estate Trends, Fall 2006 p7. The index is published by the PMI Group which sells private mortgage insurance. [19] Statistical analysis of the share of ARMs and the risk index shows a positive and significant correlation. [coefficient =9.2, t-stat =5.7, R-Squared = 0.72, df=30]. [20] OFHEO News Release, Nov. 30, 2006. [21] U.S. Home Prices: Does Bust Always Follow Boom? FDIC Feb. 10, 2005.


Chapter 5

CONSUMER HANDBOOK ON ADJUSTABLE-RATE MORTGAGES Federal Reserve Board

Adjustable-rate mortgages (ARMs) are loans with interest rates that change. ARMs may start with lower monthly payments than fixed-rate mortgages, but keep the following in mind: • • • •

Your monthly payments could change. They could go up—sometimes by a lot—even if interest rates don’t go up. Your payments may not go down much, or at all—even if interest rates go down. You could end up owing more money than you borrowed—even if you make all your payments on time. If you want to pay off your ARM early to avoid higher payments, you might have to pay a penalty.

You need to compare features of ARMs to find the one that best fits your needs. See the Mortgage Shopping Worksheet on page 118-119. This handbook explains how ARMs work and discusses some of the issues that borrowers may face. It includes ways to reduce the risks and gives some pointers about

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Federal Reserve Board

advertising and other ways you can get information from lenders and other trusted advisers. Important ARM terms are defined in a glossary. And the Mortgage Shopping Worksheet can help you ask the right questions and figure out whether an ARM is right for you. Ask lenders to help you fill out the worksheet so you can get the information you need to compare mortgages.

MORTGAGE SHOPPING WORKSHEET Ask your lender or broker to help you fill out this worksheet. Name of lender or broker and contact information Mortgage amount Loan term (e.g., 15 years, 30 years) Loan description (e.g., fixed rate, 3/1 ARM, payment-option ARM, interest-only ARM) Basic Features for Comparison Fixed-rate mortgage interest rate and annual percentage rate (APR) (For graduated-payment or stepped-rate mortgages, use the ARM columns.) ARM initial interest rate and APR How long does the initial rate apply? What will the interest rate be after the initial period? ARM features How often can the interest rate adjust? What is the index and what is the current rate? (See chart on page 8.) What is the margin for this loan? Interest-rate caps What is the periodic interest-rate cap? What is the lifetime interest-rate cap? How high could the rate go? How low could the interest rate go on this loan? What is the payment cap? Can this loan have negative amortization (that is, increase in size)? What is the limit to how much the balance can grow before the loan will be recalculated? Is there a prepayment penalty if I pay off this mortgage early? How long does that penalty last? How much is it? Is there a balloon payment on this mortgage? If so, what is the estimated amount and when would it be due? What are the estimated origination fees and charges for this loan? Monthly Payment Amounts What will the monthly payments be for the first year of the loan? Does this include taxes and insurance? Condo or homeowner’s association fees? If not, what are the estimates for these amounts? What will my monthly payment be after 12 months if the index rate… …stays the same? …goes up 2%? …goes down 2%? What is the most my minimum monthly payment could be after 1 year?

Consumer Handbook on Adjustable-Rate Mortgages What is the most my minimum monthly payment could be after 3 years? What is the most my minimum monthly payment could be after 5 years?

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WHAT IS AN ARM? An adjustable-rate mortgage differs from a fixed-rate mortgage in many ways. With a fixed-rate mortgage, the interest rate stays the same during the life of the loan. With an ARM, the interest rate changes periodically, usually in relation to an index, and payments may go up or down accordingly. Shopping for a mortgage is not as simple as it used to be. To compare two ARMs with each other or to compare an ARM with a fixed-rate mortgage, you need to know about indexes, margins, discounts, caps on rates and payments, negative amortization, payment options, and recasting (recalculating) your loan. You need to consider the maximum amount your monthly payment could increase. Most important, you need to know what might happen to your monthly mortgage payment in relation to your future ability to afford higher payments. Lenders generally charge lower initial interest rates for ARMs than for fixed-rate mortgages. At first, this makes the ARM easier on your pocketbook than a fixed-rate mortgage for the same loan amount. Moreover, your ARM could be less expensive over a long period than a fixed-rate mortgage—for example, if interest rates remain steady or move lower. Against these advantages, you have to weigh the risk that an increase in interest rates would lead to higher monthly payments in the future. It’s a trade-off—you get a lower initial rate with an ARM in exchange for assuming more risk over the long run. Here are some questions you need to consider: • • • •

Is my income enough—or likely to rise enough—to cover higher mortgage payments if interest rates go up? Will I be taking on other sizable debts, such as a loan for a car or school tuition, in the near future? How long do I plan to own this home? (If you plan to sell soon, rising interest rates may not pose the problem they do if you plan to own the house for a long time.) Do I plan to make any additional payments or pay the loan off early?

Lenders and Brokers Mortgage loans are offered by many kinds of lenders—such as banks, mortgage companies, and credit unions. You can also get a loan through a mortgage broker. Brokers “arrange” loans; in other words, they find a lender for you. Brokers generally take your application and contact several lenders, but keep in mind that brokers are not required to find the best deal for you unless they have contracted with you to act as your agent.

Consumer Handbook on Adjustable-Rate Mortgages

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HOW ARMS WORK: THE BASIC FEATURES Initial Rate and Payment The initial rate and payment amount on an ARM will remain in effect for a limited period of time—ranging from just 1 month to 5 years or more. For some ARMs, the initial rate and payment can vary greatly from the rates and payments later in the loan term. Even if interest rates are stable, your rates and payments could change a lot. If lenders or brokers quote the initial rate and payment on a loan, ask them for the annual percentage rate (APR). If the APR is significantly higher than the initial rate, then it is likely that your rate and payments will be a lot higher when the loan adjusts, even if general interest rates remain the same.

The Adjustment Period With most ARMs, the interest rate and monthly payment change every month, quarter, year, 3 years, or 5 years. The period between rate changes is called the adjustment period. For example, a loan with an adjustment period of 1 year is called a 1-year ARM, and the interest rate and payment can change once every year; a loan with a 3-year adjustment period is called a 3-year ARM.

Loan Descriptions Lenders must give you written information on each type of ARM loan you are interested in. The information must include the terms and conditions for each loan, including information about the index and margin, how your rate will be calculated, how often your rate can change, limits on changes (or caps), an example of how high your monthly payment might go, and other ARM features such as negative amortization.

The Index The interest rate on an ARM is made up of two parts: the index and the margin. The index is a measure of interest rates generally, and the margin is an extra amount that the lender adds. Your payments will be affected by any caps, or limits, on how high or low your rate can go. If the index rate moves up, so does your interest rate in most circumstances, and you will probably have to make higher monthly payments. On the other hand, if the index rate goes down, your monthly payment could go down. Not all ARMs adjust downward, however—be sure to read the information for the loan you are considering. Lenders base ARM rates on a variety of indexes. Among the most common indexes are the rates on 1-year constant-maturity Treasury (CMT) securities, the Cost of Funds Index (COFI), and the London Interbank Offered Rate (LIBOR). A few lenders use their own cost of funds as an index, rather than using other indexes. You should ask what index will be used,

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how it has fluctuated in the past, and where it is published—you can find a lot of this information in major newspapers and on the Internet. To help you get an idea of how to compare different indexes, the following chart shows a few common indexes over an 11-year period (1996–2006). As you can see, some index rates tend to be higher than others, and some change more often. But if a lender bases interest-rate adjustments on the average value of an index over time, your interest rate would not change as dramatically.

The Margin To determine the interest rate on an ARM, lenders add a few percentage points to the index rate, called the margin. The amount of the margin may differ from one lender to another, but it is usually constant over the life of the loan. The fully indexed rate is equal to the margin plus the index. If the initial rate on the loan is less than the fully indexed rate, it is called a discounted index rate. For example, if the lender uses an index that currently is 4% and adds a 3% margin, the fully indexed rate would be


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If the index on this loan rose to 5%, the fully indexed rate would be 8% (5% + 3%). If the index fell to 2%, the fully indexed rate would be 5% (2% + 3%). Some lenders base the amount of the margin on your credit record—the better your credit, the lower the margin they add—and the lower the interest you will have to pay on your mortgage. In comparing ARMs, look at both the index and margin for each program.

No-Doc/Low-Doc Loans When you apply for a loan, lenders usually require documents to prove that your income is high enough to repay the loan. For example, a lender might ask to see copies of your most recent pay stubs, income tax filings, and bank account statements. In a no-doc or low-doc loan, the lender doesn’t require you to bring proof of your income, but you will usually have to pay a higher interest rate or extra fees to get the loan. Lenders generally charge more for no-doc/low-doc loans.

INTEREST-RATE CAPS An interest-rate cap places a limit on the amount your interest rate can increase. Interest caps come in two versions: • •

periodic adjustment caps, which limit the amount the interest rate can adjust up or down from one adjustment period to the next after the first adjustment, and lifetime caps, which limit the interest-rate increase over the life of the loan. By law, virtually all ARMs must have a lifetime cap.

Periodic Adjustment Caps Let’s suppose you have an ARM with a periodic adjustment interest-rate cap of 2%. However, at the first adjustment, the index rate has risen 3%. The following example shows what happens.

Examples in this Handbook All examples in this handbook are based on a $200,000 loan amount and a 30-year term. Payment amounts in the examples do not include taxes, insurance, condominium or home-

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owner association fees, or similar items. These amounts can be a significant part of your monthly payment.

In this example, because of the cap on your loan, your monthly payment in year 2 is $138.70 per month lower than it would be without the cap, saving you $1,664.40 over the year. Some ARMs allow a larger rate change at the first adjustment and then apply a periodic adjustment cap to all future adjustments. A drop in interest rates does not always lead to a drop in your monthly payments. With some ARMs that have interest-rate caps, the cap may hold your rate and payment below what it would have been if the change in the index rate had been fully applied. The increase in the interest that was not imposed because of the rate cap might carry over to future rate adjustments. This is called carryover. So at the next adjustment date, your payment might increase even though the index rate has stayed the same or declined. The following example shows how carryovers work. Suppose the index on your ARM increased 3% during the first year. Because this ARM limits rate increases to 2% at any one time, the rate is adjusted by only 2%, to 8% for the second year. However, the remaining 1% increase in the index carries over to the next time the lender can adjust rates. So when the lender adjusts the interest rate for the third year, the rate increases by 1%, to 9%, even if there is no change in the index during the second year.


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In general, the rate on your loan can go up at any scheduled adjustment date when the lender’s standard ARM rate (the index plus the margin) is higher than the rate you are paying before that adjustment.

Lifetime Caps The next example shows how a lifetime rate cap would affect your loan. Let’s say that your ARM starts out with a 6% rate and the loan has a 6% lifetime cap—that is, the rate can never exceed 12%. Suppose the index rate increases 1% in each of the next 9 years. With a 6% overall cap, your payment would never exceed $1,998.84—compared with the $2,409.11 that it would have reached in the tenth year without a cap.

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PAYMENT CAPS In addition to interest-rate caps, many ARMs—including payment-option ARMs—limit, or cap, the amount your monthly payment may increase at the time of each adjustment. For example, if your loan has a payment cap of 7½%, your monthly payment won’t increase more than 7½% over your previous payment, even if interest rates rise more. For example, if your monthly payment in year 1 of your mortgage was $1,000, it could only go up to $1,075 in year 2 (7½% of $1,000 is an additional $75). Any interest you don’t pay because of the payment cap will be added to the balance of your loan. A payment cap can limit the increase to your monthly payments but also can add to the amount you owe on the loan. (This is called negative amortization, a term that is explained on page 22.) Let’s assume that your rate changes in the first year by 2 percentage points but your payments can increase no more than 7½% in any one year. The following graph shows what your monthly payments would look like.

While your monthly payment will be only $1,289.03 for the second year, the difference of $172.69 each month will be added to the balance of your loan and will lead to negative amortization. Some ARMs with payment caps do not have periodic interest-rate caps. In addition, as explained below, most payment-option ARMs have a built-in recalculation period, usually every 5 years. At that point, your payment will be recalculated (lenders use the term recast) based on the remaining term of the loan. If you have a 30-year loan and you are at the end of year 5, your payment will be recalculated for the remaining 25 years. The payment cap does not apply to this adjustment. If your loan balance has increased, or if interest rates have risen faster than your payments, your payments could go up a lot.


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TYPES OF ARMS Hybrid ARMs Hybrid ARMs often are advertised as 3/1 or 5/1 ARMs—you might also see ads for 7/1 or 10/1 ARMs. These loans are a mix—or a hybrid—of a fixed-rate period and an adjustablerate period. The interest rate is fixed for the first few years of these loans—for example, for 5 years in a 5/1 ARM. After that, the rate may adjust annually (the 1 in the 5/1 example), until the loan is paid off. In the case of 3/1 or 5/1 ARMs • •

the first number tells you how long the fixed interest-rate period will be and the second number tells you how often the rate will adjust after the initial period.

You may also see ads for 2/28 or 3/27 ARMs—the first number tells you how long the fixed interest-rate period will be, and the second number tells you the number of years the rates on the loan will be adjustable. Some 2/28 and 3/27 mortgages adjust every 6 months, not annually.

Interest-Only ARMs An interest-only (I-O) ARM payment plan allows you to pay only the interest for a specified number of years, typically between 3 and 10 years. This allows you to have smaller monthly payments for a period of time. After that, your monthly payment will increase—even if interest rates stay the same—because you must start paying back the principal as well as the interest each month. For some I-O loans, the interest rate adjusts during the I-O period as well. For example, if you take out a 30-year mortgage loan with a 5-year I-O payment period, you can pay only interest for 5 years and then you must pay both the principal and interest over the next 25 years. Because you begin to pay back the principal, your payments increase after year 5, even if the rate stays the same. Keep in mind that the longer the I-O period, the higher your monthly payments will be after the I-O period ends.

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Payment-Option ARMs A payment-option ARM is an adjustable-rate mortgage that allows you to choose among several payment options each month. The options typically include the following: •

• •

a traditional payment of principal and interest, which reduces the amount you owe on your mortgage. These payments are based on a set loan term, such as a 15-, 30-, or 40-year payment schedule. an interest-only payment, which pays the interest but does not reduce the amount you owe on your mortgage as you make your payments. a minimum (or limited) payment that may be less than the amount of interest due that month and may not reduce the amount you owe on your mortgage. If you choose this option, the amount of any interest you do not pay will be added to the principal of the loan, increasing the amount you owe and your future monthly payments, and increasing the amount of interest you will pay over the life of the loan. In addition, if you pay only the minimum payment in the last few years of the loan, you may owe a larger payment at the end of the loan term, called a balloon payment.

The interest rate on a payment-option ARM is typically very low for the first few months (for example, 2% for the first 1 to 3 months). After that, the interest rate usually rises to a rate closer to that of other mortgage loans. Your payments during the first year are based on the initial low rate, meaning that if you only make the minimum payment each month, it will not reduce the amount you owe and it may not cover the interest due. The unpaid interest is added to the amount you owe on the mortgage, and your loan balance increases. This is called negative amortization. This means that even after making many payments, you could owe more than you did at the beginning of the loan. Also, as interest rates go up, your payments are likely to go up. Payment-option ARMs have a built-in recalculation period, usually every 5 years. At this point, your payment will be recalculated (lenders use the term recast) based on the remaining term of the loan. If you have a 30-year loan and you are at the end of year 5, your payment will be recalculated for the remaining 25 years. If your loan balance has increased because you have made only minimum payments, or if interest rates have risen faster than your payments, your payments will increase each time your loan is recast. At each recast, your new minimum payment will be a fully amortizing payment and any payment cap will not apply. This means that your monthly payment can increase a lot at each recast. Lenders may recalculate your loan payments before the recast period if the amount of principal you owe grows beyond a set limit, say 110% or 125% of your original mortgage amount. For example, suppose you made only minimum payments on your $200,000 mortgage and had any unpaid interest added to your balance. If the balance grew to $250,000 (125% of $200,000), your lender would recalculate your payments so that you would pay off the loan over the remaining term. It is likely that your payments would go up substantially. More information on interest-only and payment-option ARMs is available in the Federal Reserve Board’s brochure titled Interest-Only Mortgage Payments and Payment-Option ARMs—Are They for You?


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CONSUMER CAUTIONS Discounted Interest Rates Many lenders offer more than one type of ARM. Some lenders offer an ARM with an initial rate that is lower than their fully indexed ARM rate (that is, lower than the sum of the index plus the margin). Such rates—called discounted rates, start rates, or teaser rates—are often combined with large initial loan fees, sometimes called points, and with higher rates after the initial discounted rate expires. Your lender or broker may offer you a choice of loans that may include “discount points” or a “discount fee.” You may choose to pay these points or fees in return for a lower interest rate. But keep in mind that the lower interest rate may only last until the first adjustment. If a lender offers you a loan with a discount rate, don’t assume that means that the loan is a good one for you. You should carefully consider whether you will be able to afford higher payments in later years when the discount expires and the rate is adjusted. Here is an example of how a discounted initial rate might work. Let’s assume that the lender’s fully indexed one-year ARM rate (index rate plus margin) is currently 6%; the monthly payment for the first year would be $1,199.10. But your lender is offering an ARM with a discounted initial rate of 4% for the first year. With the 4% rate, your first-year’s monthly payment would be $954.83. With a discounted ARM, your initial payment will probably remain at $954.83 for only a limited time—and any savings during the discount period may be offset by higher payments over the remaining life of the mortgage. If you are considering a discount ARM, be sure to compare future payments with those for a fully indexed ARM. In fact, if you buy a home or refinance using a deeply discounted initial rate, you run the risk of payment shock, negative amortization, or prepayment penalties or conversion fees.

Payment Shock Payment shock may occur if your mortgage payment rises sharply at a rate adjustment. Let’s see what would happen in the second year if the rate on your discounted 4% ARM were to rise to the 6% fully indexed rate.

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As the example shows, even if the index rate were to stay the same, your monthly payment would go up from $954.83 to $1,192.63 in the second year. Suppose that the index rate increases 1% in one year and the ARM rate rises to 7%. Your payment in the second year would be $1,320.59. That’s an increase of $365.76 in your monthly payment. You can see what might happen if you choose an ARM because of a low initial rate without considering whether you will be able to afford future payments. If you have an interest-only ARM, payment shock can also occur when the interest-only period ends. Or, if you have a payment-option ARM, payment shock can happen when the loan is recast. The following example compares several different loans over the first 7 years of their terms; the payments shown are for years 1, 6, and 7 of the mortgage, assuming you make interest-only payments or minimum payments. The main point is that, depending on the terms and conditions of your mortgage and changes in interest rates, ARM payments can change quite a bit over the life of the loan—so while you could save money in the first few years of an ARM, you could also face much higher payments in the future.

Negative Amortization— When You Owe More Money than You Borrowed Negative amortization means that the amount you owe increases even when you make all your required payments on time. It occurs whenever your monthly mortgage payments are not large enough to pay all of the interest due on your mortgage—the unpaid interest is added to the principal on your mortgage, and you will owe more than you originally borrowed. This can happen because you are making only minimum payments on a payment-option mortgage or because your loan has a payment cap. For example, suppose you have a $200,000, 30-year payment-option ARM with a 2% rate for the first 3 months and a 6% rate for the remaining 9 months of the year. Your minimum payment for the year is $739.24, as shown in the previous graph. However, once


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the 6% rate is applied to your loan balance, you are no longer covering the interest costs. If you continue to make minimum payments on this loan, your loan balance at the end of the first year of your mortgage would be $201,118—or $1,118 more than you originally borrowed. Because payment caps limit only the amount of payment increases, and not interest-rate increases, payments sometimes do not cover all the interest due on your loan. This means that the unpaid interest is automatically added to your debt, and interest may be charged on that amount. You might owe the lender more later in the loan term than you did at the beginning. A payment cap limits the increase in your monthly payment by deferring some of the interest. Eventually, you would have to repay the higher remaining loan balance at the interest rate then in effect. When this happens, there may be a substantial increase in your monthly payment. Some mortgages include a cap on negative amortization. The cap typically limits the total amount you can owe to 110% to 125% of the original loan amount. When you reach that point, the lender will set the monthly payment amounts to fully repay the loan over the remaining term. Your payment cap will not apply, and your payments could be substantially higher. You may limit negative amortization by voluntarily increasing your monthly payment. Be sure you know whether the ARM you are considering can have negative amortization.

Home Prices, Home Equity, and Arms Sometimes home prices rise rapidly, allowing people to quickly build equity in their homes. This can make some people think that even if the rate and payments on their ARM get too high, they can avoid those higher payments by refinancing their loan or, in the worst case, selling their home. It’s important to remember that home prices do not always go up quickly—they may increase a little or remain the same, and sometimes they fall. If housing prices fall, your home may not be worth as much as you owe on the mortgage. Also, you may find it difficult to refinance your loan to get a lower monthly payment or rate. Even if home prices stay the same, if your loan lets you make minimum payments (see payment-option ARMs on page 33), you may owe your lender more on your mortgage than you could get from selling your home.

Prepayment Penalties and Conversion If you get an ARM, you may decide later that you don’t want to risk any increases in the interest rate and payment amount. When you are considering an ARM, ask for information about any extra fees you would have to pay if you pay off the loan early by refinancing or selling your home, and whether you would be able to convert your ARM to a fixed-rate mortgage.

Prepayment Penalties Some ARMs, including interest-only and payment-option ARMs, may require you to pay special fees or penalties if you refinance or pay off the ARM early (usually within the first 3 to 5 years of the loan). Some loans have hard prepayment penalties, meaning that you will

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pay an extra fee or penalty if you pay off the loan during the penalty period for any reason (because you refinance or sell your home, for example). Other loans have soft prepayment penalties, meaning that you will pay an extra fee or penalty only if you refinance the loan, but you will not pay a penalty if you sell your home. Also, some loans may have prepayment penalties even if you make only a partial prepayment. Prepayment penalties can be several thousand dollars. For example, suppose you have a 3/1 ARM with an initial rate of 6%. At the end of year 2 you decide to refinance and pay off your original loan. At the time of refinancing, your balance is $194,936. If your loan has a prepayment penalty of 6 months’ interest on the remaining balance, you would owe about $5,850. Sometimes there is a trade-off between having a prepayment penalty and having lower origination fees or lower interest rates. The lender may be willing to reduce or eliminate a prepayment penalty based on the amount you pay in loan fees or on the interest rate in the loan contract. If you have a hybrid ARM—such as a 2/28 or 3/27 ARM—be sure to compare the prepayment penalty period with the ARM’s first adjustment period. For example, if you have a 2/28 ARM that has a rate and payment adjustment after the second year, but the prepayment penalty is in effect for the first 5 years of the loan, it may be costly to refinance when the first adjustment is made. Most mortgages let you make additional principal payments with your monthly payment. In most cases, this is not considered prepayment, and there usually is no penalty for these extra amounts. Check with your lender to make sure there is no penalty if you think you might want to make this type of additional principal prepayment.

Conversion Fees Your agreement with the lender may include a clause that lets you convert the ARM to a fixed-rate mortgage at designated times. When you convert, the new rate is generally set using a formula given in your loan documents. The interest rate or up-front fees may be somewhat higher for a convertible ARM. Also, a convertible ARM may require a fee at the time of conversion.

Graduated-Payment or Stepped-Rate Loans Some fixed-rate loans start with one rate for one or two years and then change to another rate for the remaining term of the loan. While these are not ARMs, your payment will go up according to the terms of your contract. Talk with your lender or broker and read the information provided to you to make sure you understand when and by how much the payment will change.


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WHERE TO GET INFORMATION Disclosures from Lenders You should receive information in writing about each ARM program you are interested in before you have paid a non-refundable fee. It is important that you read this information and ask the lender or broker about anything you don’t understand—index rates, margins, caps, and other ARM features such as negative amortization. After you have applied for a loan, you will get more information from the lender about your loan, including the APR, a payment schedule, and whether the loan has a prepayment penalty. The APR is the cost of your credit as a yearly rate. It takes into account interest, points paid on the loan, any fees paid to the lender for making the loan, and any mortgage insurance premiums you may have to pay. You can compare APRs on similar ARMs (for example, compare APRs on a 5/1 and a 3/1 ARM) to determine which loan will cost you less in the long term, but you should keep in mind that because the interest rate for an ARM can change, APRs on ARMs cannot be compared directly to APRs for fixed-rate mortgages. You may want to talk with financial advisers, housing counselors, and other trusted advisers. Contact a local housing counselling agency, call the U.S. Department of Housing and Urban Development toll-free at 800-569-4287, or visit www.hud.gov/offices/hsg/sfh/ hcc/hccprof14.cfm to find a center near you.

Newspapers and the Internet When buying a home or refinancing your existing mortgage, remember to shop around. Compare costs and terms, and negotiate for the best deal. Your local newspaper and the Internet are good places to start shopping for a loan. You can usually find information on interest rates and points for several lenders. Since rates and points can change daily, you’ll want to check information sources often when shopping for a home loan. The Mortgage Shopping Worksheet may also help you. Take it with you when you speak to each lender or broker and write down the information you obtain. Don’t be afraid to make lenders and brokers compete with each other for your business by letting them know that you are shopping for the best deal.

Advertisements Any initial information you receive about mortgages probably will come from advertisements or mail solicitations from builders, real estate brokers, mortgage brokers, and lenders. Although this information can be helpful, keep in mind that these are marketing materials—the ads and mailings are designed to make the mortgage look as attractive as possible. These ads may play up low initial interest rates and monthly payments, without emphasizing that those rates and payments could increase substantially later. So, get all the facts.

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Any ad for an ARM that shows an initial interest rate should also show how long the rate is in effect and the APR on the loan. If the APR is much higher than the initial rate, your payments may increase a lot after the introductory period, even if interest rates stay the same. Choosing a mortgage may be the most important financial decision you will make. You are entitled to have all the information you need to make the right decision. Don’t hesitate to ask questions about ARM features when you talk to lenders, mortgage brokers, real estate agents, sellers, and your attorney, and keep asking until you get clear and complete answers.

GLOSSARY Adjustable-Rate Mortgage (ARM) A mortgage that does not have a fixed interest rate. The rate changes during the life of the loan based on movements in an index rate, such as the rate for Treasury securities or the Cost of Funds Index.

Annual Percentage Rate (APR) A measure of the cost of credit, expressed as a yearly rate. It includes interest as well as points, broker fees, and certain other credit charges that you are required to pay. Because all lenders follow the same rules when calculating the APR, it provides you with a good basis for comparing the cost of loans, including mortgages, over the term of the loan.

Balloon Payment A lump-sum payment that may be required when a mortgage loan ends. This can happen when the lender allows you to make smaller payments until the very end of the loan. A balloon payment will be a much larger payment compared with the other monthly payments you made.

Buydown With a buydown, the seller pays an amount to the lender so that the lender can give you a lower rate and lower payments, usually for an initial period in an ARM. The seller may increase the sales price to cover the cost of the buydown. Buydowns can occur in all types of mortgages, not just ARMs.


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Cap, Interest Rate A limit on the amount your interest rate can increase. Interest caps come in two versions: periodic adjustment caps, which limit the interest-rate increase from one adjustment period to the next, and lifetime caps, which limit the interest-rate increase over the life of the loan. By law, virtually all ARMs must have an overall cap.

Cap, Payment A limit on how much the monthly payment may change, either each time the payment changes or during the life of the mortgage. Payment caps may lead to negative amortization because they do not limit the amount of interest the lender is earning.

Conversion Clause A provision in some ARMs that allows you to change the ARM to a fixed-rate loan at some point during the term. Conversion is usually allowed at the end of the first adjustment period. At the time of the conversion, the new fixed rate is generally set at one of the rates then prevailing for fixed-rate mortgages. The conversion feature may be available at extra cost.

Discounted Initial Rate (Also Known as a Start Rate or Teaser Rate) In an ARM with a discounted initial rate, the lender offers you a lower rate and lower payments for part of the mortgage term (usually for 1, 3, or 5 years). After the discount period, the ARM rate will probably go up depending on the index rate. Discounts can occur in all types of mortgages, not just ARMs.

Equity The difference between the fair market value of the home and the outstanding balance on your mortgage plus any outstanding home equity loans.

Hybrid ARM These ARMs are a mix—or a hybrid—of a fixed-rate period and an adjustable-rate period. The interest rate is fixed for the first several years of the loan; after that, the rate could adjust annually. For example, hybrid ARMs can be advertised as 3/1 or 5/1—the first number tells you how long the fixed interest-rate period will be and the second number tells you how often the rate will adjust after the initial period.

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Index The economic indicator used to calculate interest-rate adjustments for adjustable-rate mortgages. No one can be sure when an index rate will go up or down. See the chart in the text for examples of how some common indexes have changed in the past.

Interest The price paid for borrowing money, usually given in percentages and as an annual rate.

Interest-Only Payment ARM An I-O payment ARM plan allows you to pay only the interest for a specified number of years. After that, you must repay both the principal and the interest over the remaining term of the loan.

Margin The number of percentage points the lender adds to the index rate to calculate the ARM interest rate at each adjustment.

Negative Amortization Occurs when the monthly payments do not cover all the interest owed. The interest that is not paid in the monthly payment is added to the loan balance. This means that even after making many payments, you could owe more than you did at the beginning of the loan. Negative amortization can occur when an ARM has a payment cap that results in monthly payments that are not high enough to cover the interest due or when the minimum payments are set at an amount lower than the amount you owe in interest.

Payment-Option ARM An ARM that allows you to choose among several payment options each month. The options typically include (1) a traditional amortizing payment of principal and interest, (2) an interest-only payment, or (3) a minimum (or limited) payment that may be less than the amount of interest due that month. If you choose the minimum-payment option, the amount of any interest you do not pay will be added to the principal of your loan (see negative amortization).


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Points (May Be Called Discount Points) One point is equal to 1 percent of the principal amount of your mortgage. For example, if the mortgage is for $200,000, one point equals $2,000. Lenders frequently charge points in both fixed-rate and adjustable-rate mortgages in order to cover loan origination costs or to provide additional compensation to the lender or broker. These points usually are collected at closing and may be paid by the borrower or the home seller, or may be split between them. Discount points (sometimes called discount fees) are points that you voluntarily choose to pay in return for a lower interest rate.

Prepayment Penalty Extra fees that may be due if you pay off the loan early by refinancing your loan or selling your home, usually limited to the first 3 to 5 years of the loan’s term. If your loan includes a prepayment penalty, be aware of the penalty you would have to pay. Compare the length of the prepayment penalty period with the first adjustment period of the ARM to see if refinancing is cost-effective before the loan first adjusts. Some loans may have prepayment penalties even if you make only a partial prepayment.

Principal The amount of money borrowed or the amount still owed on a loan.

FOR MORE INFORMATION Looking for the Best Mortgage—Shop, Compare, Negotiate (at www.federalreserve.gov/pubs/mortgage/mortb_1.htm) Interest-Only Mortgage Payments and Payment-Option ARMs—Are They for You? (at www.federalreserve.gov/pubs/mortgage_interestonly/) A Consumer’s Guide to Mortgage Lock-Ins (at www.federalreserve.gov/pubs/lockins/default.htm) A Consumer’s Guide to Mortgage Settlement Costs (at www.federalreserve.gov/pubs/settlement/default.htm) Know Before You Go . . .To Get a Mortgage: A Guide to Mortgage Products and a Glossary of Lending Terms (at www.bos.frb.org/consumer/knowbeforeyougo/mortgage/ mortgage.pdf)

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Partners Online Mortgage Calculator (at www.frbatlanta.org/partnerssoftwareonline/dsp_main.cfm) This information was prepared by the Board of Governors of the Federal Reserve System and the Office of Thrift Supervision in consultation with the following organizations:

AARP American Association of Residential Mortgage Regulators America’s Community Bankers Center for Responsible Lending Conference of State Bank Supervisors Consumer Federation of America Consumer Mortgage Coalition Consumers Union Credit Union National Association Federal Deposit Insurance Corporation Federal Reserve Board’s Consumer Advisory Council Federal Trade Commission Financial Services Roundtable Independent Community Bankers Association Mortgage Bankers Association Mortgage Insurance Companies of America National Association of Federal Credit Unions National Association of Home Builders National Association of Mortgage Brokers National Association of Realtors National Community Reinvestment Coalition National Consumer Law Center National Credit Union Administration


Chapter 6

A CONSUMER'S GUIDE TO MORTGAGE SETTLEMENT COSTS Federal Reserve Board Mortgage- and Lender-Related Settlement Costs Charges for Establishing and Transferring Ownership Amounts Paid to State and Local Governments "All-in-One" Pricing of Settlement Costs Estimates of Settlement Costs Settlement Cost Tips More Information on Settlement Costs and Mortgages Settlement Costs Worksheet Mortgage settlement--sometimes called mortgage closing--can be confusing. A settlement may involve several people and many documents and fees. This information will help you understand all that is involved. Although the focus of this guide is on settlements for home purchases, much of it will also be useful if you are refinancing a mortgage. Settlement costs can be high, so it pays to shop around and negotiate with the seller, your lender, and your attorney or settlement agent. The less you have to pay in settlement costs, the more funds you will have for other things. Different regions have different customs and practices regarding who pays for what at settlement. Buyers and sellers are free to negotiate certain fees. In slow-moving real estate markets, the seller may agree to pay points or fees for the buyer. In fast-moving markets, the buyer may have to agree to pay more costs to close the deal. Whatever you negotiate will become the sales contract. However, be careful; if some buyer’s costs are shifted to the seller, it may increase the price you pay for the property. You can reduce some settlement costs by shopping around for the services. The point is this: the more you know about the process, the better your chances are for saving money at settlement time. Because practices vary significantly from area to area, it is difficult to provide estimates for settlement costs that fit everywhere. However, one rule of thumb for buyers is to figure that settlement costs will be about 3% of the price of your home. In some relatively high-tax areas of the country, 5% to 6% is more common. Some settlement costs, such as homeowner’s insurance, private mortgage insurance, or points can be more expensive if your credit rating is low. Knowing your credit score can help you understand how lenders will evaluate your applications. Beginning December 2004 your lender is required to give you a copy of your credit score.

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MORTGAGE- AND LENDER-RELATED SETTLEMENT COSTS Most people associate settlement costs with mortgage loan charges. These fees and charges vary, so it pays to shop around for the best combination of mortgage terms and settlement costs. Mortgage-related costs that may apply to your loan include the following items.

Application Fee Imposed by your lender or broker, this charge covers the initial costs of processing your loan request and checking your credit report. Estimated cost: $75 to $300, including the cost of the credit report for each applicant

Loan Origination Fee The origination fee (also called underwriting fee, administrative fee, or processing fee) is charged for the lender’s work in evaluating and preparing your mortgage loan. This fee can cover the lender’s attorney’s fees, document preparation costs, notary fees, and so forth. Estimated cost: 1% to 1.5% of the loan amount

Points Points are a one-time charge imposed by the lender, usually to reduce the interest rate of your loan. One point equals 1% of the loan amount. For example, 1 point on a $100,000 loan would be $1,000. In some cases--especially in refinancing--the points can be financed by adding them to the amount that you borrow. However, if you pay the points at settlement, they are deductible on your income taxes in the year they are paid (different deduction rules apply when you refinance or purchase a second home). In your purchase offer, you may want to negotiate with the seller to have the seller pay your points. Estimated cost: 0% to 3% of the loan amount

Appraisal Fee Lenders want to be sure that the property is worth at least as much as the loan amount. This fee pays for an appraisal of the home you want to purchase or refinance. Some lenders and brokers include the appraisal fee as part of the application fee; you can ask the lender for a copy of your appraisal. If you are refinancing and you have had a recent appraisal, some lenders may waive the requirement for a new appraisal. Estimated cost: $300 to $700

A Consumer's Guide to Mortgage Settlement Costs

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Lender-Required Home Inspection Fees The lender may require a termite inspection and an analysis of the structural condition of the property by an engineer or consultant. In rural areas, lenders may require a septic system test and a water test to make sure the well and water system will maintain an adequate supply of water for the house (this is usually a test for quantity, not for water quality; your county health department may require a water quality test as well, but this test may be paid for outside of the settlement). Keep in mind that this inspection is for the benefit of the lender; you may want to request your own inspection to make sure the property is in good condition. Estimated costs: $175 to $350

Prepaid Interest Your first regular mortgage payment is usually due about 6 to 8 weeks after you settle (for example, if you settle in August, your first regular payment will be due on October 1; the October payment covers the cost of borrowing the money for the month of September). Interest costs, however, start as soon as you settle. The lender will calculate how much interest you owe for the part of the month in which you settle (for example, if you settle on August 16, you would owe interest for 15 days--August 16 through 31). Estimated cost: Depends on loan amount, interest rate, and the number of days that must be paid for (a $120,000 loan at 6% for 15 days, about $300; a $142,500 loan at 6% for 15 days, about $356).

Private Mortgage Insurance (Private MI) If your down payment is less than 20% of the value of the house, the lender will usually require mortgage insurance. The insurance policy covers the lender’s risk in the event that you do not make the loan payments. Typically, you will pay a monthly premium along with each month’s mortgage payment. Your private MI can be canceled at your request, in writing, when your reach 20% equity in your home, based on your original purchase price, if your mortgage payments are current and you have a good payment history. By federal law your private MI payments will automatically stop when you acquire 22% equity in your home, based on the original appraised value of the house, as long as your mortgage payments are current. Estimated cost: 0.5% to 1.5% of the loan amount to pre-pay for the first year Some lenders will pay for private MI--called lender’s private mortgage insurance (LPMI)--and in turn will charge a higher interest rate. Unlike private MI that you pay, there is no automatic cancellation once you acquire 22% equity. To eliminate the LPMI, you must refinance the loan, which in turn means carefully considering market interest rates and settlement costs at the time to see if refinancing would be an advantage, rather than keeping your current mortgage.

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FHA, VA, or RHS Fees The Federal Housing Administration (FHA) offers insured mortgages and the Veterans Administration (VA) and the Rural Housing Service (RHS) offer mortgage guarantees. If you are getting a mortgage insured by the FHA or guaranteed by the VA or the RHS, you will have to pay FHA mortgage insurance premiums or VA or RHS guarantee fees. As with Private MI, insurance premium payments will stop when you acquire 22% equity in your home. FHA fees are about 1.5% of the loan amount. VA guarantee fees range from 1.25% to 2% of the loan amount, depending on the size of your down payment (the higher your down payment, the lower the fee percentage). RHS fees are 1.75% of the loan amount.

Homeowner’s Insurance Your lender will require that you have a homeowner’s insurance policy (sometimes called hazard insurance) in effect at settlement. The policy protects against physical damage to the house by fire, wind, vandalism, and other causes. This insures that the lender’s investment will be secured even if the house is destroyed. If you are buying a condominium, the hazard insurance may be part of your monthly condominium fee; you may still want homeowner’s insurance for your furnishings and valuables. Estimated cost: $300 to $1,000 (depending on the value of the home and the amount of coverage; you can estimate the cost to be about $3.50 per $1,000 of the purchase price of the home).

Flood Determination Fee If your home is in a flood hazard area where federally subsidized flood insurance is available, lenders cannot make a mortgage loan for your home unless you buy flood insurance. Your lender may charge a fee to find out whether the home is in a flood hazard area. Estimated cost: $15 to $50 (this is not the cost for the flood insurance; flood insurance, if required, would be in addition to your homeowners insurance and may cost from $350 to $2,800 depending on location and property value)

Escrow (or Reserve) Funds Some lenders require that you set aside money in an escrow (reserve) account to pay for property taxes, homeowner’s insurance, and flood insurance (if you need it). Lenders use escrow funds to ensure that these items are paid on time to protect their interest in your home. With an escrow account, money is held by the lender or the lender’s agent, who then pays the taxes and insurance bills when they are due. At settlement, you may need to provide some payment into this account, depending on when payments will be due. For example, if you are buying your home in August and property taxes are due the following January, you will need


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to deposit funds into your escrow account at settlement so that you have enough to pay the taxes when they become due in January.

Survey Costs Lenders require a survey to confirm the location of buildings and improvements on the land. Some lenders require a complete (and more costly) survey to ensure that the house and other structures are legally where you and the seller say they are. Estimated cost: $150 to $400

Other Miscellaneous Settlement Costs Depending upon the location and type of property, and the extra services you or your lender request, you may also have to pay some of the following fees at settlement: •

•

•

•

•

Assumption fee. If you are assuming (or taking over) an existing mortgage, the lender may charge a fee. Estimated cost: Depends on the lender, but will range from several hundred dollars to 1% of the amount of the loan you are assuming Expenses prorated between the seller and the buyer. In your purchase contract, you may agree to split some costs with the seller. In addition to prorated property taxes, some of these expenses may involve large amounts. For example, annual condominium fees, homeowners’ association fees, water bills, and other lump-sum service charges may be split between you and the seller to cover your respective periods of ownership for the calendar year or tax period. Inspections. As a buyer, if you make your purchase offer contingent on the results of a home inspection--such as testing for structural damage, water quality, and radon gas emissions--you will have to pay for these inspections. Escrow account funds. In the purchase contract, you can request that the seller set up an escrow account to cover any costs for repairs, radon mitigation, house painting, or other items. For example, if you have not had a chance to test all the appliances (for instance, if you buy in the summer, you may not test the furnace), you may request an escrow account to cover repairs if they are needed in the future. The seller may agree to split the costs with you, in which case you would need these funds at settlement. Fees paid to find a lender. As a buyer, you may work with a mortgage broker or other third party to find a mortgage loan. For example, you may want to work with a broker to find a loan with nonstandard terms or conditions. Brokers arrange transactions rather than lending money directly; in other words, they find a lender for you. Brokers will generally contact several lenders regarding your application, but they are not obligated to find the best deal for you unless they have contracted with you to act as your agent. Estimated cost: Depends on agreement with the broker; can range from no fee to a percentage of the loan amount

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CHARGES FOR ESTABLISHING AND TRANSFERRING OWNERSHIP Title Search The goal of a title search is to assure you and your lender that the seller is the legal owner of the property and that there are no outstanding claims or liens against the property that you are buying. The title search may be performed by a lawyer, an escrow or title company, or other specialist. Public real estate records can be spread among several local government offices, including surveyors, county courts, tax assessors, and recorders of deeds. Liens, records of deaths, divorces, court judgments, and contests over wills--all of which can affect ownership rights--must also be examined. If real estate records are computerized, the title search can be completed fairly quickly. In some cases, however, the title search may involve visiting courthouses and examining other public records and files, which is more time-consuming.

Title Insurance Most lenders require a title insurance policy. This policy insures the lender against an error in the results of the title search. If a problem arises, the insurance covers the lender’s investment in your mortgage. The cost of the policy (a one-time premium) is usually based on the loan amount and is often paid by the buyer. However, you may negotiate with the seller to pay all or part of the premium. The title insurance required by the lender protects only the lender. To protect yourself against title problems, you may want to buy an “owner’s” title insurance policy. Normally the additional premium cost is based on the cost of the lender’s policy, but this premium can vary from area to area. Some advice on keeping title insurance costs low: If the house you are buying was owned by the seller for only a few years, check with the seller’s title company. You may be able to get a “re-issue rate,” because the time between title searches was short. As well, if you are refinancing, you may be able to get a “re-issue rate” on your title insurance. The premium is likely to be lower than the regular rate for a new policy. If no claims have been made against the title since the previous title search was done, the insurer may consider the property to be a lower insurance risk. Usually you will have to buy title insurance from a company acceptable to your lender. However, you can still shop around for the best premium rates (which can vary depending on how much competition there is in a market area). If you decide to buy an “owner’s title policy,” look for one with as few exclusions from coverage as possible. Exclusions are listed in each policy, and if a policy has many exclusions--that is, situations under which the insurer will not pay for your title problems--you may end up with little coverage. The estimated cost of title services and title insurance varies by state. For example, a lender’s policy on a $100,000 loan can range from $175 in one state to $900 in another. In some states, the price can even vary by county.


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Settlement Companies and others Conducting the Settlement Settlements are conducted by title insurance companies, real estate brokers, lending institutions, escrow companies, or attorneys. In most cases, the settlement agent is providing a service to the lender, and you may be required to pay for these services. You can also hire your own attorney to represent you at all stages of the transaction, including settlement. You may be involved in some of the closing activities and not in others, depending on local practices and on the professionals with whom you are working. In some regions, all the people involved in the sale--the buyer; the seller; the lender; the real estate agents; attorneys for the buyer, seller, and lender; and representatives from the title firm--may meet to sign forms and transfer funds. In other regions, settlement is handled by a title or escrow firm that collects all the funding, paperwork, and signatures and makes the necessary disbursements. The firm delivers the check to the seller and the house keys to you. Costs for settlement services vary widely, depending on the professional services involved. Regardless of the way settlement is handled in your region, shop around and ask for information on all services provided and all fees charged.

AMOUNTS PAID TO STATE AND LOCAL GOVERNMENTS In some parts of the country transfer and recording fees are low. In other parts of the country costs of transfer fees, recording fees, and property taxes collected by local and state governments may be as much as 1.25% of the loan amount. Some of these fees, such as the recording fee and transfer fee, are one-time fees. Although there is no way to avoid paying these fees and taxes, you may be able to negotiate with the seller to pay some of these costs. But remember, you must include these terms as part of the purchase offer for the property. Amounts for property taxes may go into an escrow account. The amount you will need depends on when property taxes are due and the timing of the settlement. The lender should be able to give you an approximation of these costs at the time you apply for the mortgage.

“ALL-IN-ONE” PRICING OF SETTLEMENT COSTS Some lenders have bundled most of their settlement costs into a single price. Generally, they combine the following fees: • • • • • • • • •

Application Origination underwriting and processing points pest inspection appraisal credit reports lender’s attorney flood certification

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title search and title insurance recording and fees for other tax services

This all-in-one price, however, does not include all of the fees needed at settlement. You will also need funds for the following: • • • • • •

prepaid interest (based on the day of the month you settle) mortgage and transfer taxes (determined by your state or local taxing agency) private mortgage insurance (if needed) homeowners (hazard) insurance flood insurance (if needed) and reserve (or escrow) funds for property taxes and homeowners insurance.

ESTIMATES OF SETTLEMENT COSTS At various points in your loan application process, you are entitled to get estimates of the costs and fees associated with getting a mortgage and going through settlement.

The “Good Faith Estimate” With such a long list of potential charges at settlement, it is important to know what to expect. The Real Estate Settlement Procedures Act (RESPA) requires your mortgage lender to give you a “good faith estimate” of all your closing costs within 3 business days of submitting your application for a loan, whether you are purchasing or refinancing the home. This is a good faith estimate, but the actual expenses at closing may be somewhat different. If you are purchasing the home, you will also get an information booklet, Buying Your Home: Settlement Costs and Helpful Information.

Truth in Lending Information For home purchases, the lender is required, under the Truth in Lending Act, to provide a statement containing “good faith estimates” of the costs of the loan within 3 business days of submitting your application. This estimate will include your total finance charge and the annual percentage rate (APR). The APR expresses the cost of your loan as an annual rate. This rate is likely to be higher than the stated contract interest rate on your mortgage because it takes into account discount points, mortgage insurance, and certain other fees that add to the cost of your loan. When refinancing your mortgage, you will receive the truth in lending disclosures before you settle.


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The “HUD-1” Statement When you purchase a home or refinance your mortgage, the Real Estate Settlement Procedures Act also requires the lender to give you a copy of the HUD-1 or HUD-1A Settlement Statement 1 day before you go to settlement, if you request it. This final statement of settlement costs will show all the fees and charges you will be expected to pay at settlement.

Fees Paid Outside of Settlement Some fees may be listed on the HUD-1 and marked as “Paid Outside of Closing” (or “POC”). You will pay some of these fees, such as for credit reports and appraisals, before settlement. Other fees, such as those to a mortgage broker, you will pay at settlement.

Sample Settlement Costs Because costs may vary from one area to another and from one lender to another, the following example is an estimate only. This example is based on a $150,000 home with a 5% or a 20% down payment. Excluding reserves for property taxes and down payment, settlement costs for the 5% down payment loan vary between $4,690 and $13,940; settlement costs for the 20% down payment loan vary between $4,285 and $12,060. Your costs may be higher or lower than the examples below.

Item

Typical range

Estimate for $150,000 house

(percent except

(in dollars except as noted)

as noted) 5% down

20% down

payment

payment

Down Payment

--

7,500

30,000

Mortgage amount

--

142,500

120,000

Items payable in connection with the loan ("800" series on HUD-1 form) Application fee (may include credit report fees)

--

75 to 300

75 to 300

Loan origination fee (may also include underwriting fees, administrative fees, lender's attourney fees, notary fees, and so on)

1 to 1.5 of loan

1,452 to 2,137

1,200 to 1,800

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Item

Estimate for $150,000 house (in dollars except as noted) 5% down payment

20% down payment

0 to 3

0 to 4,500

0 to 3,600

Appraisal fee

--

350 to 700

350 to 700

Lender's inspection fee

--

175 to 350

175 to 350

$300 to $1,000

--

--

1

1

1

Points

Assumption fee (if applicable) Broker fee (if applicable)

Items payable in advance ("900" series on HUD-1 form) Prepaid interest Homeowner's insurance (hazard insurance) Flood determination (flood insurance, if needed, is additional)

2

350

295

$500 to $700

5253

5253

--

15 to 50

15 to 50

Reserves (escrow) deposited with lender ("1000" series on HUD-1 form) Homeowners insurance

--

250 to 350

250 to 350

Private MI

--

125 to 250

--

Property taxes

4

--

--

Title charges ("1100" series on HUD-1 form) Title search and lender's title insurance

--

700 to 900

700 to 900

Owner's title insurance

--

--

--

Government recording and tarnsfer fees ("1200" series on HUD-1 form) Recording fees for deed, mortgage, city/county taxes, and state taxes

0 to 1.5 of loan

0 to 2,137

0 to 1,800

150 to 300

150 to 300

Additional charges ("1300" series on HUD-1 form) Survey

--

A Consumer's Guide to Mortgage Settlement Costs Typical range (percent except as noted)

Item

149

Estimate for $150,000 house (in dollars except as noted) 5% down payment

20% down payment

Additional charges ("1300" series on HUD-1 form) Survey

--

150 to 300

150 to 300

Pest inspection

--

50 to 90

50 to 90

Settlement fees

--

500 to 1,000

500 to 1,000

Other amounts due from borrower ("100" series on HUD-1 form) Personal property; assessments; prorated condominium fees; homeowners' association fees; prorated taxes; fuel, oil, and propane; and so forth

5

5

5

Note: "--" = not applicable

1. May be a dollar amount or a percentage. 2. Depends on interest rate, the day of the month that settlement takes place, and the amount borrowed. The example assumes that there are 15 days left in the month and that the interest rate on the loan amount is 6%. 3. These are the fees if using $3.50 per $1,000 of purchase price as an estimate. 4. Varies greatly and depends on local tax rates. 5. These items vary depending on your agreement with the seller.

SETTLEMENT COST TIPS • • •

Think about settlement fees before you submit your purchase offer. Remember many fees and charges are negotiable. Use the Settlement Costs Worksheet and compare costs by shopping among several lenders and brokers.

This information has been prepared to help you make the important decisions involved in buying and financing your home. However it should not be viewed as a replacement for professional advice. Talk with attorneys, mortgage lenders, real estate agents, and other advisers for information about lending practices, mortgage instruments, and your own interests before you commit to a specific loan.


Chapter 7

A CONSUMER'S GUIDE TO MORTGAGE LOCK-INS Federal Reserve Board WHAT IS A LOCK-IN? A lock-in, also called a rate-lock or rate commitment, is a lender’s promise to hold a certain interest rate and a certain number of points for you, usually for a specified period of time, while your loan application is processed. (Points are additional charges imposed by the lender that are usually prepaid by the consumer at settlement but can sometimes be financed by adding them to the mortgage amount. One point equals one percent of the loan amount.) Depending upon the lender, you may be able to lock in the interest rate and number of points that you will be charged when you file your application, during processing of the loan, when the loan is approved, or later. A lock-in that is given when you apply for a loan may be useful because it’s likely to take your lender several weeks or longer to prepare, document, and evaluate your loan application. During that time, the cost of mortgages may change. But if your interest rate and points are locked in, you should be protected against increases while your application is processed. This protection could affect whether you can afford the mortgage. However, a locked-in rate could also prevent you from taking advantage of price decreases, unless your lender is willing to lock in a lower rate that becomes available during this period. It is important to recognize that a lock-in is not the same as a loan commitment, although some loan commitments may contain a lock-in. A loan commitment is the lender’s promise to make you a loan in a specific amount at some future time. Generally, you will receive the lender’s commitment only after your loan application has been approved. This commitment usually will state the loan terms that have been approved (including loan amount), how long the commitment is valid, and the lender’s conditions for making the loan such as receipt of a satisfactory title insurance policy protecting the lender.

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Will Your Lock-in Be in Writing? Some lenders have preprinted forms that set out the exact terms of the lock-in agreement. Others may only make an oral lock-in promise on the telephone or at the time of application. Oral agreements can be very difficult to prove in the event of a dispute. Some lenders' lock-in forms may contain crucial information that is difficult to understand or that is in fine print. For example, some lock-in agreements may become void through some unrelated action such as a change in the maximum rate for Veterans Administration guaranteed loans. Thus, it is wise to obtain a blank copy of a lender’s lock-in form to read carefully before you apply for a loan. If possible, show the lock-in form to a lawyer or real estate professional. It is wise to obtain written, rather than verbal, lock-in agreements to make sure that you fully understand how your lender’s lock-ins and loan commitments work and to have a tangible record of your arrangements with the lender. This record may be useful in the event of a dispute.

Will You Be Charged for a Lock-in? Lenders may charge you a fee for locking in the rate of interest and number of points for your mortgage. Some lenders may charge you a fee up-front, and may not refund it if you withdraw your application, if your credit is denied, or if you do not close the loan. Others might charge the fee at settlement. The fee might be a flat fee, a percentage of the mortgage amount, or a fraction of a percentage point added to the rate you lock in. The amount of the fee and how it is charged will vary among lenders and may depend on the length of the lockin period.

What Options Are Available for Setting the Mortgage Terms? Lenders may offer different options in establishing the interest rate and points that you will be charged, such as: •

•

Locked-In Interest Rate--Locked-In Points. Under this option, the lender lets you lock in both the interest rate and points quoted to you. This option may be considered to be a true lock-in because your mortgage terms should not increase above the interest rate and points that you’ve agreed upon even if market conditions change. Locked-In Interest Rate--Floating Points. Under this option, the lender lets you lock in the interest rate, while permitting or requiring the points to rise and fall (float) with changes in market conditions. If market interest rates drop during the lock-in period, the points may also fall. If they rise, the points may increase. Even if you float your points, your lender may allow you to lock-in the points at some time before settlement at whatever level is then current. (For instance, say you’ve locked in a 10½ percent interest rate, but not the 3 points that went with that rate. A month later, the market interest rate remains the same, but the points the lender charges for

A Consumer's Guide to Mortgage Lock-Ins

•

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that rate have dropped to 2½. With your lender’s agreement, you could then lock in the lower 2½ points.) If you float your points and market interest rates increase by the time of settlement, the lender may charge a greater number of points for a loan at the rate you’ve locked in. In this case, the benefit you might have had by locking in your rate may be lost because you’ll have to pay more in up-front costs. Floating Interest Rate--Floating Points. Under this option, the lender lets you lock in the interest rate and the points at some time after application but before settlement. If you think that rates will remain level or even go down, you may want to wait on locking in a particular rate and points. If rates go up, you should expect to be charged the higher rate. Because practices vary, you may want to ask your lender whether there are other options available to you.

How Long Are Lock-Ins Valid? Usually the lender will promise to hold a certain interest rate and number of points for a given number of days, and to get these terms you must settle on the loan within that time period. Lock-ins of 30 to 60 days are common. But some lenders may offer a lock-in for only a short period of time (for example, 7 days after your loan is approved) while some others might offer longer lock-ins (up to 120 days). Lenders that charge a lock-in fee may charge a higher fee for the longer lock-in period. Usually, the longer the period, the greater the fee. The lock-in period should be long enough to allow for settlement, and any other contingencies imposed by the lender, before the lock-in expires. Before deciding on the length of the lock-in to ask for, you should find out the average time for processing loans in your area and ask your lender to estimate (in writing, if possible) the time needed to process your loan. You’ll also want to take into account any factors that might delay your settlement. These may include delays that you can anticipate in providing materials about your financial condition and, in case you are purchasing a new house, unanticipated construction delays. Finally, ask for a lock-in with as few contingencies as possible.

What Happens if the Lock-in Period Expires? If you don’t settle within the lock-in period, you might lose the interest rate and the number of points you had locked in. This could happen if there are delays in processing whether they are caused by you, others involved in the settlement process, or the lender. For example, your loan approval could be delayed if the lender has to wait for any documents from you or from others such as employers, appraisers, termite inspectors, builders, and individuals selling the home. On occasion, lenders are themselves the cause of processing delays, particularly when loan demand is heavy. This sometimes happens when interest rates fall suddenly. If your lock-in expires, most lenders will offer the loan based on the prevailing interest rate and points. If market conditions have caused interest rates to rise, most lenders will charge you more for your loan. One reason why some lenders may be unable to offer the lock-in rate after the period expires is that they can no longer sell the loan to investors at the

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lock-in rate. (When lenders lock in loan terms for borrowers, they often have an agreement with investors to buy these loans based on the lock-in terms. That agreement may expire around the same time that the lock-in expires and the lender may be unable to afford to offer the same terms if market rates have increased.) Lenders who intend to keep the loans they make may have more flexibility in those cases where settlement is not reached before the lock-in expires.

How Can You Speed up the Approval of the Loan? While the lender has the greatest role in how fast your loan application is processed, there are certain things you can do to speed up its approval. Try to find out what documentation the lender will require from you. Much of the information required by your lender can be brought with you when you apply for a loan. This may help to get your application moving more quickly through the process. When you first meet with your lender, be sure to bring the following documents: • •

• • • • •

The purchase contract for the house (if you don’t have the contract, check with your real estate agent or the seller). Your bank account numbers, the address of your bank branch and your latest bank statement, plus pay stubs, W-2 forms, or other proof of employment and salary, to help the lender check your finances. If you are self-employed, balance sheets, tax returns for 2-3 previous years, and other information about your business. Information about debts, including loan and credit card account numbers and the names and addresses of your creditors. Evidence of your mortgage or rental payments, such as cancelled checks. Certificate of Eligibility from the Veterans Administration if you want a VAguaranteed loan. Your lender may be able to help you obtain this. Be sure to respond promptly to your lender’s requests for information while your loan is being processed. It is also a good idea to call the lender and real estate agent from time to time. By calling occasionally, you can check on the status of your application, and offer to help contact others such as employers who may need to provide documents and other information for your loan. It is also helpful to keep notes on your contacts with the lender so that you will have a record of your conversations.

ASK ABOUT LOCK-INS When you’re ready to settle on your loan, you’ll want to get the loan terms that you’ve locked in. To increase that likelihood, it is important to learn as much as you can about what the lender is promising you before you apply for a loan. Ask for the following information when you shop for a loan:

A Consumer's Guide to Mortgage Lock-Ins

155

Lock-ins and Fees • • • • • •

Does the lender offer a lock-in of the interest rate and points? When will the lender let you lock in the interest rate and points? When you apply? When the loan is approved? Will the lock-in be in writing? If the lock-in is not in writing, you will have no record of the lender’s agreement with you in case of a dispute. Does the lender charge a fee to lock in your interest rate? Does the fee increase for longer lock-in periods? If so, how much? If you have locked in a rate, and the lender’s rate drops, can you lock in at the lower rate? Does the lender charge you an additional fee to lock in the lower rate? Can you float your interest rate and points for now, and lock them in later?

Loan Processing Time • • •

How long does the lender expect to take to process your loan? What has been the lender’s average time for processing loans recently? Has the lender’s loan volume increased? Heavy volume might increase the lender’s average processing time.

Expiration of Lock-ins • • •

What rate will be charged if the lock-in expires before settlement-the rate in effect when the lock-in expires? If you don’t settle within the lock-in period, will the lender refund some or all of your application or lock-in fees if you decide to cancel the loan application? If your lock-in expires and you want to get another lock-in at the rate in effect at the time of the expiration, will the lender charge an additional fee for the second lock-in?

COMPLAINTS ABOUT LOCK-INS Knowing what to look for puts you in a better position to decide whether, when, and how long to lock in mortgage terms. Also, by helping to keep the loan process moving, you can lessen the chance that your lock-in will run out before settlement. But what if your lock-in does lapse? If you believe that the lapse was due to delays caused by the lender or someone else involved in the loan process, you should try first to reach a mutually satisfactory agreement with the lender. If that effort fails, consider writing to the appropriate state or federal regulatory agency. Some lender actions, such as offering lock-in terms which are impossible to fulfill, failing to process your loan diligently, or causing your lock-in to expire are improper-and may even be illegal. In addition, because you may have contractual rights under your lock-in or loan

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commitment, you may want to consult with an attorney. Be aware, though, that complaints may not be resolved as quickly as may be necessary for a home purchase. Depending upon their authority under applicable state or federal law, regulatory agencies may either attempt to help you resolve your complaint directly or record your complaint and recommend other action.

GLOSSARY # 203(b): FHA program which provides mortgage insurance to protect lenders from default; used to finance the purchase of new or existing one- to four family housing; characterized by low down payment, flexible qualifying guidelines, limited fees, and a limit on maximum loan amount. 203(k): this FHA mortgage insurance program enables homebuyers to finance both the purchase of a house and the cost of its rehabilitation through a single mortgage loan.

A Amenity: a feature of the home or property that serves as a benefit to the buyer but that is not necessary to its use; may be natural (like location, Woods, water) or man-made (like a swimming pool or garden). Amortization: repayment of a mortgage loan through monthly installments of principal and interest; the monthly payment amount is based on a schedule that will allow you to own your home at the end of a specific time period (for example, 15 or 30 years) Annual Percentage Rate (APR): calculated by using a standard formula, the APR shows the cost of a loan; expressed as a yearly interest rate, it includes the interest, points, mortgage insurance, and other fees associated with the loan. Application: the first step in the official loan approval process; this form is used to record important information about the potential borrower necessary to the underwriting process. Appraisal: a document that gives an estimate of a property's fair market value; an appraisal is generally required by a lender before loan approval to ensure that the mortgage loan amount is not more than the value of the property. Appraiser: a qualified individual who uses his or her experience and knowledge to prepare the appraisal estimate. ARM: Adjustable Rate Mortgage; a mortgage loan subject to changes in interest rates; when rates change, ARM monthly payments increase or decrease at intervals determined by the lender; the Change in monthly -payment amount, however, is usually subject to a Cap. Assessor: a government official who is responsible for determining the value of a property for the purpose of taxation.

158

Glosary

Assumable mortgage: a mortgage that can be transferred from a seller to a buyer; once the loan is assumed by the buyer the seller is no longer responsible for repaying it; there may be a fee and/or a credit package involved in the transfer of an assumable mortgage.

B Balloon Mortgage: a mortgage that typically offers low rates for an initial period of time (usually 5, 7, or 10) years; after that time period elapses, the balance is due or is refinanced by the borrower. Bankruptcy: a federal law Whereby a person's assets are turned over to a trustee and used to pay off outstanding debts; this usually occurs when someone owes more than they have the ability to repay. Borrower: a person who has been approved to receive a loan and is then obligated to repay it and any additional fees according to the loan terms. Building code: based on agreed upon safety standards within a specific area, a building code is a regulation that determines the design, construction, and materials used in building. Budget: a detailed record of all income earned and spent during a specific period of time.

C Cap: a limit, such as that placed on an adjustable rate mortgage, on how much a monthly payment or interest rate can increase or decrease. Cash reserves: a cash amount sometimes required to be held in reserve in addition to the down payment and closing costs; the amount is determined by the lender. Certificate of title: a document provided by a qualified source (such as a title company) that shows the property legally belongs to the current owner; before the title is transferred at closing, it should be clear and free of all liens or other claims. Closing: also known as settlement, this is the time at which the property is formally sold and transferred from the seller to the buyer; it is at this time that the borrower takes on the loan obligation, pays all closing costs, and receives title from the seller. Closing costs: customary costs above and beyond the sale price of the property that must be paid to cover the transfer of ownership at closing; these costs generally vary by geographic location and are typically detailed to the borrower after submission of a loan application. Commission: an amount, usually a percentage of the property sales price, that is collected by a real estate professional as a fee for negotiating the transaction.. Condominium: a form of ownership in which individuals purchase and own a unit of housing in a multi-unit complex; the owner also shares financial responsibility for common areas. Conventional loan: a private sector loan, one that is not guaranteed or insured by the U.S. government.

Glossary

159

Cooperative (Co-op): residents purchase stock in a cooperative corporation that owns a structure; each stockholder is then entitled to live in a specific unit of the structure and is responsible for paying a portion of the loan. Credit history: history of an individual's debt payment; lenders use this information to gauge a potential borrower's ability to repay a loan. Credit report: a record that lists all past and present debts and the timeliness of their repayment; it documents an individual's credit history. Credit bureau score: a number representing the possibility a borrower may default; it is based upon credit history and is used to determine ability to qualify for a mortgage loan.

D Debt-to-income ratio: a comparison of gross income to housing and non-housing expenses; With the FHA, the-monthly mortgage payment should be no more than 29% of monthly gross income (before taxes) and the mortgage payment combined with non-housing debts should not exceed 41% of income. Deed: the document that transfers ownership of a property. Deed-in-lieu: to avoid foreclosure ("in lieu" of foreclosure), a deed is given to the lender to fulfill the obligation to repay the debt; this process doesn't allow the borrower to remain in the house but helps avoid the costs, time, and effort associated with foreclosure. Default: the inability to pay monthly mortgage payments in a timely manner or to otherwise meet the mortgage terms. Delinquency: failure of a borrower to make timely mortgage payments under a loan agreement. Discount point: normally paid at closing and generally calculated to be equivalent to 1% of the total loan amount, discount points are paid to reduce the interest rate on a loan. Down payment: the portion of a home's purchase price that is paid in cash and is not part of the mortgage loan.

E Earnest money: money put down by a potential buyer to show that he or she is serious about purchasing the home; it becomes part of the down payment if the offer is accepted, is returned if the offer is rejected, or is forfeited if the buyer pulls out of the deal. EEM: Energy Efficient Mortgage; an FHA program that helps homebuyers save money on utility bills by enabling them to finance the cost of adding energy efficiency features to a new or existing home as part of the home purchase Equity: an owner's financial interest in a property; calculated by subtracting the amount still owed on the mortgage loon(s)from the fair market value of the property. Escrow account: a separate account into which the lender puts a portion of each monthly mortgage payment; an escrow account provides the funds needed for such expenses as property taxes, homeowners insurance, mortgage insurance, etc.

160

Glosary

F Fair Housing Act: a law that prohibits discrimination in all facets of the homebuying process on the basis of race, color, national origin, religion, sex, familial status, or disability. Fair market value: the hypothetical price that a willing buyer and seller will agree upon when they are acting freely, carefully, and with complete knowledge of the situation. Fannie Mae: Federal National Mortgage Association (FNMA); a federally-chartered enterprise owned by private stockholders that purchases residential mortgages and converts them into securities for sale to investors; by purchasing mortgages, Fannie Mae supplies funds that lenders may loan to potential homebuyers. FHA: Federal Housing Administration; established in 1934 to advance homeownership opportunities for all Americans; assists homebuyers by providing mortgage insurance to lenders to cover most losses that may occur when a borrower defaults; this encourages lenders to make loans to borrowers who might not qualify for conventional mortgages. Fixed-rate mortgage: a mortgage with payments that remain the same throughout the life of the loan because the interest rate and other terms are fixed and do not change. Flood insurance: insurance that protects homeowners against losses from a flood; if a home is located in a flood plain, the lender will require flood insurance before approving a loan. Foreclosure: a legal process in which mortgaged property is sold to pay the loan of the defaulting borrower. Freddie Mac: Federal Home Loan Mortgage Corporation (FHLM); a federally-chartered corporation that purchases residential mortgages, securitizes them, and sells them to investors; this provides lenders With funds for new homebuyers.

G Ginnie Mae: Government National Mortgage Association (GNMA); a government-owned corporation overseen by the U.S. Department of Housing and Urban Development, Ginnie Mae pools FHA-insured and VA-guaranteed loans to back securities for private investment; as With Fannie Mae and Freddie Mac, the investment income provides funding that may then be lent to eligible borrowers by lenders. Good faith estimate: an estimate of all closing fees including pre-paid and escrow items as well as lender charges; must be given to the borrower within three days after submission of a loan application.

H HELP: Homebuyer Education Learning Program; an educational program from the FHA that counsels people about the homebuying process; HELP covers topics like budgeting, finding a home, getting a loan, and home maintenance; in most cases, completion of the program may entitle the homebuyer to a reduced initial FHA mortgage insurance premium-from 2.25% to 1.75% of the home purchase price.

Glossary

161

Home inspection: an examination of the structure and mechanical systems to determine a home's safety; makes the potential homebuyer aware of any repairs that may be needed. Home warranty: offers protection for mechanical systems and attached appliances against unexpected repairs not covered by homeowner's insurance; ,overage extends over a specific time period and does not cover the home's structure. Homeowner's insurance: an insurance policy that combines protection against damage to a dwelling and Is contents with protection against claims of negligence )r inappropriate action that result in someone's injury or )property damage. Housing counseling agency: provides counseling and assistance to individuals on a variety of issues, including loan default, fair housing, and homebuying. HUD: the U.S. Department of Housing and Urban Development; established in 1965, HUD works to create a decent home and suitable living environment for all Americans; it does this by addressing housing needs, improving and developing American communities, and enforcing fair housing laws. HUD1 Statement: also known as the "settlement sheet," it itemizes all closing costs; must be given to the borrower at or before closing. HVAC: Heating, Ventilation and Air Conditioning; a home's heating and cooling system.

I Index: a measurement used by lenders to determine changes to the Interest rate charged on an adjustable rate mortgage. Inflation: the number of dollars in circulation exceeds the amount of goods and services available for purchase; inflation results in a decrease in the dollar's value. Interest: a fee charged for the use of money . Interest rate: the amount of interest charged on a monthly loan payment; usually expressed as a percentage. Insurance: protection against a specific loss over a period of time that is secured by the payment of a regularly scheduled premium.

J Judgment: a legal decision; when requiring debt repayment, a judgment may include a property lien that secures the creditor's claim by providing a collateral source.

L Lease purchase: assists low- to moderate-income homebuyers in purchasing a home by allowing them to lease a home with an option to buy; the rent payment is made up of the monthly rental payment plus an additional amount that is credited to an account for use as a down payment. Lien: a legal claim against property that must be satisfied When the property is sold

162

Glosary

Loan: money borrowed that is usually repaid with interest. Loan fraud: purposely giving incorrect information on a loan application in order to better qualify for a loan; may result in civil liability or criminal penalties. Loan-to-value (LTV) ratio: a percentage calculated by dividing the amount borrowed by the price or appraised value of the home to be purchased; the higher the LTV, the less cash a borrower is required to pay as down payment. Lock-in: since interest rates can change frequently, many lenders offer an interest rate lock-in that guarantees a specific interest rate if the loan is closed within a specific time. Loss mitigation: a process to avoid foreclosure; the lender tries to help a borrower who has been unable to make loan payments and is in danger of defaulting on his or her loan

M Margin: an amount the lender adds to an index to determine the interest rate on an adjustable rate mortgage. Mortgage: a lien on the property that secures the Promise to repay a loan. Mortgage banker: a company that originates loans and resells them to secondary mortgage lenders like :Fannie Mae or Freddie Mac. Mortgage broker: a firm that originates and processes loans for a number of lenders. Mortgage insurance: a policy that protects lenders against some or most of the losses that can occur when a borrower defaults on a mortgage loan; mortgage insurance is required primarily for borrowers with a down payment of less than 20% of the home's purchase price. Mortgage insurance premium (MIP): a monthly payment -usually part of the mortgage payment - paid by a borrower for mortgage insurance. Mortgage Modification: a loss mitigation option that allows a borrower to refinance and/or extend the term of the mortgage loan and thus reduce the monthly payments.

O Offer: indication by a potential buyer of a willingness to purchase a home at a specific price; generally put forth in writing. Origination: the process of preparing, submitting, and evaluating a loan application; generally includes a credit check, verification of employment, and a property appraisal. Origination fee: the charge for originating a loan; is usually calculated in the form of points and paid at closing.

P Partial Claim: a loss mitigation option offered by the FHA that allows a borrower, with help from a lender, to get an interest-free loan from HUD to bring their mortgage payments up to date.

Glossary

163

PITI: Principal, Interest, Taxes, and Insurance - the four elements of a monthly mortgage payment; payments of principal and interest go directly towards repaying the loan while the portion that covers taxes and insurance (homeowner's and mortgage, if applicable) goes into an escrow account to cover the fees when they are due. PMI: Private Mortgage Insurance; privately-owned companies that offer standard and special affordable mortgage insurance programs for qualified borrowers with down payments of less than 20% of a purchase price. Pre-approve: lender commits to lend to a potential borrower; commitment remains as long as the borrower still meets the qualification requirements at the time of purchase. Pre-foreclosure sale: allows a defaulting borrower to sell the mortgaged property to satisfy the loan and avoid foreclosure. Pre-qualify: a lender informally determines the maximum amount an individual is eligible to borrow. Premium: an amount paid on a regular schedule by a policyholder that maintains insurance coverage. Prepayment: payment of the mortgage loan before the scheduled due date; may be Subject to a prepayment penalty. Principal: the amount borrowed from a lender; doesn't include interest or additional fees.

R Radon: a radioactive gas found in some homes that, if occurring in strong enough concentrations, can cause health problems. Real estate agent: an individual who is licensed to negotiate and arrange real estate sales; works for a real estate broker. REALTOR: a real estate agent or broker who is a member of the NATIONAL ASSOCIATION OF REALTORS, and its local and state associations. Refinancing: paying off one loan by obtaining another; refinancing is generally done to secure better loan terms (like a lower interest rate). Rehabilitation mortgage: a mortgage that covers the costs of rehabilitating (repairing or Improving) a property; some rehabilitation mortgages - like the FHA's 203(k) - allow a borrower to roll the costs of rehabilitation and home purchase into one mortgage loan. RESPA: Real Estate Settlement Procedures Act; a law protecting consumers from abuses during the residential real estate purchase and loan process by requiring lenders to disclose all settlement costs, practices, and relationships

S Settlement: another name for closing . Special Forbearance: a loss mitigation option where the lender arranges a revised repayment plan for the borrower that may include a temporary reduction or suspension of monthly loan payments.

164

Glosary

Subordinate: to place in a rank of lesser importance or to make one claim secondary to another. Survey: a property diagram that indicates legal boundaries, easements, encroachments, rights of way, improvement locations, etc. Sweat equity: using labor to build or improve a property as part of the down payment

T Title 1: an FHA-insured loan that allows a borrower to make non-luxury improvements (like renovations or repairs) to their home; Title I loans less than $7,500 don't require a property lien. Title insurance: insurance that protects the lender against any claims that arise from arguments about ownership of the property; also available for homebuyers. Title search: a check of public records to be sure that the seller is the recognized owner of the real estate and that there are no unsettled liens or other claims against the property. Truth-in-Lending: a federal law obligating a lender to give full written disclosure of all fees, terms, and conditions associated with the loan initial period and then adjusts to another rate that lasts for the term of the loan.

U Underwriting: the process of analyzing a loan application to determine the amount of risk involved in making the loan; it includes a review of the potential borrower's credit history and a judgment of the property value.

V VA: Department of Veterans Affairs: a federal agency which guarantees loans made to veterans; similar to mortgage insurance, a loan guarantee protects lenders against loss that may result from a borrower default.

INDEX A ABA, 2, 4, 6, 9, 20, 24, 25, 33, 36, 41, 46, 47 abatement, 76 academics, 50 access, 7, 8, 13, 19, 33, 37, 46, 73, 84 accessibility, 8 accidents, 68 accountability, 25 accuracy, 82 adjustment, 8, 23, 121, 123, 124, 125, 126, 129, 132, 135, 136, 137 advertisements, 133 advertising, 21, 44, 45, 118 affiliated business arrangement, 2 age, 50, 52, 54, 57, 58, 61, 62, 64, 65, 66, 70, 76, 83 agent, 1, 2, 5, 7, 8, 9, 11, 12, 14, 15, 17, 19, 20, 22, 24, 25, 28, 29, 31, 32, 33, 36, 38, 39, 40, 43, 45, 46, 47, 48, 72, 73, 74, 75, 76, 77, 82, 84, 86, 88, 91, 120, 139, 142, 143, 145, 154, 163 aging, 61, 68 Alaska, 22, 47 ALTA, 2, 4, 14, 43, 45, 48 alternative, 30, 38, 42, 91, 95, 96, 98, 99, 100, 101, 102, 104, 105, 109, 111, 113, 114 alternatives, 6, 70, 99 ambiguity, 39 American Land Title Association, 2, 4, 43 amortization, 95, 96, 98, 99, 100, 113, 118, 120, 121, 126, 128, 129, 130, 131, 133, 135, 136 annual rate, 55, 136, 146 appendix, 42 appraisals, 147 appraised value, 56, 78, 141, 162 Arizona, 58 armed forces, 93 asbestos, 76 assessment, 34

assets, 24, 51, 64, 85, 158 assignment, 56 auditing, 4, 44 authority, 1, 2, 6, 7, 9, 30, 34, 36, 37, 38, 39, 40, 41, 65, 82, 156 automation, 88 availability, 49, 55, 67, 109 awareness, 42

B balance sheet, 44, 154 banking, 4, 41, 43, 96, 98, 99, 109 bankruptcy, 89 banks, 21, 46, 95, 97, 120 behavior, 43 bonding, 32 bonds, 102 borrowers, 7, 40, 49, 50, 52, 53, 55, 56, 57, 60, 61, 62, 64, 65, 66, 67, 78, 80, 84, 85, 87, 91, 92, 95, 96, 98, 99, 100, 101, 102, 103, 105, 108, 109, 110, 111, 113, 114, 118, 153, 160, 162, 163 borrowing, 51, 61, 109, 136, 141 business costs, 16 business cycle, 9 buyer, 6, 7, 8, 14, 17, 39, 40, 41, 51, 77, 90, 91, 97, 98, 100, 103, 105, 111, 139, 143, 144, 145, 157, 158, 159, 160, 162

C California, 3, 9, 11, 14, 15, 17, 18, 21, 26, 27, 29, 31, 32, 33, 34, 38, 42, 43, 45, 46, 47, 48, 53, 55, 58, 68, 70, 96, 111 candidates, 61 cash flow, 101 causation, 113

166

Index

Census, 69 certificate, 57 certification, 145 children, 51, 64, 76, 83, 101 circulation, 161 classes, 21 clients, 45 codes, 77 collateral, 54, 56, 64, 65, 97, 99, 102, 114, 161 commerce, 73 communication, 36, 48 community, 73, 88 compensation, 2, 20, 22, 24, 36, 88, 137 competency, 34 competition, 1, 2, 3, 5, 17, 19, 20, 22, 24, 25, 29, 31, 37, 38, 39, 42, 144 competitor, 30, 47 complexity, 19 compliance, 33 components, 16, 33 composition, 103 concentration, 95, 96, 100, 111, 113 conflict, 24 conflict of interest, 24 Congress, 1, 6, 40, 41, 47, 66, 67, 109 Connecticut, 58 construction, 75, 153, 158 consumer protection, 7, 42, 48, 98, 99 consumers, 1, 2, 3, 4, 5, 6, 9, 14, 16, 17, 18, 19, 20, 21, 22, 23, 25, 26, 28, 29, 30, 31, 35, 36, 37, 38, 39, 40, 41, 43, 44, 47, 55, 62, 87, 95, 96, 99, 100, 109, 113, 114, 163 control, 10, 25 conversion, 49, 50, 51, 56, 57, 64, 129, 132, 135 cooling, 161 correlation, 113, 115 cost saving, 25, 38 costs, 1, 2, 3, 5, 6, 8, 10, 12, 15, 16, 17, 25, 26, 28, 29, 30, 31, 32, 33, 38, 39, 40, 41, 42, 43, 44, 47, 51, 58, 61, 62, 67, 71, 72, 77, 78, 79, 80, 84, 86, 88, 89, 90, 95, 97, 102, 104, 109, 111, 131, 133, 137, 139, 140, 141, 143, 144, 145, 146, 147, 149, 153, 158, 159, 161, 163 counsel, 37 counseling, 56, 57, 84, 90, 91, 93, 161 couples, 63 coverage, 7, 8, 12, 29, 30, 62, 77, 142, 144, 163 covering, 113, 131 credit, 55, 56, 57, 58, 59, 60, 61, 63, 70, 72, 80, 82, 83, 84, 85, 87, 88, 89, 90, 97, 100, 104, 105, 120, 123, 133, 134, 139, 140, 145, 147, 152, 154, 158, 159, 162, 164 credit rating, 139

creditors, 154 current limit, 59, 87 customers, 19, 20, 29, 32, 62, 84

D daily living, 67 danger, 162 data collection, 33 database, 73, 84 death, 52, 56, 67 deaths, 144 debt, 49, 50, 54, 57, 61, 62, 64, 67, 70, 72, 78, 80, 83, 88, 90, 98, 102, 131, 159, 161 debts, 71, 72, 81, 82, 85, 89, 120, 154, 158, 159 decisions, vii, 19, 149 deduction, 140 defects, 7, 25 delinquency, 96 delivery, 40 demand, 9, 153 demographics, 62 Department of Commerce, 47 Department of Health and Human Services, 69 Department of Housing and Urban Development, 2, 3, 4, 43, 47, 55, 69, 73, 86, 133, 160, 161 Department of Justice, 47 deposits, 12 desire, 28 disability, 73, 84, 160 disaster, 93 disbursement, 14 disclosure, 24, 34, 38, 96, 99, 164 discount rate, 109, 129 discrimination, 73, 160 displacement, 56 disposition, 36 distribution, 42, 114 District of Columbia, 14, 16, 45, 48, 58 division, 47 divorce, 7 doors, 75 draft, 6, 41 duration, 98

E earnings, 34, 36 economic indicator, 136 education, 31, 32, 41, 42, 87 Education, 91, 160 elderly, 49, 50, 51, 55, 56, 58, 61, 62, 63, 64, 67, 68

Index employees, 7, 24, 36, 44 employment, 154, 162 energy, 74, 92, 159 energy efficiency, 92, 159 environment, 1, 3, 42, 43, 95, 109, 113 equipment, 31 equity, 26, 27, 44, 49, 50, 51, 52, 56, 57, 58, 61, 63, 64, 67, 70, 72, 78, 80, 89, 103, 104, 105, 109, 131, 135, 141, 142, 164 estate planning, 64 evolution, 50 examinations, 4, 8, 9, 14, 15, 22, 33, 38, 46, 48 expertise, 19 exposure, 9, 76, 111, 112, 114

F failure, 17, 32, 159 Fair Housing Act, 160 faith, 78, 146, 160 family, 23, 55, 57, 59, 64, 66, 71, 72, 82, 88, 157 Fannie Mae, 3, 49, 57, 58, 60, 70, 90, 91, 160, 162 fear, 38, 103, 109 federal government, 49 Federal Home Loan and Mortgage Corporation, 3, 4, 44 federal law, 4, 9, 141, 156, 158, 164 Federal National Mortgage Association, 3, 4, 44, 46, 57, 70, 160 Federal Register, 114 Federal Reserve Board, 128, 138 finance, 50, 92, 97, 146, 157, 159 financial institutions, 95, 98, 100, 110 financial markets, 97 financial performance, 26 financial stability, 82 financial system, 95, 96 financing, 77, 92, 97, 149 firms, 51 fixed costs, 10 fixed rate, 97, 99, 101, 102, 109, 114, 118, 135 flexibility, 55, 99, 154 float, 152, 155 flood, 77, 86, 142, 145, 146, 148, 160 flooding, 76 focusing, 33, 74 food, 50, 51 foreclosure, 89, 90, 159, 162, 163 fraud, 32, 35, 84, 162 Freddie Mac, 3, 58, 90, 91, 160, 162 freedom, 72 frustration, 30, 36 fuel, 149

167

funding, 145, 160 funds, 13, 14, 20, 47, 54, 57, 59, 63, 64, 67, 70, 78, 88, 89, 97, 104, 105, 109, 121, 139, 142, 143, 145, 146, 159, 160 furniture, 74, 85

G Georgia, 58 goals, 6, 114 goods and services, 161 government, 4, 8, 30, 38, 44, 66, 67, 145, 157, 158, 160 Government Accountability Office, 99, 114 government intervention, 38 graph, 126, 130 grass, 76 groups, 99 growth, 33, 55, 61, 62, 64, 68, 103, 105, 111 guidance, 45, 48, 95, 96, 98, 99, 100, 113 guidelines, 6, 41, 45, 46, 48, 89, 91, 92, 157

H Hawaii, 58 hazardous materials, 77 health, 51, 62, 64, 67, 76, 105, 141, 163 health care, 51, 64 health problems, 62, 163 heating, 161 hedging, 109 hiring, 4 home value, 58, 59, 60, 64, 65, 66, 82 homeowners, 49, 50, 51, 52, 54, 55, 56, 57, 58, 59, 61, 62, 63, 64, 65, 66, 67, 68, 70, 110, 142, 143, 146, 149, 159, 160 honesty, 38 House, 3, 42, 50, 67, 68, 69, 96, 102, 103, 104, 106, 107, 108, 110, 113 household income, 97, 102, 103, 105 households, 61, 102, 104 housing, 37, 50, 68, 72, 86, 87, 88, 90, 93, 99, 100, 102, 103, 104, 105, 108, 110, 112, 113, 114, 131, 133, 157, 158, 159, 161 HUD, 1, 2, 3, 4, 5, 6, 9, 16, 18, 19, 20, 21, 22, 24, 29, 30, 33, 35, 36, 37, 39, 40, 41, 42, 43, 44, 47, 48, 55, 56, 62, 64, 65, 66, 68, 73, 74, 75, 84, 86, 87, 90, 93, 147, 148, 149, 161, 162 hurricanes, 77 hybrid, 127, 132, 135

168

Index

I identification, 38 images, 13 incentives, 21, 46 income, 49, 50, 51, 52, 53, 54, 55, 58, 62, 63, 64, 65, 71, 72, 79, 80, 82, 85, 87, 88, 90, 102, 105, 109, 113, 120, 123, 140, 158, 159, 160, 161 income tax, 85, 123, 140 indication, 22, 111, 112, 162 individual character, 74 individual characteristics, 74 industry, vii, 1, 2, 3, 4, 6, 10, 11, 12, 13, 14, 15, 16, 17, 18, 19, 21, 22, 24, 25, 26, 29, 30, 32, 33, 34, 37, 38, 39, 40, 41, 42, 43, 45, 46, 47, 62, 99, 100 inflation, 50, 79, 103, 109, 111, 161 information sharing, 37 inspections, 143 inspectors, 153 institutions, 84, 96, 98, 99, 100, 145 instruments, 49, 50, 149 insulation, 75 insurability, 33 insurance, 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 13, 14, 15, 16, 17, 18, 19, 20, 21, 22, 23, 24, 25, 26, 27, 28, 29, 30, 31, 32, 33, 34, 35, 36, 37, 38, 39, 40, 41, 42, 43, 44, 45, 46, 47, 48, 51, 52, 56, 57, 62, 64, 65, 66, 67, 72, 76, 77, 78, 80, 81, 86, 87, 89, 91, 92, 104, 115, 118, 123, 133, 139, 141, 142, 144, 145, 146, 148, 151, 157, 159, 160, 161, 162, 163, 164 integrity, 34 interest rates, 9, 52, 61, 65, 66, 70, 79, 81, 84, 95, 96, 97, 100, 101, 102, 109, 110, 111, 113, 114, 117, 120, 121, 124, 126, 127, 128, 130, 132, 133, 134, 141, 152, 153, 157, 162 Internet, 88, 122, 133 investment, vii, 63, 72, 87, 103, 142, 144, 160 investors, 100, 114, 153, 160

J joint ventures, 46 judgment, 72, 161, 164 jurisdiction, 48 justification, 30

L labor, 8, 13, 89, 105, 107, 164 labor markets, 105 land, 143 language, 99

law enforcement, 35 laws, 3, 5, 12, 16, 30, 32, 33, 34, 35, 37, 38, 42, 43, 45, 48, 77, 86, 161 lawyers, 14 layering, 99, 100 legality, 22, 37 legislation, 35, 67, 99 lending, 35, 39, 77, 83, 84, 96, 99, 109, 143, 145, 146, 149 librarians, 73 licenses, 34, 35 life expectancy, 49, 51, 64, 65, 66 lifetime, 49, 50, 51, 52, 54, 55, 62, 64, 118, 123, 125, 135 likelihood, 62, 113, 154 living environment, 86, 161 loans, 46, 49, 50, 51, 54, 56, 57, 58, 59, 60, 61, 64, 66, 67, 70, 78, 81, 87, 88, 90, 92, 93, 96, 97, 99, 100, 102, 109, 110, 111, 113, 117, 120, 123, 127, 128, 129, 130, 131, 132, 134, 135, 137, 152, 153, 154, 155, 160, 162, 164 local government, 8, 13, 14, 144 location, 12, 24, 72, 100, 142, 143, 157, 158 long-term care insurance, 56, 62, 67 Los Angeles, 59, 104, 108, 111, 112 lower prices, 38 LTC, 62 lying, 77

M major cities, 15 management, 45, 100 mandates, 84, 98 market, 2, 3, 4, 5, 6, 7, 9, 10, 11, 14, 16, 19, 20, 29, 34, 35, 38, 40, 41, 42, 43, 44, 46, 48, 50, 51, 58, 77, 97, 99, 100, 102, 103, 104, 105, 107, 108, 112, 113, 114, 135, 141, 144, 152, 153, 157, 159, 160 market concentration, 9 market share, 10, 20, 34 market structure, 29 market value, 51, 135, 157, 159, 160 marketing, 2, 3, 5, 8, 20, 24, 34, 35, 36, 38, 39, 40, 41, 43, 100, 133 markets, 1, 2, 3, 4, 5, 9, 10, 11, 17, 26, 29, 35, 39, 42, 43, 95, 100, 103, 104, 105, 107, 108, 110, 112, 113, 114, 139 Maryland, 39, 58, 70 Massachusetts, 58, 107 measurement, 161 measures, 88, 95 median, 15, 26, 50, 58

Index Medicaid, 61, 63 Medicare, 63 Miami, 104, 108, 111, 112 migration, 105 military, 88 Minnesota, 12, 14, 33, 46, 58 MIP, 56, 162 missions, 86 models, 30, 38 money, 2, 6, 7, 9, 21, 24, 25, 26, 32, 36, 37, 38, 40, 41, 71, 75, 76, 77, 78, 80, 81, 86, 89, 92, 97, 117, 130, 136, 137, 139, 141, 142, 143, 159, 161, 162 mortality, 52 mortality risk, 52 motivation, 19 multiple factors, 9

N NAIC, 1, 3, 6, 24, 31, 38, 41, 42, 43, 44, 45, 48 nation, 13, 68 National Association of Insurance Commissioners, 3, 42, 43 national origin, 160 nationality, 73, 84 natural disasters, 76, 77 Nebraska, 39 negligence, 161 negotiating, 75, 77, 158 negotiation, 78 New Jersey, 58 New Orleans, 104 New York, 3, 11, 13, 14, 21, 27, 31, 32, 35, 42, 53, 58, 104, 108, 111, 112, 114 newspapers, 122

O obligation, 82, 158, 159 observations, 113 oil, 149 older people, 68 online information, 46 organization, 14, 25, 45, 48, 88 organizations, 3, 25, 43, 138 oversight, 1, 2, 5, 6, 32, 34, 38, 40, 41, 44 overtime, 88 ownership, 3, 4, 7, 9, 10, 11, 12, 24, 33, 38, 45, 143, 144, 158, 159, 164 ownership structure, 38

169

P partnerships, 46 penalties, 6, 9, 20, 21, 34, 36, 37, 40, 58, 129, 131, 132, 137, 162 permit, 55, 61, 69, 82 pests, 75 photographs, 75 planning, 6, 83, 95 plants, 4, 7, 13 policy rate, 15, 27 policymakers, 50 pools, 160 poor, 25, 50, 64, 68, 80 portfolio, 109 power, 38, 61, 76 preferential treatment, 24 premiums, 2, 3, 4, 5, 7, 8, 11, 14, 15, 16, 23, 25, 26, 27, 28, 30, 33, 42, 43, 44, 45, 47, 56, 62, 66, 76, 87, 92, 133, 142 pressure, 5, 16, 29, 37, 110 prevention, 8 price competition, 4, 16, 17, 19, 26, 29, 39 price index, 102, 115 prices, 1, 2, 3, 4, 16, 17, 19, 20, 22, 25, 26, 28, 29, 30, 37, 38, 39, 41, 42, 50, 75, 87, 95, 96, 99, 102, 103, 105, 107, 108, 110, 111, 112, 113, 114, 131 private investment, 160 private sector, 158 probability, 112 production, 44, 45 profit, 22, 25, 28 profitability, 33 profits, 3, 20, 25, 26 program, 30, 49, 50, 51, 52, 55, 57, 58, 60, 61, 62, 64, 66, 67, 68, 87, 89, 91, 92, 123, 133, 157, 159, 160 propane, 149 property taxes, 51, 57, 73, 81, 142, 143, 145, 146, 147, 159 purchasing power, 50

Q quality of life, 74 quality of service, 20

R race, 73, 84, 160 radon, 76, 143 range, 52, 99, 107, 142, 143, 144, 147, 148, 149

170

Index

rate of return, 51 real estate, 2, 3, 4, 5, 7, 9, 12, 17, 18, 19, 20, 21, 22, 23, 24, 25, 26, 29, 34, 35, 36, 37, 39, 40, 41, 42, 43, 45, 46, 47, 48, 51, 72, 73, 74, 75, 76, 77, 78, 80, 82, 84, 86, 88, 91, 99, 100, 133, 134, 139, 144, 145, 149, 152, 154, 158, 163, 164 Real Estate Services Providers Council, 3, 12 Real Estate Settlement Procedures Act, 2, 3, 5, 47, 84, 146, 147, 163 Real Estate Settlement Procedures Act (RESPA),, 2 reduction, 29, 90, 92, 105, 109, 163 reforms, 37 regional, 4, 9, 42, 105, 113 Registry, 86 regulation, 1, 6, 9, 30, 31, 34, 35, 41, 42, 62, 158 regulations, 3, 6, 22, 32, 33, 35, 37, 38, 39, 40, 41, 43, 47, 56, 99 regulators, 1, 2, 3, 4, 5, 6, 15, 17, 18, 19, 20, 21, 22, 23, 24, 25, 26, 27, 28, 29, 30, 31, 33, 34, 35, 36, 37, 38, 40, 41, 43, 44, 45, 46, 48, 98, 99 regulatory oversight, 5 rehabilitation, 87, 92, 93, 157, 163 reinsurance, 5, 21, 22, 23, 37, 46 relationship, 4, 5, 9, 11, 24, 39, 43, 44, 113 relationships, 34, 36, 37, 84, 99, 100, 163 religion, 73, 84, 160 rent, 20, 31, 44, 45, 72, 86, 87, 88, 89, 161 repair, 51, 57, 74 reputation, 25, 32, 82 reserves, 88, 147, 158 resources, 2, 30, 35, 36, 37, 64, 72, 73 RESPA, 1, 2, 3, 5, 6, 7, 9, 18, 20, 22, 23, 24, 30, 34, 35, 36, 37, 38, 39, 40, 41, 47, 48, 84, 146, 163 responsiveness, 30, 36 RESPRO, 3, 12, 25, 43, 46 retirement, 83, 88 retirement pension, 88 returns, 82, 85, 154 revenue, 11, 34 risk, 11, 14, 15, 17, 22, 23, 29, 47, 49, 52, 54, 56, 62, 64, 65, 77, 95, 96, 98, 99, 100, 101, 105, 108, 109, 110, 111, 112, 113, 114, 115, 120, 129, 131, 141, 144, 164 risk management, 98, 100, 113 rural areas, 141

S safety, 75, 76, 98, 158, 161 sales, 2, 8, 17, 18, 34, 40, 41, 43, 46, 48, 51, 55, 56, 63, 65, 73, 82, 95, 134, 139, 158, 163 sample, 1, 4, 15, 20, 21, 26, 27, 28, 29, 30, 31, 33, 34, 35, 44, 46, 47, 101, 110

sanctions, 34, 47 satisfaction, 25, 82 savings, 2, 5, 17, 18, 25, 61, 67, 88, 89, 92, 93, 101, 103, 104, 108, 129 school, 72, 73, 120 search, 3, 4, 5, 7, 8, 12, 13, 14, 15, 16, 17, 23, 25, 28, 29, 30, 33, 43, 44, 45, 72, 83, 144, 146, 148, 164 searches, 2, 4, 7, 8, 9, 13, 14, 15, 38, 46, 144 searching, 8 SEC, 3, 4, 27, 37, 48 securities, 48, 121, 134, 160 Securities and Exchange Commission, 3, 4, 43 Securities and Exchange Commission (SEC), 4 security, 52, 72, 77, 87 self-employed, 154 Senate, 42 series, 22, 147, 148, 149 service provider, 9, 22, 24, 36, 46, 84 settlements, 20, 21, 24, 36, 37, 40, 44, 45, 47, 139 severe stress, 112 severity, 67 sex, 73, 84, 160 shares, 12, 113, 158 sharing, 11, 37, 45, 48, 70 shock, 110, 129, 130 short-term interest rate, 109, 114 sign, 22, 32, 75, 84, 86, 91, 145 signs, 114 skimming, 91 Social Security, 63, 88 society, 68 software, 13 soil, 76 South Dakota, 39 spectrum, 98 speculation, 99 speed, 154 SSI, 63 stability, 72 stages, 145 stakeholders, 6, 30, 38 standards, 4, 44, 47, 96, 98, 99, 102, 158 state laws, 20, 35, 46 state oversight, 42 state regulators, 2, 4, 5, 6, 14, 30, 32, 33, 34, 35, 36, 37, 38, 39, 41, 44 stock, 103, 159 storage, 74 stress, 103, 105 students, 63 subsidization, 5, 26 suffering, 56 summer, 143

Index Sun, 68 supply, 84, 141 support services, 68 survival, 54 survival rate, 54 survivors, 64 sweat, 89 systems, 16, 42, 44, 73, 74, 75, 78, 100, 161

T tax deduction, 79 tax rates, 74, 149 taxation, 63, 157 technology, 8 telephone, 88, 152 tenure, 49, 54, 55 Texas, 3, 11, 12, 13, 15, 21, 27, 29, 31, 32, 35, 38, 42, 43, 46, 69 theory, 38 thinking, 71 time, vii, 3, 7, 8, 13, 17, 36, 39, 42, 44, 49, 54, 55, 57, 74, 75, 77, 78, 79, 80, 81, 83, 84, 87, 88, 90, 97, 98, 100, 101, 103, 104, 105, 109, 110, 111, 117, 120, 121, 122, 124, 126, 127, 128, 129, 130, 132, 135, 139, 140, 141, 142, 144, 145, 151, 152, 153, 154, 155, 157, 158, 159, 161, 162, 163 timing, 145 title insurance, 1, 2, 3, 4, 5, 6, 7, 8, 9, 15, 16, 17, 18, 19, 20, 21, 22, 23, 25, 26, 29, 30, 31, 34, 35, 36, 38, 39, 40, 41, 42, 43, 44, 46, 48, 144 title insurance market, 1, 6 tornadoes, 77 total costs, 38 tourism, 105 trade, 45, 46, 48, 51, 120, 132 trade-off, 51, 120, 132 training, 11, 20, 36 trajectory, 107 transaction costs, 51, 54, 65 transactions, 3, 5, 13, 17, 18, 20, 22, 25, 26, 40, 51, 143 transition, 113 transparency, 39, 41, 42 transportation, 72, 73 trend, 107, 114

171

trust, 16, 72, 158 tuition, 120

U underwriter, 4, 8, 10, 13, 14, 15, 24, 38, 44, 45 unemployment, 88, 105, 107, 108 unemployment rate, 105, 107, 108 unions, 120 United States, 3, 4, 48, 69, 70, 112 updating, 14 urban areas, 93

V validity, 46 values, 5, 16, 66 vandalism, 142 variable, 96, 97 variables, 51 Vermont, 58 veterans, 164 victims, 93 Virginia, 39, 58, 112 vulnerability, 2, 39

W waste disposal, 75, 76 water heater, 75 water quality, 141, 143 web, 93 WHO, 87 wind, 142 windows, 75 worry, 74 writing, 25, 27, 83, 133, 141, 153, 155, 162 wrongdoing, 36

Y yield, 114

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