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Don't Expect Much From Unregulated Regulators

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The seeds of this article were planted in my brain some 30-odd years ago, when I did a consulting project for HUD, for which they contracted to pay me $2,500. Three months after delivery and acceptance of my report by HUD, I realized I had not yet been paid and I contacted the person who had retained me. This elicited what I came to realize was a stock reply of an unregulated regulator: The payment was "in process."

The same Q and A were repeated multiple times, and a year went by. At that point, in a fit of pique, I wrote a letter to the Secretary of HUD asking why it was not possible for his agency to discharge an uncontested debt within a year. Three days later I received a check for $2,500. Two days after that I received another check for $2,500.

It never occurred to me to seek help from someone or some entity outside the agency, because then as now, HUD was an unregulated regulator. Neither did I stop to consider whether the bureaucratic lethargy that delayed my payment might have other negative consequences of far greater importance. I didn't pursue that line of thought until last week, when my colleagues and I were suddenly faced with one.

We were upgrading our reverse mortgage calculator to handle house purchases by seniors. In 2008, Congress extended the HECM reverse mortgage program, administered by HUD, to cover house purchases. Thenceforth, seniors could buy a house and finance the purchase in part with a HECM reverse mortgage. The costly intervening step of buying the house with a forward mortgage and paying it off with a reverse mortgage, was no longer necessary.

We assumed that lenders extending reverse mortgages to seniors buying houses would offer multiple combinations of interest rate and upfront fees. This has long been the practice on forward mortgages, and has become increasingly common on HECM reverse mortgages issued on homes already owned. Higher-rate loans carry rebates from the lender that are used to pay upfront settlement charges, including title insurance and mortgage insurance.

For example, on August 14, one lender on our site offered a senior of 83 with a house worth $500,000 and a $313,000 existing mortgage balance an adjustable rate HECM at 2.529% and a rebate of $12,057. The rebate reduced the settlement costs on the HECM to $1,868. If the borrower expected to be out of the HECM within five years, this would cost the senior less in total than the lower-rate ARMs available that day on which the lender charged fees instead of paying rebates.

I was astounded, therefore, when lenders told us that HUD did not allow rebates on HECM purchase transactions! We checked all the relevant HUD documents, and nowhere did we find a statement that rebates paid by lenders were not allowed. On the other hand, we did not find any statement explicitly authorizing rebates, either.

What we did find were strict prohibitions against any participants in the transaction, including lenders, contributing to the down payment required of the senior. We have no problems with these rules, which are designed to prevent seniors from being charged more for houses than they are worth. We know that when home sellers pay some of the settlement costs of home buyers, sale prices end up higher. That happens because negotiations on who pays settlement costs and negotiations on the sale price occur together -- they are part of the same negotiation process.

In contrast, the offering of multiple combinations of interest rate and upfront fees by lenders, and the selection of a preferred combination by the borrower, are not part of the negotiation on sale price. Offering borrowers multiple price combinations cannot affect the sale price of the house.

Evidently what happened was that HUD was not sure that rebates from lenders wouldn't affect prices, so they left the issue ambiguous. They did not explicitly prohibit rebates, but neither did they explicitly exclude rebates from the prohibitions on other kinds of payments.

I was told that when they were asked about it by lenders several years ago, they said "we will look into it." This is another stock reply of a regulator that knows it need not do any follow-up because it is not being monitored.

When a regulation is left ambiguous, the interpretation by the industry involved will depend on the culture of the industry. In many industries, the prevailing assumption is that what is not explicitly prohibited is permissible. The mortgage industry, however, is so rule-driven and mortgage lenders so risk-averse that they often assume that what is not expressly authorized is prohibited.

That seems to be the case here. We have not found any lenders willing to offer rebates on purchase HECMs. HUD has effectively shut down a potentially valuable service to seniors without explicitly prohibiting it, thus avoiding any need to justify its actions. Unregulated regulators can get away with that.

Note: The article above was sent to HUD with an invitation to comment. No response was received but HUD had it only for three days prior to publication. The following week, however, I was pleasantly surprised to be contacted by two HUD officials, who told me that a working group had been formed to examine the issue. Several email exchanges followed on substantive issues, and at this writing I am cautiously optimistic that the question will be resolved, one way or another, by an official policy directive. Stay tuned.

You can contact the professor at http://mtgprofessor.com