CFPB warns consumers about home equity contracts, comparing their features to reverse mortgages

The Consumer Financial Protection Bureau (CFPB) this month published an issue spotlight that takes a closer look at home equity contracts, or what the industry refers to as home equity investments (HEIs) that offer a lump sum payment to clients in exchange for a stake in their home equity.

At the time the contract is settled, the homeowner must pay a lump sum back to the provider, an amount that is also partially based on the home’s value.

But the HEI industry could carry a lot of risks for consumers, the bureau said, since it uses nonstandard disclosures and does not have an industry-standard mechanism for calculating what the final owed payment from homeowners will be. It also operates outside of the regulatory purview of other home-equity tapping products, including the Federal Housing Administration (FHA)-sponsored Home Equity Conversion Mortgage (HECM).

Comparisons to HECM loans

In fact, the HECM loan is brought up multiple times in the report as a point of comparison to existing HEI products. One key finding from the bureau’s Office of Mortgage Markets is that HEI companies often market themselves against reverse mortgage products, touting the products as not being debt-based instruments that do not require monthly payments.

But unlike HECM loans, HEI products are backed primarily by financial companies based on investments by Wall Street firms “that are interested in their high returns,” the bureau said.

But the bureau added that many of the touted features of home equity contracts are “risky,” with the CFPB comparing them to loan features that were prominent in the run-up to the 2008 housing crisis.

The companies advertise no monthly payments and “require consumers to assume all costs for property taxes, hazard insurance, and property maintenance, and require a large settlement payment, similar to the loans originated in the early 2000s that were negative amortizing and required a balloon payment at the end of the loan term,” the report said.

The report also said that such contracts “tout loose underwriting requirements, enabling them to reach homeowners with low credit scores or little to no income.”

Most home-secured options on the market today do not have these features, with the notable exception of the HECM program, the bureau found. HECM loans are “repaid in a final lump sum rather than in monthly payments to the company and require consumers to pay hazard insurance and property taxes and to maintain the home,” the bureau noted. “They also require the consumer to stay in their home as their primary residence and have limited income requirements.”

But HECM loans are insured and regulated by the FHA, and they are only available for homeowners who are at least 62 years old. Home equity contracts have no age restrictions, while HECM loans also require counseling from a U.S. Department of Housing and Urban Development (HUD)-certified housing counseling agency prior to the loan’s origination.

HECMs also generally allow for the homeowner to remain in their property until they die or move out, rather than imposing a time-based requirement for repayment, the CFPB said.

Bureau files amicus brief

The same day that the CFPB published its issue spotlight, it also took its stance on home equity contracts further by publishing a consumer advisory bulletin, which asked consumers to “beware” of such products due to their expenses and associated risks. The bureau also filed an amicus brief — a statement of interest — in a court case involving a home equity contract company.

HousingWire’s Reverse Mortgage Daily (RMD) reviewed the amicus brief, filed in the Roberts v. Unlock Partnership Solutions case in the U.S. District Court for the District of New Jersey. In the brief, the CFPB takes the position that a home equity contract counts as a residential mortgage, and it often corroborates that perspective with comparisons to reverse mortgages.

“Many homeowners expect that when they put their house on the line in exchange for getting money, they will also get certain protections. But right now, some home equity contract companies say that they don’t have to follow those laws,” the bureau said in a rundown of its recent HEI activity. “The CFPB filed a brief in a court case where one home equity contract company said exactly that.”

The bureau specifically cites the HECM loan’s nonrecourse feature, the requirement that HECM repayment is contingent on a termination event (such as death of the borrower), and determination of the payment obligation having some basis in the home’s value at the time of said event.

The facts of the case, the bureau argues, illustrate a key point that “a product that is in substance a nonrecourse reverse mortgage could, if [the contract provider in the legal case] were correct, be recharacterized in form as an equity investment in the consumer’s home in order to evade [the Truth in Lending Act (TILA)].”

The provider’s position is that its product is not a residential mortgage.

Recent legal case

Several of the points of comparison between home equity contracts and reverse mortgages are already playing out in another legal case in Washington state. Another contract provider, Unison, states that its product is not a reverse mortgage under the definitions of state law.

But plaintiffs in the case allege that it meets all the requirements of a reverse mortgage, and that Unison is seeking to avoid the regulatory mechanisms that work for reverse mortgages.

”Unison’s product is a reverse mortgage stripped of the essential safeguards meant to protect homeowners,” Thomas Scott-Railton, an attorney for the plaintiffs in the case, said in October when reached by RMD. “We believe that as courts take a closer look at these products, they’ll agree they are reverse mortgages — or at the very least an unlawful attempt to circumvent reverse mortgage laws.”

In that case, however, an attorney for Unison claimed such products are not reverse mortgages under state law, partially because the state Legislature has declined to add equity contracts to its definition of a reverse mortgage. A three-judge panel in that case was animated in its questions for both parties, but a determination has yet to be made.