What is a reverse mortgage, and whom does it benefit? | In Principle

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What is a reverse mortgage, and whom does it benefit?

In September 2014 the Polish Sejm adopted the long-awaited but controversial Reverse Mortgage Act. The act still requires the approval of the Senate and the President—and this new financial product deserves a closer look.

Reverse mortgages in one form are already being offered in Poland by mortgage funds. The services offered by these funds are not overseen by the Polish Financial Supervision Authority or governed by any separate law. Essentially, they involve the transfer of home equity to the mortgage fund by persons over 65 in exchange for a promise to pay the homeowner a lifetime annuity.

Lawmakers decided to introduce reverse mortgages as a similar institution, but with major differences. The new act is designed to ensure the safety of borrowers by limiting the entities permitted to grant reverse mortgages and regulating in detail the rules for these financial products.

Under the newly adopted act, “through a reverse mortgage agreement a bank undertakes to place a specific sum of money at the borrower’s disposal for an indefinite period, to be repaid after the borrower’s death, and the borrower undertakes to establish security for repayment of such amount together with interest and other costs.” The act thus introduces into Polish law a new type of contract: the reverse mortgage agreement. It is to be a classified type of bilateral agreement. The borrower could be only an individual who is the owner of real estate, the holder of cooperative title to a unit, or the holder of the right of perpetual usufruct of land. The act also covers joint owners of real estate and persons who hold a share in cooperative title to a unit or a share in perpetual usufruct.

Significantly, throughout the duration of the reverse mortgage agreement, the borrower would retain title to the property and could make free use of the property, as well as receive funds under the reverse mortgage, which could be paid out in instalments or as a lump sum. If the agreement provides for payment in instalments, it is possible that the last instalment of the reverse mortgage loan would be paid out long before the borrower’s death. This is a different approach than that now being used by mortgage funds, which promise to pay their clients an annuity for as long as they live.

There would also be limitations on who could serve as a reverse mortgage lender. Such loans could be made only by Polish banks, branches of foreign banks, branches of credit institutions, or credit institutions conducting cross-border activity. This means that the loans could be made only by entities subject to oversight by the Polish Financial Supervision Authority or equivalent banking regulator in another EU member state. The apparent purpose of this approach is to assure a high degree of security for borrowers. Notably, cooperative building societies (SKOK in Polish) are excluded from the group of lenders who could grant reverse mortgage credit.

The act includes a number of rules intended to protect borrowers. Before entering into a reverse mortgage agreement, the bank would be required to provide the borrower a form containing a detailed set of information covering items listed in the act. The act also includes specific requirements for the written content of the reverse mortgage agreement. The borrower could withdraw from the agreement within 30 days after signing—a longer period than provided in the Consumer Credit Act. Moreover, the borrower could not be charged any costs for withdrawing from the agreement, except for non-refundable fees already paid to state administrative agencies or courts. The act also guarantees borrowers the right to repay all or part of the credit without being charged a commission by the bank.

The bank would have only a very limited possibility of terminating the borrower’s agreement, if one of a fixed list of conditions set forth in the act were met, namely:

  • Execution is commenced against the property or the right securing the reverse mortgage loan by a creditor other than the bank.
  • The borrower transfers title to the property or the right securing the loan to a third party without the consent of the bank.
  • The value of the property is significantly reduced due to the fault of the borrower.
  • The borrower refuses to authorise the bank to take out an insurance policy on the property or to take other actions listed in the act.

It should be pointed out that the bank would not be entitled to terminate the contract if the property lost much of its value for reasons not attributable to the borrower—for example due to a collapse in the real estate market.

The bank’s claim under a reverse mortgage agreement could be secured only by (i) establishment of a mortgage and (ii) disclosure in the land and mortgage register of the claim for transfer of ownership of the real estate, the right of perpetual usufruct or cooperative title to the unit. In the agreement, the borrower could also be required not to transfer title to the property. However, the bank would not be permitted to establish other security. More specifically, under a literal reading of the act, the bank could not require the borrower to provide an assignment of rights under an insurance policy or a voluntary submission to enforcement, both of which requirements are commonly used in the case of mortgage loans in Poland.

The borrower’s heirs would have 12 months following the borrower’s death to repay the entire amount owed under the reverse mortgage agreement, in which case the bank’s claim for transfer of title to the property would lapse. But if the loan were not repaid by that time, the bank’s claim for transfer of title to the property would then become due and payable. In that situation, it would be necessary to conclude an agreement transferring ownership of the real estate, the right of perpetual usufruct or cooperative title to the unit to the bank. If the relevant entities could not be located among the borrower’s heirs, the bank could demand appointment of a curator to conclude the transfer.

Within 30 days after transfer of the property, the bank and the transferor would hire an appraiser to value the property. Then, within 30 days after issuance of the appraisal, the bank would be required to pay the transferor the difference between the market value of the property and the total amount to be repaid under the reverse mortgage loan, or notify the transferor that the amount owed was higher than the market value of the property.

The act clearly provides potential borrowers a high degree of protection, which should make this new type of loan attractive for homeowners. It may be of particular interest to older people who own property but now have trouble obtaining credit. But the act includes a number of obligations and limitations which may make reverse mortgage lending unattractive to banks, such as:

  • The very narrow range of permissible security
  • The fundamental inability to terminate the agreement if the real estate market collapses and the property loses value (making it potentially necessary to rely on a general change-of-conditions clause—rebus sic stantibus)
  • Extensive rights on the part of borrowers to withdraw from the agreement
  • Doubts concerning settlement of the value of the property (beyond the scope of this article).

In a survey by financial advisers Home Broker Doradcy Finansowi, reported by biznes.pl, only one major bank in Poland said it was greatly interested in reverse mortgage lending. Most of the banks said they were not very interested in the idea or were undecided. If the new act becomes law, time will tell if the new institution of the reverse mortgage becomes popular on the market.

Łukasz Szymański and Laura Piórkowska, Banking & Finance Practice, Wardyński & Partners