Problem.Planning.Reverse mortgages

     This problem derives from (and considerably simplifies) facts reported in a class action filed in 1998 in the Superior Court of the State of California for the County of San Mateo.  You may learn more about the class action (and thereby also enhance your understanding of civil procedure) by skimming the following pleadings and other documents filed in the case (for which you will need Acrobat Reader):  the third amended complaint, the answers to the complaints, the proposed settlement, the notice of the action and of the proposed settlement.  For additional background information concerning reverse mortgages, I encourage you to visit the website of the National Reverse Mortgage Lenders Association as well as an explanation of reverse mortgages published on the web by the Federal Trade Commission. 

     Financial Freedom Senior Funding, Inc. is a corporation specializing in making reverse mortgage loans, largely to senior citizen homeowners who live on fixed income and are in need of cash.  The assets of Financial Freedom include a portfolio of reverse mortgage loans, including a $58,000 loan made to widow Lacy Eckhardt two and a half years ago.  Mrs. Eckhardt was 69 years old at the time that she obtained the loan.  Within the few years preceding the loan she had been in chronically poor health and frequently had been hospitalized.  As part of the cost of the loan she paid appraisal fees, recording fees, points, and other fees totaling $2,000, bringing the principal amount of the loan to $60,000.  The loan accrued interest at the rate of 7.5% per annum, compounded monthly.  For example, at the end of the first month, interest of $375 (($60,000 x 7.5%) / 12) was added to the $60,000 principal amount of her debt, bringing the amount of her debt to $60,375.  At the end of the second month, interest of $377.34 (($60,375 x 7.5% / 12) was added to the $60,375 principal amount of her debt.  Financial Freedom took a mortgage on her home to secure repayment of the debt.  Repayment of the debt, as it increased from month to month, was due upon her death, payable from the proceeds of the sale of the house.  In addition to repayment of the loan, the loan documents that Ms. Eckhardt read and signed included a shared appreciation clause that entitled Financial Freedom to 50% of the appreciation in the value of the home from the time of the loan until the time of its sale. The loan documents stated the value of the home to be $980,000 at the time of the loan, based upon an appraisal from an appraiser hired by Finanical Freedom. 

     Mrs. Eckhardt died a couple of years after obtaining the proceeds of the loan.  The executor for her estate has entered into an agreement to sell the house for $2.2 million (net of costs).  Financial Freedom has submitted to the escrow a payment demand for close to $700,000.  Her heirs have contested the payment claim in arbitration, claiming the loan to have been unconscionable.  They have advanced the claim in arbitration because the loan documents, while permitting the lender to use the court system to foreclose on the mortgage should Mrs. Eckhard default (e.g. by failing to carry homeowner's insurance) or should the executor of her estate fail to timely sell the home, required any dispute initiated by the borrower or her heirs to be resolved through binding arbitration.  

     You are in-house counsel to Financial Freedom.  Because of the claim of unconscionability, its CEO has asked you whether Financial Freedom should alter its reverse mortgage lending policies and, if so, how.   What is your response and why?