It was last April, right after the release of President Obama’s 2014 budget, when Assistant Housing Secretary Carol Galante was quoted as saying…
“The President’s budget projects that FHA may need a $943 million credit from the U.S. Treasury in October to make certain sufficient reserves are on hand today to cover projected losses over the next 30-years. This is not a certainty and FHA is taking every appropriate action to reduce the likelihood that such assistance is needed.”
So, what’s going on here? Why is the Federal Housing Administration (“FHA”) projected to lose so much money on its insuring of reverse mortgages?
The overall answer is simple… it’s just another outcome of the severe decline in U.S. home values, which began during the summer of 2006. You see, one of the key benefits of HUD’s Home Equity Conversion Mortgage (“HECM”), is that they are “non-recourse” loans.
That means that at the end of the reverse mortgage, which occurs either upon the death of the last surviving spouse or the sale of the home, if the balance owed exceeds the home’s value… then the borrower (or borrower’s heirs) can just walk away and owe nothing… with the balance paid by FHA, who is the insurer of these loans.
To cover this risk of loss at the end of a reverse mortgage, FHA receives an initial premium and an annual mortgage insurance premium, which borrowers pay at the rate of 1.25 percent of the outstanding loan balance.
Obviously, during the decades of steady home appreciation, or at least more stable home values, at the end of a reverse mortgage there was often still equity in the home and therefore some owners refinanced and others sold the properties, but few walked away. However, since home values have fallen, more and more people at the end of a reverse mortgage have found that the home’s value was now less than the amount owed on the loan… and since they couldn’t refinance… they took advantage of their option to simply walk away, owing nothing.
It’s also important to take note of the word, “projected” in Galante’s statement above. The losses mentioned are not today’s losses, rather they are losses that are projected to be realized in the 20-30 years ahead as a result of homeowners walking away at the end of reverse mortgages.
This is the first time in the history of the FHA that such a bailout might be needed by the agency, but it’s important to recognize that its cause is the same as what’s caused trillions of dollars in losses elsewhere… the sharp and prolonged decline in U.S home values.
Reverse Mortgage Daily, an organization described as “the premier independent source for news, commentary, and analysis covering the reverse mortgage industry,” agrees on the source of FHA’s projected loss related to its reverse mortgage program…
“It results from projected losses to the FHA’s mutual mortgage insurance fund, stemming from losses on reverse mortgages and forward loans sustained during the housing crisis and marked by continued low home values.”
The simple fact is that the FHA has been tapped to play a key role in the housing market ever since the mortgage crisis put an end to sub-prime loans. Since 2009, the FHA has backed roughly one-third of all new mortgages for home purchases… and many of these loans were made to borrowers with credit scores that would have otherwise made it impossible for them to obtain financing.
But, as a result, there has been increasing concern that FHA, because it’s funded through mortgage-insurance premiums, “could run out of money if the economic recovery doesn’t pick up steam,” according to The Wall Street Journal.
Not surprisingly, FHA is already seeking an independent analyst to render a second opinion on the amount of the agency’s projected losses. According to FHA deputy assistant secretary of risk management and regulatory affairs Frank Vetrano…
“The goal of bringing in additional analysis is to increase the larger overall effort of transparency to provide another perspective as FHA continues to work to develop enhanced internal capabilities.”
In other words, “We’re hoping we can find someone with a more optimistic view of the future than ours, which will allow us to reduce the projections for future losses that may occur as a result of the ridiculous mortgages we allowed to be insured before the housing market meltdown.” Or something like that.
We were destined to see an overcorrection…
The mortgage meltdown that began in 2007, led to a collapse in home values across the country, fueled unprecedented numbers of foreclosures, decimating consumer spending, and driving unemployment to the highest levels in decades. Ultimately, the financial crisis of 2008, would leave the nation’s largest investment and commercial on the brink of insolvency, and create the need for never-before-seen levels of financial support from taxpayers and the Federal Reserve.
Undeniably, much of the economic carnage was caused by increasing amounts of mortgage lending that abandoned all reasonable underwriting standards and delivered loan products with features that ranged from the merely undesirable to those considered outright predatory.
As the reality of what had happened became increasingly clear in 2009, it also became clear that, in the tradition of Sarbanes Oxley, we would soon be passing new legislation and changing all sorts of rules related to lending… all supposedly designed to afford more protections to borrowers, while reducing systemic risk to the financial system itself.
HUD’s new rules related to reverse mortgages are just a part of those changes made in the wake of the financial crisis and resulting economic meltdown, and in fact, relative to changes made that affect other areas of mortgage finance, they are a particularly well reasoned part.
To better understand what caused FHA’s projected losses on HUD’s reverse mortgage program, I contacted Edward Pinto, who is now a Research Fellow at the American Enterprise Institute (“AEI”). Last year, I interviewed Ed on a Mandelman Matters Podcast, and he’s always the first person I call when my question has to do with FHA, because he very likely knows more about FHA than anyone on the planet.
Not only does Ed write AEI’s monthly “FHA Watch,” but in December 2012, Ed completed a study of 2.4 million FHA-insured loans concluding that the agency’s policies were in fact responsible for “a high proportion of working-class families losing their homes.”
Ed is a former executive vice president and chief credit officer for Fannie Mae, and over the last few years he’s done what has been widely referred to as, “groundbreaking research on the role of federal housing policy in the 2008 mortgage and financial crisis.”
Ed specializes in housing finance and specifically focuses on how government housing policies impact mortgages, foreclosures, and the availability of affordable housing for working-class families. Currently, he’s researching policy options related to the rebuilding of the US housing finance sector.
According to Ed, “insuring reverse mortgages is risky business.” He explained to me that reverse mortgages have “a number of moving parts that all need to work right to avoid losses.” He also acknowledged that the projections we’re talking about “must be made 20-30 years in advance and erroneous projections can have a big impact.”
Ed offered the following list of factors that can have a significant impact on the insuring of reverse mortgages…
How long will the borrower(s) live?
How well will the house being maintained?
What is the trend of future interest rates, in light of the fact that reverse mortgages are ARMs?
Will the borrower have the funds to pay the property taxes and insurance?
What percentage of the homes will be acquired by FHA at the end of the reverse mortgage, as this adds significantly to program expenses?
How to address the moral hazard issue, resulting from borrowers knowing more than the insurer?
What will be the course of house prices going forward?
In an email I received from Ed in response to my questions about FHA’s projected losses on reverse mortgages, he said…
“You are right that house price trends are extremely important and a key factor. However, the other items above also present serious risks. For example, FHA had expected that the heirs would take the property and pay off the mortgage. Instead, a much higher percentage than expected gave up their interest, which transferred the substantial cost of maintenance and property disposition to FHA.”
Lastly, Ed pointed out… as I fully expected him to do… that it’s also the government-as-the-only-lender that causes problems… and by “problems,” he means: “losses.” At the close of his email he quite characteristically said…
“Finally, one should always be nervous when the government is the only game in town—the private sector and Fannie were forced out because they could not compete with FHA.”
(I’ve discussed the issue of government lending with Ed on several occasions and I don’t think there’s any question that Ed is the leading proponent of any campaign to get the government out of the lending business. Although I find his goal admirable, and even desirable… with investors having lost trust in the ratings agencies and now essentially addicted to the government guarantees offered by Fannie’s and Freddie’s bonds, I’m just not sure it’s going to be possible for a long time.)
So, what’s changing about HUD’s reverse mortgage program… and when?
Overall, it’s likely that somewhat fewer homeowners will be able to qualify for reverse mortgages, and certainly the maximum dollar amount that homeowners will be able to access will be reduced slightly. But, overall, the changes are not likely to dramatically reduce the demand for reverse mortgages.
1. NOW ONLY ONE. In the past there were always two types of reverse mortgages… one was called the “standard” and the other the “saver”. The new rules, however, essentially combine the two types into one.
2. HOW MUCH? Starting on Sept. 30th, many borrowers on average will be able to access roughly 15 percent less home equity than the previously available maximum. For example, under the new rules a 62-year-old will only be allowed to access up to 52.6 percent of his or her home’s appraised value, assuming a 5 percent interest rate. Under the current rules, that same person was allowed to access up to 61.9 percent of the home’s value.
3. THE COSTS? The amounts initially withdrawn will now, in part, determine a reverse mortgage’s cost. Those that elect in the first year, to receive 60 percent or more of the total available will pay a higher amount. The fee, which is 2.5 percent of the property’s appraised value, is termed “an initial mortgage insurance premium.” Those who withdraw less than 60 percent will only be required to pay 0.5 percent of the property’s value, although either amount can be wrapped into the loan.
Prior to the new rules taking effect, these same fees were set at 2 percent for standard reverse mortgages, so the new fees aren’t likely to come as any sort of shock to borrowers. The other insurance fee associated with reverse mortgages, referred to as the “annual mortgage insurance premium,” stays unchanged at 1.25 percent of the outstanding loan balance.
4. YEAR ONE LIMITS? The new rules place a limit on the amounts withdrawn in year one. For example, if a homeowner were eligible to withdraw $200,000 in total… only 60 percent of that total will be available in year one, or $120,000. In some cases, however, homeowners can access a bit more.
Examples include, when an existing mortgage, along with federal debts, combine to exceed the 60 percent year one max. Such debts are referred to as “mandatory obligations,” and since homeowners must pay them off as part of their qualifying for the loan, the new rules allow them to withdraw an additional 10 percent of the maximum allowable, above what is needed to satisfy these types of financial obligations. So, if the max allowable is $200,000, that 10 percent bump would allow for an additional $20,000 in year one.
5. QUALIFYING? For the first time ever, lenders will be required to assess a borrower’s ability to pay property taxes and homeowners insurance bills. And in some instances, lenders will require certain borrowers to set aside funds to cover property taxes and insurance in the future. As of Jan. 13, 2014… lenders are to conduct an analysis of all sources of borrower income, including earnings, pensions, Social Security, funds held in IRA and 401(k) accounts, et al… and credit history will also become a factor in some instances.
Lenders are also being required to consider the amounts the borrower(s) have left after normal living expenses. If a single homeowner can show $500-$600 is left after paying monthly living expenses, he or she will probably not be required to set aside a significant amount of the loan’s proceeds to cover property taxes and insurance in future years.
If a lender’s determination is that a borrower may not be able to cover property taxes and insurance in future years, it may require funds to be set aside, or it may arrange for deductions from monthly payments or such amounts may be charged to the credit line.
Without question, this aspect of the new rules will hit seniors harder in some parts of the country than in others, such as in areas where homes cost less, thus making property taxes and insurance, relative to the appraised value of the property, higher in percentage terms. Of course, on the positive side of the coin, although it does reduce the amount of cash available through a reverse mortgage, reserving for property taxes and insurance does eliminate the potential for losing a home due to failure to pay such costs.
We’ll just have to see how it goes…
The FHA says it’s hoping that the changes will cause borrowers to access funds made available through a reverse mortgage more slowly over time, as opposed to taking it all in year one, the obvious idea being that doing so will reduce the chances of running out of money too soon… and that’s certainly a positive thing.
In reality, however, the new limits on year one withdrawals don’t slow things down all that much, so it’s unclear just how much of a positive impact will result from such limitations.
Overall, how much of a difference are the new rules likely to make in terms of preventing future losses for FHA’s insurance fund? Well, it seems pretty obvious that the answer to that question is going to be primarily driven by the same factor causing the losses predicted today… home values in future years.
If home values rise at some reasonable rate over time, then the FHA will lose a lot less because more people will either sell or refinance the homes at the end of the reverse mortgages. If they don’t, then more will walk away. That’s not hard to predict, right? Every other factor involved in losses to FHA, it appears to me, is comparatively speaking, at least… pocket change.
Look, since 2009… we’ve turned the FHA into the new sub-prime. We knew what we were doing at the federal level, it wasn’t any sort of accident. As a result, the default rate on FHA loans, no matter how you slice it, are high… perhaps shockingly so. But, we also used the FHA to prop up the housing market when there wasn’t any way to do so… and we’ve used it to refinance some absolutely horrible debt that was all but certain to default anyway. So, it is what it is… and yes, it’s taxpayers that are on the hook this time.
But, so what? Think how much worse things would be today if we were to cut out one-third of all home sales since 2009. Where would we be then? Well, we’d probably still be blathering on about a housing recovery, so maybe that’s not the best question… but you get what I mean, right?
Reverse mortgages in past years were seen largely as a crisis management tool… something you don’t even consider unless no other options exist. Going forward, I predict that will not be the case. Reverse mortgages are destined to become an integral and valuable component of everyone’s retirement financial planning strategy.
We’re living longer and we’ve not saved nearly enough to cover the higher costs of health care that are certainly in our future. Our children will need more from us than past generations needed from their parents too, and for the most part, we’re ready and willing to be there for them whatever they need.
Understanding reverse mortgages won’t be optional… in fact, they’re a lot like long-term care insurance… annuities… investing inside permanent life insurance policies… estate planning… arthritis… many of us don’t understand those things all that well either… but we will soon enough. There’s not a doubt in my mind about that.
Mandelman out.
FIND OUT HOW A REVERSE MORTGAGES CAN WORK FOR YOU BY TALKING WITH THE EXPERTS AT IMPAC MORTGAGE…
CONTACT RICHARD JOHNSON
AT IMPAC MORTGAGE TODAY.