Government Plans Big Reverse-Mortgage Curbs

January 7, 2013

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Reverse mortgages, long criticized for high fees and other anti-consumer features, turn out to actually be the opposite—such a good deal that the government is nearly $3 billion in the hole on outstanding mortgages. As a result, the Federal Housing Administration (FHA) will later this month unveil sharp curbs on its loan product, called the Home Equity Conversion Mortgage (HECM).

When the new rules are issued, consumers will need to take a close look at the terms of these loans. While the specifics of the changes have yet to be announced, they will lead to consumers being able to access a smaller share of their home's equity when they take out a reverse mortgage. In addition, lenders will probably be required to set aside a portion of the borrower's home equity to pay future property taxes and home-insurance premiums. And there may also be limits that restrict lower-wealth borrowers from taking out a HECM.

The FHA (and thus taxpayers) has been losing the most money on the most popular HECM loan: a fixed-rate loan known as the Standard HECM loan. This type of loan will be halted under the new rules. Most borrowers thus will be required to consider a newer reverse mortgage called the HECM Saver.

The HECM Standard loan often carries steep insurance fees and other charges. But it pays out a higher percentage of a homeowner's equity than the Saver, which charges nearly no insurance fees and is less costly to consumers. But it is also a more conservative loan to the FHA because it pays out a smaller percentage of an owner's equity than does the HECM Standard loan. This provides the government a bigger cushion against loan losses that could eventually lead to costly insurance claims by private lenders.

Housing columnist Kenneth Harney recently cited research estimating that a home valued at $200,000 would generate $130,400 in funds under a Standard loan but only $108,600 using a Saver loan. This example was based on a 68-year-old borrower and a fixed-rate loan at 5 percent interest.

HECMs are available to homeowners who are at least 62 years old and have a relatively small mortgage or none at all. They have been a popular way for financially strapped owners to pull equity from their home, continue living in the home, and no longer make mortgage payments to private lenders. In a HECM, those payments are drawn from the portion of the home's equity that is not paid out to owners.

Homeowners may access varying percentages of their home equity, depending on their age and how much money they still owe on the home. Any mortgages on the property must be repaid, usually with part of the HECM loan proceeds, before homeowners can access any equity funds. They can pull down proceeds in a lump sum, as regular payments, or as a line of credit. Private lenders make the loans and the FHA insures them from losses should they not receive all the interest charges and loan fees to which they are entitled.

A key feature of reverse mortgages is that homeowners may stay in their homes so long as they continue maintaining the property and pay property taxes and home insurance. Even after their home equity turns negative (due to accumulated interest and loan charges to lenders) the owners may still reside in their home as long as the loan is not in default. HECMs are known as non-recourse loans, meaning borrowers can walk away from the loan without having to repay any accumulated charges.

The problem with the fixed-rate Standard HECM loan is that borrowers tended to take all their funds out right away in a lump sum. And they often fell behind on property taxes and home-insurance premiums, depleting any remaining equity in the home and exposing the lenders to growing losses.

"The vast majority of borrowers take out 80 percent or more of the maximum amount possible in one initial cash draw," the FHA said in its annual report to Congress last November. "HECM loans with such high up-front draws are twice as likely to have a tax-and-insurance default as are loans with initial draws of 60 percent, and four times as high as those with initial draws of 40 percent of the maximum allowed."

These repayment problems, in addition to falling home prices, have caused owners and estate executors to walk away from loans rather than trying to sell properties themselves. Traditionally, the agency said, 70 percent of HECM property sales were handled by owners or estate executors. In the past year, however, 70 percent of such properties were instead conveyed to the government, adding to its program losses. The FHA has estimated that the economic value of the HECM loans was a negative $2.8 billion in fiscal year 2012, compared with a positive value of $1.4 billion in fiscal 2011.

"FHA will take immediate action to reduce the amount borrowers are permitted to draw at the time of origination of their HECM loan," the agency's report said. "FHA will consolidate the Fixed Rate Standard program with the Fixed Rate HECM Saver product, resulting in a reduction of the maximum amount of funds available to a HECM borrower. Further, the principal limit factors that are used to determine the maximum amount a homeowner may borrow using the remaining HECM products will be reduced across the board."