Editor’s note: This is the first of a five-part series.
A reverse mortgage is a secured loan to an elderly homeowner on which the borrower’s debt rises over time, but which need not be repaid until the borrower dies, sells the house or moves out permanently.
The "forward" mortgages that are used to purchase homes build equity, which is calculated as the value of the home less the mortgage balance. Borrowers pay down the balance over time. Reverse mortgages, in contrast, reduce equity because loan balances rise over time.
The reverse mortgage meets the needs of elderly homeowners who don’t have enough income to do what they want to do, and who have no qualms about not passing a debt-free house to their heirs.
Reverse mortgages before 1988
The history of reverse mortgage programs goes back to the 1970s, but none of the early ventures lasted, and none provided a model for others to follow. Despite the need, reverse mortgages were a hard sell because the instruments were complicated, the sponsors were usually unknown, and elderly homeowners were fearful of making a mistake that might cost them their home. Some of the early programs reinforced these fears because they did not provide adequate consumer protections.
Growth of HECMs: 1988-2008
The landscape began to change in 1988 with the development of a federal program under the FHA authorizing the Home Equity Conversion Mortgage (HECM). The borrower protections built into this program, along with the imprimatur of the federal government, paved the way toward increasing acceptance by elderly homeowners. Lenders were attracted to the program because FHA assumed 99 percent of the risk, meaning that if the loan balance on a HECM was larger than the recoverable value of the home when the borrower died, FHA took the loss.
Under the HECM program, the maximum amount the homeowner can withdraw is called the "net principal limit," or NPL. The NPL is determined by:
1. The lower of the FHA national loan size limit, the appraised value of the home, and the sale price if the HECM is used to purchase the home.
2. The ages of the borrowers, which determine their expected life.
3. The expected interest rate on the HECM, which determines how fast the borrower’s debt will grow.
4. The upfront mortgage insurance premium set by FHA.
5. Origination fees set by the lender subject to ceilings set by FHA.
6. Other settlement costs set by title insurers and others.
The number of new HECMs rose slowly until 2003, then accelerated, reaching a peak of 114,000 in 2009 (year ending in September). During this period, private programs that worked in much the same way arose to meet demands from borrowers with higher-value homes whose borrowing power under the HECM program was limited by legal ceilings on FHA loan amounts. In 2007, I counted seven private programs offering "jumbo" reverse mortgages.
Impact of the financial crisis
The financial crisis and decline in home values had a major impact on the HECM program. Declining home values increased losses to FHA on outstanding HECMs, and reduced the NPL on new HECMs. The negative impact of declining property values, reductions in the assumed rate of property appreciation, and increasing mortgage insurance premiums were only partly offset by lower interest rates.
The crisis also drove the private jumbo programs from the market. These mortgages were all securitized, and when the private mortgage securities market collapsed, the relatively small part of it directed to reverse mortgages collapsed with it. The market hole this created was partly filled by an increase in HECM loan limits, with a uniform national limit of $625,000 replacing a patchwork of lower county-based limits.
The financial crisis also saw the emergence of a new and unanticipated problem: tax delinquencies. An increasing number of HECM borrowers are not meeting their obligation to pay property taxes, which puts them in default and vulnerable to foreclosure and eviction.
In addition, the three largest HECM lenders — Bank of America, Wells Fargo and MetLife — decided to leave the market. This may have been related to fear of a public relations disaster in connection with tax delinquencies. However, more than enough HECM lenders remain.
FHA has been innovative recently in developing three new HECM products that expand the options available to homeowners. A fixed-rate HECM is available to those allergic to variable rates. A "saver" HECM is available to those allergic to large upfront fees. And a new "HECM for Purchase" program makes it possible for a senior to purchase a house with a HECM in one transaction. These new programs will be discussed in future articles.
But the most pressing challenge today is tax defaults, which if not resolved could destroy the HECM program. It will be discussed next week.