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March 20th, 2012

FHA reverse mortgages are flawed and need fixing

by Peter Miller

 

4-FHA-logoEarlier this month, Moody’s Investors Service downgraded $5 billion of Home Equity Conversion Mortgage (HECM) bonds, a ratings change which ought to catch the attention of someone at HUD.

While the FHA mortgage program has been doing better in general, the situation with reverse mortgages is very different–claims for HECMs are up 64.6 percent.

When the market is down, HECMs don’t perform

The HECM reverse mortgage program continue to be a drain on the FHA because the entire concept does not work in extended down markets for three reasons:

  1. The typical FHA reverse mortgage is outstanding six years
  2. U.S. home prices peaked in April 2007 and have declined nationwide since then
  3. Reverse mortgages are a loan product that produces negative amortization–the final debt is larger than the original loan amount

FHA: 100 percent responsible

While reverse mortgage balances are growing, home values are falling. If the loan is outstanding long enough, the result is that the home cannot be sold for as much as the debt. The FHA, which has insured the loan, is 100 percent responsible for any and all loss.

There are solutions to reduce risk

There are several solutions which could resolve the reverse mortgage losses which HUD will face in the future (it’s too late to avoid the losses from past loans):

  1. Discontinue the program: The most obvious step would be to do what private companies do when they have a product or service that’s not selling: they discontinue it. Indeed, many large lenders have withdrawn from the reverse mortgage marketplace and it would make sense for HUD to consider the same option.
  2. Stop investing in the program: Instead of taking the obvious course, HUD is doubling down. It has just announced that it will spend an additional $4 million on reverse-mortgage counseling, money that will only encourage the origination of more reverse mortgages and thus future claims.
  3. Make smaller loans: Another idea would be to make future reverse mortgage loans less risky by assuring that the loan sizes are smaller. The way to do this is to require more owner equity. With lower loan-to-value ratios, HUD would have more protection in the event of a reverse mortgage claim.
  4. Less lender guarantees: Risk would also be reduced by lowering the guarantees now made to lenders. Lenders today have 100 percent protection against any loss and thus no skin in the game and little reason to decline reverse mortgage business. You can be certain that once lender money was at risk, fewer reverse mortgages would result in claims.

HUD: It’s time to take a closer look

There’s no doubt that the reverse mortgage program is well intended and that it has helped selected borrowers. But HUD has an obligation to protect the FHA program. HUD needs to examine the real results created by reverse mortgages and to thoroughly reconsider the guarantees paid to lenders.

Because we’re in an election year, major changes to the reverse mortgage program are unlikely in 2012. But surely someone at HUD is looking at the numbers and wondering why the FHA continues to guarantee a loan product with inherent flaws.

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3 Responses to “FHA reverse mortgages are flawed and need fixing”

  1. John Says: March 20th, 2012 at 4:52 pm

    The fact that bonds are downgraded means discontinue the program?
    What about all the “forward” backed bonds that have been downgraded?

    Peter, I do really enjoy your writing, but the OMB budget shows the program has a negative subsidy rate (cash flow positive) for the last two years.

    Yes, the program did lose money a few years, but the reality is that it has been improved through raising insurance premiums, lowering the amount available to borrowers, ect.

    John

  2. mtdlv1 Says: March 21st, 2012 at 10:53 am

    Whoa big fella!

    Discontinue the program with reference to product not selling? I understand that the “Big Boys” who got out were concerned that they were going to be forced to evict seniors who aren’t able to pay their taxes and insurance and they didn’t want that to be piled upon the criticizm banks are under already. Also, it seems to me that allowing our parents to remain in their homes is a much better option than forcing them to move into government subsidized housing where they will be just another sad lonely face in a crowded home. Doesn’t it make sense to eliminate the mortgage payment so that keeping up is just that much easier?

  3. Peter G. Miller Says: March 23rd, 2012 at 11:01 am

    John — you make some good points but because of the continuing decline in home values since 2007 HUD will have to face a large number of claims — remember that the typical HECM lasts 6 years…and it’s five years since 2007, meaning that a large number of reverse loans with no equity remain outstanding.

    MTdy1 — I’m all for folks staying their homes, the question is can HUD subsidize such financing at a time when every program that might benefit Main Street is being attacked on Capital Hill? Rand Paul, for one, has suggested eliminating all HUD funding to save money. See:

    Why Rand Paul Is Wrong On Public Housing

    No budget for HUD means no HECMs, housing for the poor, FHA loans, financing for multi-family housing, etc.

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