Editor’s note: This is Part 1 of a six-part series. Read Part 2, Part 3, Part 4, Part 5 and Part 6.
A reverse mortgage is a loan to an elderly homeowner on which the borrower’s debt rises over time, but which needn’t be repaid until the borrower dies, sells the house or moves out permanently. The role of the reverse mortgage is to put more money in the pockets of seniors by allowing equity depletion while they are still alive.
The "forward" mortgages that are used to purchase homes build equity — the value of the home less the mortgage balance. Borrowers pay down the balance over time, and by age 62, when they become eligible for a reverse mortgage, loan balances are either paid off or much reduced.
Reverse mortgages, in contrast, consume equity because loan balances rise over time. If there is a balance remaining on a forward mortgage at the time a reverse mortgage is taken out, it is paid off with an advance under the reverse mortgage.
The HECM program: Virtually all of the reverse mortgages written today are insured by the Federal Housing Administration (FHA) under the Home Equity Conversion Mortgage (HECM) program authorized by Congress in 1988. FHA insures the lender against loss in the event the loan balance at termination exceeds the value of the property. It also ensures the borrower that any payments due from the lender will be made, even if the lender fails.
The HECM program began slowly, with only 157 loans written in 1990, but by 2000 the number had grown to 6,600. In 2009, about 130,000 HECMs will be originated. The reverse mortgage market seems to have come of age. However, the financial crisis has taken its toll.
Credit tightening has not impacted reverse mortgages: On the positive side, the reverse mortgage market has not been impacted by the crisis-induced tightening of credit standards that has plagued the market for forward mortgages. There are no credit requirements for reverse mortgages. Similarly, the requirement that all forward mortgage borrowers must fully document their incomes has not affected reverse mortgage borrowers who are not subject to income requirements.
Private reverse mortgages have disappeared: For a time, the HECM program served as a "demonstration," stimulating the development of private programs. Just before the crisis, I counted seven such programs. They are now all gone.
The cause was a loss of funding. Private reverse 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 originators of private reverse mortgages had no place to sell them. …CONTINUED
The major focus of the private programs had been the high end of the market that the HECM program did not serve well because of FHA loan limits. The private programs had allowed owners of higher-value houses to borrow larger amounts than were possible with a HECM. Their loss left a hole in the market.
Declines in home values reduce borrowing power: Seniors with properties of modest value who, prior to the crisis, were not constrained by FHA loan limits, found their HECM borrowing power reduced. If a house declines in value by 30 percent, the amount that can be borrowed against it also declines by 30 percent.
Declines in home values create losses for FHA: Losses to FHA from insuring HECMs arise when loan balances come to exceed property values. If home prices are rising, as they were until 2006, most HECMs will terminate before this loss point is reached, and FHA’s insurance premiums generate net profits for the government. The sharp decline in house values since 2006, however, is converting those profits into losses. In response, on Sept. 23, HUD announced a 10 percent reduction in the percent of property value that seniors can borrow. A second decline may be in the cards.
Funding of HECMs under pressure: Fannie Mae had been the major source of HECM funding since the program began, but the financial crisis raised doubts about whether this would continue. In September 2008, the heavy losses suffered by Fannie Mae and Freddie Mac, much of it related to their investments in subprime mortgage securities, forced the government to place the agencies in conservatorship. They are now wards of the government with a very uncertain future.
To de-emphasize its role and hopefully attract other investors, Fannie Mae in March increased its rate margins on adjustable-rate HECMs. This shocked many seniors because higher rate margins reduce the amounts they can borrow, and it traumatized many lenders who had to explain the bad news to seniors who had HECMs in process.
To date, no private investors have come forward, but Ginnie Mae, a federal agency that insures securities issued against FHA and Veterans Affairs (VA) forward mortgages, has been filling the gap. It began its program of insuring HECM securities in 2007, and is gradually expanding into the space being vacated by Fannie Mae.
Congressional efforts to contain the damage: Actions taken by Congress as part of broader efforts to support the housing market have partly offset the adverse consequences of the financial crisis. In 2008, the system of setting maximum loan amounts on HECMs for each county was replaced by a uniform national limit of $417,000. Early in 2009, the limit was raised temporarily (through 2010) to $625,500. This has helped fill the void left by the loss of private reverse mortgage programs.
In addition, Congress authorized a "HECM for Purchase" program under which seniors could buy a house with a reverse mortgage, and a fixed-rate HECM well-suited for seniors looking to purchase a house. These programs are discussed next week.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
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