A study published in July revealed that default rates on reverse mortgages insured by the Federal Housing Administration could be reduced by as much as 50% in light of the agency’s recent rules changes.
This development comes as the FHA wishes to codify those changes and more in a proposed rule “intended to make certain FHA-insured reverse mortgages remain a viable and sustainable resource for senior homeowners …” the agency’s press statement in May read.
Reverse Mortgages for Seniors
FHA’s Home Equity Conversion Mortgage Program is considered the most common, albeit most popular, type of reverse mortgage. A reverse mortgage allows borrowers to withdraw a portion of their home equity; the idea is getting a loan wherein the lender will pay you.
If you are aged 62 and above, have low mortgage balance or own your home outright, and have the ability to pay ongoing property charges like taxes and insurance, you may be eligible for an HECM.
FHA HECM makes available a range of options as to how you will receive the payments, e.g. monthly payments, a line of credit, or a combination of both for adjustable-rate mortgages and a Single Disbursement Lump Sum for fixed-rate loans.
A reverse mortgage is similar to a traditional mortgage (forward mortgage) as they both require your home as collateral. But unlike forward mortgages, reverse mortgages do not require you to repay the loan unless you sell the home, move out, or die. The loan may also become due if you don’t make the necessary payments on property tax and insurance.
HECM Rules Changes
The financial crisis left in its wake a default rate that reached 10 percent in 2013. Moreover, the U.S. Department of Housing and Urban Development (HUD)’s Mutual Mortgage Insurance Fund (MMIF) had a negative balance. These events led to concerns over the solvency of the program and its borrowers.
Against this backdrop, the HUD made two major changes that aim to curb default risk, according to a research brief written by Stephanie Moulton, Donald R. Haurin, and Wei Shi published at the Center for Retirement Research at Boston College. These are:
Initial Principal Limit – A borrower can only withdraw or receive disbursements not exceeding 60% of the principal limit as a lump sum during the loan’s first year.
Underwriting Criteria – Lenders are required to consider a borrower’s credit risk and financial profile when underwriting loans.
The underwriting requirement, which became applicable in April 2015, was something new for HECM loans. Failure to meet such can mean being denied a loan, or setting up a LESA (Life Expectancy Set Aside) escrow account to fund future property insurance and tax charges.
What the Study Says
One concern about the underwriting criteria, the researchers wrote, is that “they could significantly reduce the take-up of HECMs, potentially conflicting with the program’s public mission.” Per the study, only 2% of eligible seniors have so far taken out a reverse mortgage.
The researchers, however, found that “the simulated impact of credit-based underwriting standards on HECM take-up is estimated to be small particularly when such standards are accompanied by a required set-aside for tax and insurance payments rather than a hard cutoff.”
“The combined impact of both types of policies could reduce take-up by 12% – primarily due to the restrictions on the initial withdrawal amount rather than the underwriting criteria,” the researchers said. “However, this impact on take-up is relatively small for a rather large reduction in estimated defaults.”
“… the combined impact of both types of policy changes could reduce property tax and insurance default by as much as 50 percent,” the researchers conclude.
FHA’s Proposed Rule
The proposed rule would enable the FHA to formalize its recent reforms to the HECM program and include new consumer protections for its borrowers.
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The new changes primarily (i) require lenders to disclose in full all features of an HECM loan and pay MIPs (mortgage insurance premiums) until the loan is paid in full, etc.; and (ii) with respect to HECM ARMs, cap increases on lifetime interest rate to 5% and reduce the cap of increases on annual interest rate from 2% to 1%.
In July, the FHA sent out a mortgagee letter containing primarily an updated HECM Financial Assessment and Property Charge Guide and held a subsequent conference call to discuss the recent changes to HECM.
Prior to getting a reverse mortgage, you are required to consult with an HECM counselor to discuss the loan’s various aspects. You can also contact an FHA-approved lender to learn more about the initial withdrawal limit, payment options and more.