Back in September, we identified a looming disaster in the reserve mortgage market and concluded that major changes might be needed to prevent the system from collapsing like the larger mortgage market did in 2008. With a few months behind us, it’s starting to look like we hit the mark: the FHA recently announced sweeping changes to their reverse mortgage products, and hinted that more changes could be coming.
Most importantly, the Federal Housing Administration (FHA) will suspend the fixed-rate Standard Home Equity Conversion Mortgage (HECM) on April 1. Better known as the FHA’s reverse mortgage, the program had been the most popular reverse mortgage loan in the country for a number of reasons:
- Lump Sum Payment: a borrower can take out a lump sum payment for the full value of their reverse mortgage; set monthly payments are also available, but rarely taken.
- High Loan Value: maximum amounts of up to $625,000, much higher than other reverse mortgage products.
- Fixed Interest Rate: allows borrowers to lock-in today’s low rates, while most other private products are adjustable.
Reasons for the Change
Widely seen as the lender of last resort after the 2008 financial crisis, the FHA shouldered huge amounts of risk by continuing to insure loans few other organizations would touch over the last few years. At the time, many analysts predicted that the FHA’s gamble would not pay off and would instead result in significant long-term losses. Those predictions are starting to appear prescient as the latest look at the FHA’s books shows them $16.3 billion in the red, with $2.8 billion coming from the reverse mortgage program alone. With Congressional leaders wary of cutting any more checks for struggling mortgages, the FHA had to find a way out of the problem on its own.
The logic behind the change is very simple: the fixed-rate Standard HECM has been a huge money loser for the FHA for many years. The high loan value combined with a lump sum payment puts the FHA on the line for hundreds of thousands of dollars on each and every single HECM. With seniors feeling the pinch of the weak economy, default rates on HECMs have skyrocketed (reverse mortgage holders default when they fail to pay the taxes or insurance on their homes). The FHA’s hope is that ending the fixed-rate Standard HECM will limit their exposure to the reverse mortgage market or at the least move borrowers to less risky products, like the Saver HECM.
The FHA’s Alternative: The Saver HECM
Even after eliminating the fixed-rate Standard HECM, the FHA will still have three reverse mortgage products: the adjustable rate Standard HECM, the fixed-rate Saver HECM, and the adjustable rate Saver HECM. Except for its interest rate, the adjustable rate Standard HECM is identical to the fixed-rate Standard. The FHA’s other reverse mortgage program, the Saver Home Equity Conversion Mortgage, is different from the Standard HECM in a number of important ways:
- Lower insurance costs – the upfront insurance fee for a Saver HECM is only 0.01%, compared to 2% on a Standard HECM.
- Smaller loan amount – Saver HECMs usually pay out only 66% of what a Standard HECM would pay out.
Importantly, the Saver HECM can be paid out in a lump sum, just like the Standard HECM. The FHA’s recent moves suggest the Saver HECM is their preferred reverse mortgage option; we’ll examine that in the next section.
Predictions and Effects
After the fixed-rate Standard HECM program is suspended, many experts predict that the Saver HECM program will see a large influx of new applicants, since it will be the best program on the market left standing. The FHA’s moves seem to indicate this is the objective, since the Saver HECM program has gone mostly untouched by recent changes. Their hope is that by moving borrowers towards smaller loans, the agency can limit its losses on reverse mortgages.
Critics, however, see things very differently. Jack Guttentag, professor emeritus at the University of Pennsylvania’s Wharton School of Business, states that suspending the fixed-rate Standard HECM will have little effect on solving the FHA’s reverse mortgage problem. Guttentag makes a simple point: the FHA has a problem with borrowers defaulting on their reverse mortgages, not with the amount of the loans they’re defaulting on. Assuming the FHA is successful in redirecting potential borrowers towards the Saver program, they will only be lowering the amount of their losses on each loan, not establishing a sustainable program for the long term.
To fix their program, the FHA needs to find a way to change the type of customer that is takes out HECM products, whether Standard or Saver. Any reverse mortgage that pays out its full amount immediately will be targeted by borrowers with short time horizons, who are the most likely to default on their loans in the future. Instead, the FHA needs to end cash-out loans and replace them with reverse mortgages that pay out their balance over time. Not only would this approach protect their bottom line, but it would be more in line with the FHA’s goal of keeping struggling seniors in their homes, since long-term payments encourage stability.
However the FHA goes about reforming its mortgage program, one thing is clear – it can’t continue to sustain losses like it has over the past few years. Returning long-term stability is vital, especially if the FHA wants to continue to play a major role in the mortgage market.