The mortgage market is sort of like that Britney Spears song, “Oops!...I Did It Again.” (All of you rolling your eyes, just bear with me).
First, it played with our hearts: Homeownership in the United States peaked at 69.2% in 2004.
Then it got lost in the game: The housing bubble burst, thanks in large part to shady lender practices, and by the beginning of 2012 one in four mortgages was underwater. As a result, there were an awful lot of people saying oops: Numerous executives, including former head of Fannie Mae Franklin D. Raines, were forced to resign amid scandal.
We eventually thought everything was peachy again, that some sort of deus ex machina had intervened: We’ve seen record low interest rates for both 15- and 30-year mortgages.
But it ultimately turned out to not be that innocent: Lack of foresight among regulators and unscrupulous lenders have once again combined to manufacture a flawed mortgage product that has the potential to not only harm those that use it, but everyone else as well.
The product in question is something called the Home Equity Conversion Mortgage, or HECM for short. It’s a type of reverse mortgage that allows homeowners age 62 and up who have paid off at least a considerable portion of their mortgage to borrow cash using home equity as collateral. HECMs allow borrowers to choose a number of different disbursement options, including equal payments for a set number of months, equal payments as long as one lives in their home, payments based on use of a line of credit, and combinations of these structures.
HECMs have become the dominant type of reverse mortgage since the Great Recession due to a combination of the lending squeeze brought on by the widespread foreclosures during the downturn and the fact that they’re the only type of reverse mortgage insured by the federal government (the Federal Housing Administration, to be specific). With many seniors across the country finding that their Social Security benefits don’t quite provide the retirement income they need, let’s just say HECMs are popular.
So, what’s the problem again?
For one thing, HECMs are grossly overpriced (spoiler alert: added revenue doesn’t go to the government either), according to Jack Guttentag, professor emeritus at the University of Pennsylvania’s Wharton School of Business.
“Lenders compete, but not in terms of price because lower prices won’t generate more business,” he wrote in an e-mail. “Borrowers are unsophisticated; HECMs are sold, not purchased.”
Lenders sell seniors on HECMs by focusing on what the loans can do for them, such as helping them pay the bills and live more comfortably during retirement. They often use aging celebrities as endorsers, and the trust that many have in these public figures, coupled with a lack of knowledge about the reverse mortgage market, leads many to believe that the price of a HECM is what it is. In reality, it’s negotiable.
The result is a system in which HECM originators pay four-to-five times for each lead than they would for other types of mortgages, and loan officers garner commissions of 3-4% of the loan amount. The high profit margins are a gold mine for those involved in selling HECMs and a burden for those doing the buying.
Buyers aren’t the only ones feeling the burden of HECMs either. Lenders and the FHA are starting to as well, and we could all be affected at some point. It’s become a trend among HECM borrowers to simply default on their property taxes and home insurance payments because there’s really no incentive to pay them. While traditional mortgages require that payments be placed in an escrow account to ensure the borrower’s ability to make them, the fact that borrowers don’t have a monthly payment obligation made this unnecessary for HECMs, at least in the minds of regulators. The problem is, many HECM borrowers are also unconcerned with the typical penalty for lack of payment, a property lien that prevents refinancing or property sale, because they never intend to do either.
For this reason, Guttentag says that regulators dropped the ball.
“They assumed that since HECMs require no monthly payment, borrowers would have no difficulty paying their taxes,” he wrote. “They lost sight of the fact that borrowers who use up all their equity have no incentive to pay taxes except to avoid foreclosure, and to my knowledge, FHA has yet to approve a HECM foreclosure.”
In other words, it would be a PR debacle to start kicking the elderly to the curb because they haven’t paid property taxes, so loan providers and the government are eating losses.
It will help that the “FHA collects hefty insurance premiums to cover losses, and they raised the premium recently,” Guttentag notes. But “how this will pan out remains to be seen. A lot depends on what happens to house values.” The problem with raising insurance premiums is that doing so forces the responsible borrowers to pay for the irresponsible folks’ mistakes. Instead, the FHA should implement the same type of escrow system for HECMs that is utilized for all other mortgages.
And finally, when it comes to counting on home values to rise, well, we all know how that type of thinking has panned out in the past.
Image: retrorocket / iStock.