Reverse mortgages are set for their second major change in less than a year. Growing problems with loan defaults—estimated to have increased in recent years to about 5 percent of all outstanding reverse mortgages—have prompted regulators at the U.S. Department of Housing and Urban Development to begin drafting new oversight rules. They would require loan applicants to demonstrate their ability to pay property taxes and home insurance premiums on their properties. The rules would apply to the government's home equity conversion mortgage (HECM) program, under which nearly all reverse mortgages are made.
Reverse mortgages have been hailed by supporters as a way for cash-strapped seniors (the youngest borrower in a household must be at least 62 years old) to tap a portion of the equity in their homes and free themselves from future mortgage payments. Under the terms of a reverse mortgage, the loans are, in effect, paid off to lenders using the remaining equity in the home that has not been paid to homeowners. Homeowners can stay in their homes as long as they're able, even after these repayments and loan fees have exhausted all of the remaining equity in the home.
However, the fees for reverse mortgages have been criticized by consumer groups as too high. And there were past abuses in which aggressive marketers convinced seniors to take out reverse mortgages and put the loan proceeds into expensive investments that were not in their best interest.
Last fall, the Federal Housing Administration—the arm of HUD that oversees the HECM program—introduced a new HECM Saver loan that features very low upfront fees. It also pays out a smaller percentage of a homeowner's equity than a standard HECM loan. This provides a larger equity cushion against loan losses and possible claims on the FHA insurance that provides safeguards to HECM borrowers and lenders.
Now, another large change in the program is under discussion, driven by the growing number of loans that are in default. While reverse mortgage borrowers no longer have to make mortgage payments to stay in their homes, they do have to pay taxes, insurance, and other upkeep expenses.
For a variety of reasons, many reverse mortgage borrowers have had problems making such payments. John Lunde is president of Reverse Market Insight, a research firm that works closely with HECM lenders and brokers to track industry operations. In a sample of firms servicing about 20 percent of the roughly 550,000 still-active HECM loans, Lunde says, "about 4 to 5 percent of the outstanding loans might be in default."
A report last year from HUD's Office of Inspector General identified about 13,000 loans in default among four large industry loan servicing companies. Peter Bell, president of the National Reverse Mortgage Lenders Association (NRMLA), said an informal member survey last year generated a rough estimate of as many as 28,000 loans in default.
While there is general agreement that defaults have been growing and are unacceptable, there have been few actual foreclosures on HECM borrowers. Under terms of the FHA insurance program, HECM lenders are responsible for keeping tax and insurance payments current on their loan properties. Thus, the lenders have been stepping in to make payments missed by homeowners. In some cases, the payments have come from remaining equity in the homes but in others, they have come from the lender's own pocket. The four servicers in the Inspector General's report last August, who were not identified, had made $35 million in such payments, the report said.
In order to actually move ahead with the foreclosure process on a HECM loan, Bell explains, lenders must formally ask the government for permission to issue a due and payable notice to delinquent borrowers. However, until recently, HUD declined to approve such requests, he said, and placed them in a "pending" category. This action kept loan insurance in place but did not guide lenders in how to help resolve the underlying default problems.
"The industry has been asking HUD to provide definitive guidance on how to deal with this population of loans for several years," Bell said. "This [presidential] administration did not run from this" decision. The Inspector General's report criticized the agency for lacking clear default guidelines and recommended it develop them along with other corrective measures.
"Clearly, a reverse mortgage requires a senior to pay insurance and taxes," says Vicki Bott, HUD deputy assistant secretary for single-family programs. "To not have specific actions for servicers to follow ... was a gap in our process regardless of the extent of the issue."
HUD recently required all HECM lenders to begin providing regular status reports on its loans. The reports were due February 7, and Bott said in a recent interview that the agency was still about a month away from being able to provide a detailed assessment of HECM defaults.
In the meantime, HUD has funded stepped-up counseling programs to begin finding ways borrowers can cure their defaults. Bell says information from his association's members indicates that the defaults are not large. About 70 percent of all defaults involved amounts of less than $5,000, he says, and another 15 percent were less than $7,500. About a third of the defaults involved only insurance payments, he says. Slightly less than a third involved insurance and tax payments, and the remainder involved only tax payments.
Bott also said the agency was working with HECM lenders to develop a new rule to reduce defaults on new loans. In the next 60 days, she said, the agency "will actually propose some level of financial analysis for new loans ... and seniors' ability to pay."
Because reverse mortgages are funded with the equity in a borrower's home, the loans have not required borrowers to meet any income or wealth standards. Consumer counseling is formally required for all HECM loan applications, and the continued financial obligations of HECM borrowers should be discussed in counseling sessions. But lenders were not required or able to gauge a borrower's ability to make tax and insurance payments after the loan was made.
Bell said the industry is supportive of a new rule. But he noted that measuring a borrower's ability to pay would need to include both income and asset tests. If there is a need to create a "set aside" to cover future tax and insurance payments, it must be carefully structured. How large would the amount be, for example, and how would it affect the amount of money that consumers can draw down in a HECM loan?
Under current rules, Bell explained, "the senior always has had the option of requesting that a set-aside be created for them. The lender has to offer that to them. However, most of them do not take it, because they want the greatest amount of money" paid out to them.