Thursday, July 16, 2015

The New Reverse Mortgage: How These Loans Work

Reverse mortgages have mystified and befuddled older homeowners for too long. Now, with significant changes in the FHA Reverse Mortgage program, it’s a worthy method to consider for improved cash flow when needed.

The subject of reverse mortgages has long been riddled with misinformation, misunderstanding, and myth. But recent changes in reverse mortgages and new program guidelines make the new reverse mortgage worth considering. Financial advisors can now more confidently recommend FHA Reverse Mortgages to improve the cash flow of their
older clients when appropriate. 


Unfortunately, in recent years the media has not painted a very flattering picture of the reverse mortgage loan program. Fortunately, things have changed. 

There are now many new ways a reverse mortgage can be used to help make life easier and safer for an older homeowner. The National Reverse Mortgage Lenders Association (NRMLA) didn’t think the general public knew enough about the new safety features of today’s reverse mortgage. That’s why in the summer of 2014 they launched a pilot program of radio, TV, and Internet commercials, along with some print media focused in test markets in Philadelphia, Denver, and Seattle. These commercials were designed to educate older homeowners and their families about the new, safe ways a reverse mortgage can be used. Take the time to inform yourself about the new reverse mortgage, without a sales pitch by visiting NRMLA’s new website with its Smart Choice theme: www.newreversemortgage.org

In today’s reverse mortgage landscape, more than 90 percent of these loans funded are insured by the Federal Housing Administration (FHA). The FHA reverse mortgage is called the Home Equity Conversion Mortgage (HECM). The HECM came into being in 1988-1989 at the urging of President Ronald Reagan. He and the White House Council on Aging saw the reverse mortgage program as a great financial instrument in helping older home owners age in place successfully. Since 1989, the HECM has become the most popular reverse mortgage because of the insurance backing it receives from the federal government,
the ease of qualifying, and the most flexible payback plan imaginable.

What is a reverse mortgage? In a nutshell, the HECM reverse mortgage enables homeowners who are sixty-two and older to access a portion of their home’s equity without the requirement of making monthly mortgage payments as long as they live in that home. HECM borrowers are still the owners of their homes, so they must continue paying property taxes, home insurance, and any other applicable property charges. The money received from a reverse mortgage is tax-free and homeowners may use the funds in any way they choose. The HECM reverse mortgage has a non-recourse feature, meaning that homeowners, and their heirs, are never responsible for paying back more than what their home is worth at the time it’s sold. 
This is because the FHA mortgage insurance protects the homeowner and the reverse mortgage lender. 

During the U.S. credit crisis in 2007-2009, there was concern that the HECM program may not have enough funds to continue insuring all of these reverse mortgages. Something needed to be done to protect the program and keep it available for the upcoming baby boomers who would begin retiring in 2011. For the record, that’s ten thousand baby boomers turning sixty-five each day for the next eighteen years. 

In August 2013, Congress passed and President Obama signed the Reverse Mortgage Stabilization Act of 2013. This amendment authorizes the Secretary of Housing and Urban Development to “establish, by notice or mortgagee letter, any additional or alternative
requirements that the Secretary, at the Secretary’s discretion, determines are necessary to improve the fiscal safety and soundness of the program.” 

There were several areas the Secretary decided were of critical importance to “realign the HECM program with its original intent, and thereby aid in the restoration of the government’s Mutual Mortgage Insurance Fund, and help ensure the continued availability of this important home loan program.” The key areas to address were as follows:

1. Reduction in the Principal Lending Limits. (Enacted on September 30, 2013.)
2. Restricting the Initial Disbursement limits. (Enacted on September. 30, 2013.)
3. Addressing the Non-Borrowing Spouse (NBS) homestead rights. (Enacted on August 4, 2014.)
4. Implementing a Financial Assessment. (Expected enactment, April 27, 2015.)


Reduction in the Principal Lending Limits


Prior to September 30, 2013, sixty-two-year old homeowners could borrow up to 61.9 percent of the appraised value of their home with the HECM. If the borrowers chose to take the full draw of funds that was available to them, it was likely they would be left with little to no equity in their home by the time they reached the ages of eighty-one to eighty-four (this is based on an annual home value appreciation of 4.0 percent each year.) As of today, the average American life expectancy is approximately eighty-two years. If the FHA continued to allow this type of borrowing, they would not have enough money in the Mutual Mortgage Insurance Fund to pay all of the projected claims.


With a HECM, borrowers are never required to pay back more than what their home is appraised at the time the home is sold. For example: If an eighty-five-year-old borrower who had a reverse mortgage sold her home with an outstanding reverse mortgage
balance of $250,000, but her home could only sell for $200,000, the servicing lender would be shorted $50,000. That’s where FHA comes in. FHA insures that the homeowner is only required to pay back the outstanding loan balance or 95 percent of the appraised
value—whichever is less. In this case, where the home can only sell for $200,000 (this price/value must be confirmed by an FHA appraiser), the homeowner only has to pay back 95 percent of the $200,000 sale price, which comes out to $190,000. Since the servicing
lender will now be shorted $60,000, FHA must pay the difference to the lender for the borrower.


The homeowners were able to borrow their home equity with an income-tax-free HECM, didn’t have to make any monthly mortgage payments for years, maybe even decades, and still not have to repay the entire loan since their home wasn’t worth enough. This
scenario is great for the borrower, but very expensive for FHA. With the influx of baby boomers and more HECM borrowers taking lump-sum distributions at earlier ages, FHA could see the handwriting on the wall and its message was loud and clear: FHA could
not afford this. 


The Solution. Effective September 30, 2013, FHA reduced the HECM Principal Limits from 61.9 percent for a sixty-two-year-old borrower down to 52.4 percent. For a ninety-year-old or older borrower, the Principal Limits were reduced less, from 77.6 percent down to 75 percent currently. Older HECM borrowers can access a larger percentage of their home’s equity. FHA also increased their Initial Mortgage Insurance Premiums by 0.50 percent. The last part to this solution was putting some restrictions on how much money borrowers could draw within the first twelve months of their HECM being opened.

Restricting the Initial Disbursement Limits

There was another concern for the HECM loan program. Strong evidence showed that borrowers who withdrew the majority of their HECM loan proceeds within the first twelve months of opening their loan, were much more likely to default on paying their property
taxes, homeowner’s insurance, or other property charges in the future. Borrowers who fail to pay these property charges put themselves at risk of foreclosure. Foreclosing on an older homeowner is the last thing any lender wants to do, but it was happening too often.

In a detailed report in 2014 prepared by Stephanie Moulton of the John Glenn School of Public Affairs, along with Donald Haurin and Wei Shi of Ohio State University’s Economics Department, showed that 9.4 percent of all HECMs are currently in default. The
most prominent cause for these defaults was HECM borrowers not paying their property charges on time. According to HUD, property charges include property taxes, hazard insurance premiums, any applicable flood insurance premiums, ground rents, condominium fees, planned unit development fees, homeowner’s association fees, and any other special assessments that may be levied by the municipalities or state law.


One item that Moulton and her associates discovered in their study of thirty thousand older homeowners who received counseling for a reverse mortgage, was that by limiting the initial disbursements on a HECM, defaults are expected to be reduced by more
than 20 percent. 


In many cases when a HECM borrower defaulted, the problem was remedied by the borrower or the borrower’s heirs. Sometimes the homeowner’s children paid the property taxes or insurance to cure the default. Other times, the problem was remedied by the borrower, or the heirs, selling the home when it became too expensive to keep. To say that all defaults end in foreclosure is not true. But avoiding defaults is still a top concern for FHA, reverse mortgage lenders, and most importantly, older homeowners.

The Solution. On September 30, 2013, FHA set forth limitations on the amount of HECM loan proceeds that can be advanced at loan closing, and during the First 12-Month Disbursement Period after loan closing. Policies were implemented that allowed for paying off Mandatory Obligations, such as existing traditional mortgages, home equity lines of credit, property taxes, judgments, loan closing costs, and required home repairs that can be paid at closing with HECM loan proceeds.


After those Mandatory Obligations are satisfied, borrowers are limited to only withdrawing up to 10 percent of their Principal Limit in additional cash at closing. Any remaining funds in the HECM cannot be accessed until the First 12-Month Disbursement Period has lapsed. At that point, there are no disbursement restrictions. 


To illustrate how the First 12-Month Disbursement Limit works, here’s a real-life client’s experience. The eighty-year-old client’s home in Portland appraised at $355,000. He had an existing mortgage balance of $110,000, on which he was paying $825 a month in principal and interest. Given his home’s appraisal, he qualified for a $233,235 Principal Limit (total loan amount).

The client could now pay off that existing mortgage, pay his 2015 property taxes, HOA dues, cover all of his closing costs, and still receive over $20,000 cashout at closing. The remaining funds from his reverse mortgage ($93,500) could be accessed next year without
restriction using the built-in line of credit feature of his loan.


By using this option with his new HECM, the client’s Initial Mortgage Insurance Premium was $1,775, or 0.50 percent of his home’s appraised value. If he had a larger existing mortgage balance that had to be paid off, or additional Mandatory Obligations that required him to access more than 60 percent of his available Principal Limit, his Initial Mortgage I Premium would have gone up to $8,875, or 2.50 percent of his home’s appraised value. With larger initial disbursements, FHA charges more for the mortgage insurance to cover the additional risk. 


Addressing the Non-Borrowing Spouse (NBS) Homestead Rights 

In the past, some homeowners would choose to remove a younger spouse from the title of their home in order to qualify for a HECM reverse mortgage. Since a person needs to be at least sixty-two years old to qualify for a HECM, a spouse who was sixty-one years old or younger could elect to be removed from the title, in order to obtain the reverse mortgage in the qualified spouse’s name only. This can be problematic because if the older spouse who is covered by the HECM dies before the non-borrowing spouse (NBS), the NBS would be forced to refinance or sell the home within six to twelve months of the death of
the HECM-covered spouse. Obviously, this could put many NBS in harm’s way. This particular issue became a hot button in the national media and needed to be addressed by FHA.


The Solution. On August 4, 2014, FHA issued a new Mortgagee Letter that allowed for new HECM loans to protect the younger non-borrowing spouse by giving new Principal Limit factors for borrowers using the NBS option. Now a HECM loan with a NBS can still be funded, and both the borrowing spouse and the NBS can live in that home for the rest of their lives without being required to make monthly mortgage payments. Technically, a ninety-year-old borrower with an eighteen-year-old spouse could take out a HECM reverse mortgage and both will be protected from making monthly mortgage payments as long as
at least one of them still lives in that home.


There is a catch! The Principal Limits can be greatly reduced to offset the risk that FHA is assuming. For example, a sixty-five-year old can access 54.2 percent of the value of the home with a HECM. If that same person had a fifty-one-year-old spouse, they would be
limited to accessing only 46 percent of the value of their home, up to the maximum home value allowed by FHA, which is $625,500. In the case of the ninety--year-old with the eighteen-year-old spouse, they’re limited to accessing only 31.7 percent of the equity in
their home. 


Implementing a Financial Assessment

Going back to the study performed by Stephanie Moulton and her team at Ohio State University, they found that utilizing credit criteria as part of a financial assessment of potential HECM borrowers can reduce the probability of future defaults. They showed that
adding a minimum FICO credit score of 500 is predicted to reduce HECM defaults by about 12 percent, while a minimum FICO score of 580 is associated with a nearly 40 percent decrease in the current default rate. Credit Scores in the 500-580 are considered to be very low. The median personal credit score in the U.S. is nearly 720.


To summarize the findings of the Moulton report, it showed that by limiting the initial disbursements in the first year of a HECM, implementing a basic credit score requirement, monitoring the property tax to income ratios, and factoring in the borrower’s previous
mortgage payment and property tax payment history, future HECM borrower defaults are expected to reduce significantly. 


The Solution. After several delays, FHA will roll out their Financial Assessment policies by April 27, 2015. 

Once the Financial Assessment piece is in place, there could be a dramatic change in the perception of reverse mortgages. With so many safety improvements made to the reverse mortgage program, it will become more appealing to retired and retiring Americans in the coming years. Having protection for the non-borrowing spouse and preserving more home equity for people who want to age in place, will only strengthen the perception of this important loan program. By performing a credit and income qualification process for
HECM borrowers to make sure they can afford to, and demonstrate a willingness to, pay their property taxes and other related property charges, the reverse mortgage program will be a much more attractive option for older adults today and in the future. •CSA


Mark Eshelman, CSA, has been a Loan Officer for over eighteen years and is a Reverse Mortgage Lending Officer at Banner Bank in Vancouver, Washington. He has a bachelor’s degree from Concordia University in Portland, Oregon, and he serves on the Housing Committee for the Clark County Commission on Aging. Contact him at MEshelman@bannerbank.com.

The New Reverse Mortgage: How These Loans Work was published in the Spring 2015 edition of the CSA Journal. 

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