Mortgage

Study: Recent changes to reverse mortgage rules cut default risk in half

New report from Center for Retirement Research at Boston College lauds HECM program

A new study from the Center for Retirement Research at Boston College states that recent changes made to the rules governing reverse mortgages, specifically those that are part of the government’s Home Equity Conversion Mortgages program, will dramatically cut the risk of default for borrowers.

According to the Boston College study, a combination of policy changes from 2013 and 2015 are projected to cut the number of defaults on new reverse mortgages by 50%.

A reverse mortgage is similar to a traditional mortgage in that it is a loan with the borrower’s home as collateral, but unlike a traditional mortgage, borrowers do not have to repay the loan as long as they remain in their home.

Reverse mortgages are only available to borrowers that are 62 or older and either have already paid off their forward mortgage or be able to pay it off with proceeds from the reverse mortgage.

For some older homeowners that are potentially in need of additional income, a reverse mortgage allows them to take the equity out of the house through lump-sum withdrawals, regular payments, or a line of credit.

The loans do not need to be paid off until the borrower dies, sells the house, or moves.

The program changes, which are designed to prevent HECM borrowers from missing their property tax and insurance payments, should help borrowers avoid falling behind, the study showed.

The study used data analysis and modeling to compare borrowers who defaulted on a reverse mortgage prior to the policy changes to new borrowers with similar financial characteristics, and found that the new policies are working and will continue to do so.

The changes to the HECM policies were initiated as a result of a rising reverse mortgage default rate in the wake of the financial crisis. According to the study, the default rate for reverse mortgages hit 10% in 2013.

Add in the negative balance in HUD’s flagship insurance fund at the time, and concerns about the program arose, the study notes.

In response to those issues, HUD announced two significant rules changes to the HECM program.

The study, which is authored by Stephanie Moulton and Donald Haurin from the Ohio State University and Wei Shi from Jinan University, recaps those rules changes as such:

The first, which took effect in 2013, restricts the amount that a borrower can withdraw as a lump sum in the first year of the loan to 60 percent of the initial principal limit,” the study states.

The second, which took effect in April 2015, requires lenders to underwrite HECMs by taking into account an applicant’s financial and credit risk profile in deciding whether to approve a loan. While underwriting is standard practice for forward mortgages, such a requirement is new for HECMs. Applicants who fail to meet the new criteria can: 1) be denied a loan; or 2) be required to set aside a portion of their available principal in an escrow account – known as a Life Expectancy Set Aside – managed by the lender to cover future property tax and insurance payments.

The study notes that currently only 2% of eligible seniors have a reverse mortgage, but state that demand has risen over the last 10 years.

In fact, the Federal Housing Administration’s Mutual Mortgage Insurance Fund topped its Congressionally mandated threshold of 2%, due in large part to the growth of the HECM program.

The FHA said late last year that its latest independent actuarial analysis shows the MMI Fund’s capital ratio stands at 2.07%, well above the 2014 level of 0.41%.

According to analysis from Compass Point Research and Trading, much of the increase to the FHA’s MMI Fund was driven by the FHA’s Home Equity Conversion Mortgage program.

Without the HECM program, the MMI Fund would sit at 1.65%, below the 2% threshold set by Congress, the Compass Point analysts noted.

“In fact, the FY15 economic net worth projections for forward mortgages of $17 billion increased only marginally from the $16.2 billion estimate released last year,” Compass Point’s Isaac Boltansky and Amy DeBone said last year. “The HECM economic net worth of $6.8 billion, on the other hand, far exceeded the previous estimate of negative $1.1 billion which drove the overall MMIF capital ratio crossing the 2.0% threshold this year.”

And according to the Boston College study, thanks to the new reverse mortgage rules, the default rate is projected to go down, which would only serve to further strengthen the FHA’s fund.

“Reverse mortgages could become increasingly popular as more households reach retirement with insufficient income. However, a recent concern is a rising default rate among borrowers. HUD has responded by restricting initial withdrawals and introducing underwriting criteria. According to the analysis (presented in the study), the combined impact of both types of policy changes could reduce property tax and insurance default by as much as 50%,” the study’s authors write.

“One of the concerns about imposing underwriting criteria is that they could significantly reduce the take-up of HECMs, potentially conflicting with the program’s public mission,” the authors continue.

“However, 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 authors conclude. “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. However, this impact on take-up is relatively small for a rather large reduction in estimated defaults.”

Peter Bell, the president and CEO of the National Reverse Mortgage Lenders Association, heralded the study’s results.

“Reverse mortgages work best when loan proceeds are used slowly and as part of a broader financial plan. As an industry, we worked with policymakers to craft reforms that would help more borrowers manage their funds over time,” Bell said.  “The CRR Brief reaffirms our message that reverse mortgages are a safe financial tool that older homeowners can use to supplement their retirement income.”

The study can be read in full here.

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