Written by Mark Browning, as originally published in The Reverse Review.

$176,900 // According to the National Association of Realtors (NAR), this figure represents the 2012 national median sales price for existing single-family homes. Since the median is the middle, this means that half the homes that sold in 2012 were higher in value and half the homes were lower. It is a representative proxy for the middle ground of the American housing scene.

$110,000 // This figure represents the approximate net amount available to a 72-year-old borrower on a national median-value home. The HECM Saver, the more cost-effective consumer

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option, generates approximately $89,000. As a function of today’s low interest rates, this is the highest level of proceeds possible under the HECM program. When interest rates normalize, proceeds will decline considerably. A modest 2 percent rise in long-term interest rates will cut proceeds by nearly one-third.

But the national median sales price does not reflect the complete picture. Of the 153 metropolitan statistical areas that contained data in NAR’s fourth-quarter 2012 report, two-thirds reported median home values significantly below the national level. The median value among these communities is approximately $139,000. This means that proceeds from Standard and Saver HECMs would be $85,000 and $71,200, respectively. These are large communities like Chicago, Houston, Atlanta, Minneapolis, Phoenix, Dallas and New Orleans. They are also midsized communities like Cleveland, Charlotte, Indianapolis, St. Louis, Kansas City and Buffalo. Then of course, there are smaller communities like Lincoln, Charleston, Cedar Rapids, Abilene and Florence. In short, these communities are a cross section of America.

14 Years // This figure represents the approximate life expectancy of the typical 72-year-old HECM user. This, coupled with Middle America’s home values, is a sobering statistic when setting the expectations for a HECM.

The HECM reverse mortgage program is at an intersection in its evolution. The models that HUD uses for forecasting and budgeting project the HECM book of business to be losing money, and that result is simply not acceptable in the current Washington climate.

The reasons for the projected losses stem mainly from the housing bubble and fall into three general categories:
-Geographic concentrations of risk and the impact of home price appreciation assumptions
-High principal use by consumers (coupled with other risks)
-Higher-than-expected tax, insurance and property charge delinquencies

The FHA has responded to this challenge with a two-pronged strategy. The preferred method is to write new rules that will qualify homeowners on their ability to pay future property charges, establish set-asides or escrows for property charge payments, and limit the ability of the homeowner to make discretionary draws. However, to make these changes, HUD first has to obtain the authority through legislative action. In the absence of authorizing legislation, the FHA has said it will reduce principal limit factors.

As all of this is going on, it is essential to keep a focus on the core objectives of the program. It is well known that much of the American middle class is woefully underfunded for retirement. Access to housing wealth, one of the largest assets of many in the middle class, is an essential element of the solution. In a December 2012 report, the Society of Actuaries reported that an astounding 83 percent of the net worth of Middle Mass Households (25th – 75th deciles) came from non-financial assets—mainly housing.

However, as the home value figures plainly reveal, a HECM on a home that represents a typical value in America can not always be expected to provide the entire financial solution for a lifetime. The idea that a HECM can be a lifelong solution for every homeowner is a recent, but unrealistic, aspiration. The realization that it may not be a failsafe lifetime solution should not exclude middle-class homeowners and families from Middle America from accessing a tool that provides significant but imperfect quality-of-life improvements. A HECM can greatly prolong a senior’s capacity to comfortably stay at home and provide meaningful benefit. Aging in place is the overwhelming preference of senior homeowners. If the HECM is to help solve the crisis facing the middle class, its design and expectations must reflect the financial realities of Middle America.

Geographic Distribution of the HECM
$252,000 // According to the FHA’s “Snapshot” report, this figure is the average value of a home securing a HECM originated in federal fiscal year 2012. This is a different figure than the national housing market. The difference can be partly explained by the history of the HECM. While industry lore has it that the first HECM was originated by James B. Nutter & Company in the heartland, the HECM market largely evolved in the major metropolitan areas along the coasts. As recently as 2006, nearly 50 percent of all HECMs were originated in California, Florida and parts of New York.

The fundamental challenge to HECM profitability stems from the housing price bubble. From 2003 through 2009, one-third of all HECMs originated nationally were concentrated in just two states: California and Florida. Magnifying the impact, the years 2006 to 2009 were among the largest production years for the HECM, resulting in large books of business compared to the entire population of HECMs. Unfortunately, these two states were also among the worst hit by the housing crisis. From 2003 to 2006, home values in California and Florida increased by 63 and 67 percent respectively. From 2007 to 2010, both states lost their entire gains. Meanwhile, 187,080 HECMs were originated in these two states at unstable values.

In 2012, HECM originations in these two states returned to levels that were representative of the number of 65-plus seniors in each state, with 11 percent for California and 8 percent for Florida. In fact, for the first time in the history of the HECM program, HECM origination volumes by state are proportional to the populations of nearly every state. This represents a major milestone that marks the normalization of geographic risk for the program. Upcoming program changes must not undo this progress.

Utilization
A second, related “problem” with the HECM is that consumers are using it. The amount of funds drawn in the initial year has been increasing for years—well before the advent of the closed-end, fixed-rate product. In its June 2012 report, the CFPB stated that the median HECM user between 2006 and 2008 drew between 73 and 88 percent of their available line during the first year.

The full-draw, fixed-rate product was introduced in 2009 and represented slightly less than 70 percent of HECM originations when the Standard version of the product was discontinued in April 2013. Coupled with bad housing markets, high utilization rates amount to a tough problem.

Tax and Insurance Delinquencies
A third, more manageable situation has emerged with rising homeowner tax and insurance delinquencies. Tax, insurance and property charge delinquencies are now occurring on approximately 9.8 percent of active loans. The delinquency rates are balanced between insurance, taxes and both. HUD data also shows that the period from origination to tax or insurance default became shorter each year through 2010, but the last two years have shown improvement. Some of the rise in delinquency is likely attributable to the extremely difficult economic environment of the past several years. Another portion is attributable to the soaring costs and limited availability of homeowner’s insurance in the Gulf states following the devastating hurricane seasons of 2004 and 2005. Changing financial circumstances and other complications of an aging constituency surely account for more. According to U.S. Census data, approximately one-third of married females entering into a HECM loan will be widowed within 10 years (16 percent for males) triggering major income and life changes. But, undoubtedly, there is a portion of borrowers whose propensity not to pay, or a near-term inability to pay, could have been detected at origination with a more thorough financial assessment of the homeowners.

The FHA has concluded that the likelihood of property charge default increases for the first four years and then declines gradually thereafter. This strongly indicates that the critical factor is the evaluation of propensity (credit and tax/insurance history) and near-term capacity, versus lifetime sustainability. Protections against adverse selection at origination are essential, but excluding large populations of users who have no intention of staying in the home for a lifetime is excessive and punitive.

Merging of Issues
As the media and the industry have picked up on these facts, two separate and distinct challenges have been bundled into one. Geographic concentrations of HECM originations in bad markets are combined with property charge defaults. However, that is simply not an accurate reflection of the facts; the two are independent situations. For example, California significantly outperforms the nation on the tax and insurance matter, but has a bad hangover on collateral value. By bundling the issues, we are misled to believe that the major problem facing HECM finances are the administrative matters of financial assessment, property charge escrows and high consumer utilization.

While taxes and insurance are important and require prompt attention, geography and home price declines are the major headwind confronting the HECM. Concentrations of risk are managed at the macro policy level, not the loan level. We should be careful not to overstate the significance of financial assessment. It can lead to the wrong conclusions and overreactions.

The Law of Unintended Consequences
Social scientists and economists have long recognized, and often ignored, the law of unintended consequences. This is the recognition that the actions of people and especially governments always have consequences that were not anticipated. It is a powerful rationale for taking restrained and incremental actions, then evaluating the results before doing more. The FHA is discussing making simultaneous, high-impact changes to the HECM program involving three interdependent factors: consumer qualification criteria, consumer impounds and set-asides, and consumer usage restrictions. Clearly, doing all of this at the same time will result in unanticipated consequences, particularly if the changes are major.

Here are some of the risks:
-Raise barriers and impediments that cause the HECM to be less appealing as a planning tool (i.e., a component of a comprehensive retirement financial plan)

-Reinforce the marginalization of the HECM as a “loan of last resort,” which carries adverse implications for user diversity

-Incent high levels of existing indebtedness entering into a HECM

-Advantage high-cost coastal markets with a higher amount of proceeds and a lower tax-to-house price ratio

-Disadvantage broad geographies with modest median home values with a lower amount of proceeds and a higher tax-to-house price ratio

-Skew toward the more expensive Standard product versus the consumer-friendly Saver product

-Skew against consumers with short (lower risk) holding time expectations

It is easy to make the HECM failsafe by excluding too many qualified prospects, particularly in the moderate housing price range. The more difficult equation is to make the program equitable and inclusive while balancing against excessive risk. America has a significant challenge with respect to providing boomers with a way to finance retirement. Reverse mortgages represent a real chance to impact the problem. The consequences of misjudging the impacts of concurrent program adjustments on consumers with few other options are impossible to reverse. An orderly sequence of single change, measure, adjust, continue would seem most prudent. A consumer focus and a mindset of retirement finance versus transactional mortgage banking will also produce results that align with the critical importance of getting it right for middle-class households. After all, it is the middle American people that are the focus… right?