In what some are calling a bombshell of a move, HUD announced that it will lower lending limits and raise premiums on reverse mortgage loans. Citing concerns over the health of FHA’s Mutual Mortgage Insurance Fund, the agency made its move without input from industry leaders, taking the reverse community by surprise.
Some are saying the new rules—which are expected to slash endorsements by as much as 30 percent—are unnecessarily harsh, limiting the program’s benefits and further stifling an industry that was just beginning to rebound from Financial Assessment. Other measures could have been taken, they say, to protect the fund without limiting borrower proceeds.
But others in the space are commending the change, labeling it a positive step for many consumers who would benefit from lower interest rates and lower ongoing insurance premiums. They claim that the latest round of changes makes the program stronger, eliminating some of the risk for HUD, ultimately making it more appealing for investors and better for borrowers.
HUD’s “Prudent Steps”
The “historically volatile” HECM program is responsible for nearly $12 billion in net losses to the MMI Fund, HUD said in an August 29 announcement of the changes. Noting that a congressional appropriation would be needed for the program to continue in 2018, the agency said measures had to be taken to maintain the level of reserves required by Congress.
“Fairness dictates that future HECM loans do not adversely impact the overall health of FHA’s insurance fund, which supports the financing needs of younger, mostly first-time homeowners with traditional FHA mortgages,” HUD said in a statement to media. “We’re taking needed and prudent steps to put the HECM program on a more sustainable footing so that it can remain a resource for senior borrowers.”
Under the new rules, set to take effect October 2, all HECM borrowers will have to pay an upfront mortgage insurance premium of 2 percent, regardless of how much money they take in their initial withdrawal, and an annual premium of 0.5 percent.
Previously, borrowers who tapped less than 60 percent of their equity in the first 12 months paid a 0.5 percent MIP, while those who borrowed more than 60 percent paid a 2.5 percent MIP. Regardless of their initial withdrawal amount, all borrowers paid an annual MIP of 1.25 percent under the old rules.
HUD said the change offers fee relief for all borrowers, and it preserves more equity by slowing the rate at which the loan balance grows over time.
“Every borrower that we put into the program represents a risk,” said HUD senior advisor Adolfo Marzol on a press call outlining the changes, “and this way every borrower that we put into the program will make a contribution toward the financial soundness of the program.”
Marzol said the changes are not intended to be sufficient enough to make back prior losses on the existing portfolio, but are simply meant to put new business on a more sound financial footing.
In addition to MIP changes, HUD lowered principal limits, meaning that most seniors will be able to borrow less money (about 20 percent less, at current rates).
According to HUD, lower PLFs “will preserve more equity for the borrower, and it will also preserve more equity for the FHA fund. It will take longer before the growth in the balance of the mortgage could potentially exceed the value of the home and cause loss to FHA.”
The new PLF adjustment lowers the expected interest rate floor to 3 percent. For every one-eighth of a percent reduction in expected rate between 5 and 3 percent, the PLF increases. The end result is that lenders will be forced to compete on interest rates.
Michael McCully, partner at New View Advisors, says he expects lenders to drop rates right away. “I think lenders will be forced to reduce rates immediately, likely closer to 4 percent, if not lower over time. It’s a game of chicken: Which lender is willing to go lower than its competitors to capture market share? Which lender will find a way to better position with consumers the new HECM to increase volume? That’s hopefully what comes out of this significant change to the program.”
McCully also says that while a 2 percent upfront MIP seems expensive, the aggregate MIP payment for borrowers over time will be lower. “Plus, lowering the annual MIP by 75 basis points per year means the borrower’s accrual rate is much lower. No one likes to pay big upfront fees, but overall I see the changes to MIP as a positive.”
Others were not so positive.
“I think it’s a bombshell for an industry that didn’t need more disruptions. We’re just recovering from FA and this thing came from out of nowhere with really no industry notice or involvement,” says Mark Browning, founder of New York-based HomeChex. “It’s disappointing that this is the path that was taken. The industry has really worked hard to have a good relationship with HUD so that there can be a bilateral dialogue, and this was really out of step with that process.”
Mike Kent, president of Liberty Home Equity Solutions, agrees that the lack of dialogue was surprising, but said he thought HUD wanted to act quickly. “It’s getting very close to the end of the fiscal year. We all know the program has to score with a negative credit subsidy in order to continue on, so I think they did what they thought they needed to do in order to make sure that would happen.”
For its part, NRMLA released a conflicted statement. While it praised FHA’s commitment to the program, it noted that the new rules diminish proceeds and increase costs for most borrowers. “We believe that there are alternative options for better managing the HECM program to reduce its overall costs and will continue to advocate for such beneficial changes to the program.”
As for other measures that could have been taken to stop the HECM’s supposed drain on the MMI Fund, many in the industry point to inefficiencies on the servicing side once loans have been assigned to HUD.
“I believe that’s what’s causing much of the pressure on the fund,” says McCully. “These changes brought about by ML17-12 aren’t the most impactful way to protect the fund. HECM has already had its PLFs reduced to a point where we believe the fund is protected. The best way would be to improve the way in which the loans HUD takes back are serviced, because that’s what’s costing the industry the most right now.”
“The process that we go through at the end of the loan is very inefficient,” agrees Browning. “These properties sit around and languish when they go into the HUD book of business. I think there are significant changes that could be made to the process that would save a lot of money and reduce the losses.”
John Lunde of Reverse Market Insight says clearing up these issues would likely take time. “It's clear that there are other levers to pull in cleaning up costs and processes on the back end of the servicing, foreclosure and assigned loan processes, but those have much longer timelines. It probably wasn’t reasonable in terms of timing.”
New Business Models
Whether or not other measures could have been taken, the fact remains that in a few weeks’ time, these changes will take effect and business as usual will be largely disrupted for the reverse community.
“I believe this round of changes is bigger than anything prior, primarily because of the reduction in the expected rate floor for calculating PLFs,” says Lunde. “The second factor that's important in this round of changes is the reduction in revenue per loan, which is likely to be perhaps 50 percent or more. Put those two factors together, and the revenue change picture is going to force a lot of cost reductions for lenders.”
Lunde says all reverse lenders will likely have to reassess their business models to stay afloat. “I think the biggest place where costs will come down is in lead acquisition, whether it shows up in marketing cost per funded loan for call centers, higher ‘self-generated’ commissions on field loan officers, or high loan sale premiums for brokers,” he says. “The best-positioned model is someone with a referral network built through shoe leather over the years that keeps low-cost leads coming in without depending on continued high marketing costs. But even there, it will be a lower-revenue model than before these changes.
Kent says there is something positive about having to reassess your business model. “There could potentially be a lot of good that comes out of this. Premiums are going to come down and people are going to have to work on being more efficient. They are going to have to raise their productivity levels; they’re going to have to re-examine what kind of marketing tools are used to attract clients and how much that costs them. There’s nothing wrong with that; there’s nothing wrong with trying to reap more efficiency out of your processes.”
The Retirement Planning Angle
Some reverse specialists who have focused their efforts in recent years on the HECM’s role in retirement income planning are frustrated with the new rules, worried they make the product less appealing from a financial planning standpoint.
“These changes are adverse for the folks who are looking to use home equity as part of their retirement planning. If you’re looking at that kind of consumer cost, you’re going to want to use it right away,” says Browning. “There’s been a lot of thought and careful planning in trying to get people to see this as a middle-class retirement tool, but for that client, this product is a whole lot less appealing now.”
Wade Pfau, a retirement income expert with the American College of Financial Services who has written extensively about the HECM’s role in financial planning, says he still thinks the product will have an appeal, although it might be slightly diminished in some cases.
“I plan to re-run all of my past analyses of reverse mortgages under the new rules, but I'm anticipating that the value is still there, it just may not be as much as before,” he says. “I think this might have some slow-down effect on line of credit growth uses, but it might actually encourage more use of the HECM to pay an existing mortgage or the HECM for Purchase program."
The Secondary Market
On the HMBS front, McCully says the inevitable short-term drop in volume we’re likely to see won’t be ideal. “Lack of volume means illiquidity, which is never good for capital markets. However, the capital markets have continued to support HMBS through other program changes that have lowered volume. And ever-increasing tail issuance continues to offset origination volume declines. The market recognized HECM-to-HECM refinance risk goes down for existing books of business and spreads have tightened for current production.”
Where ML17-12 fails investors, consumers and the industry is the increase of HECM-to-HECM refinance activity the new PLF tables will likely foster. Market clearing rates closer to 3 percent create more exposure to refinance. Brokers and lenders whose primary business model is pursuing borrowers of newly originated HECMs for the sole purpose of earning fees by refinance will have the ability to undercut established HMBS issuer/lenders. And the risk of refinance activity will make investors of new-production HMBS cautious.”
McCully says in the long run, he believes the changes will make the product more appealing for investors once new lower market rates are established. “Premiums will be lower, minimizing the exposure investors currently have to faster-than-expected prepayments. HMBS issuers will see fewer losses, lower loan loss reserves, lower foreclosures, and lower defaults. Yes, industry profitability will be reduced because premiums will come down, but the credit quality of issuers’ books of business will improve. Headline risk will be further diminished. Combined with Financial Assessment—which is working—the HECM program will be even more stable and mainstream.”
A Silver Lining
While many in the space are unhappy about the inevitable dip in volume and loss of revenue that will follow the new rules, some remain optimistic. They point out that in the end, the rules amount to a better deal for borrowers, which could lead to greater volume down the road.
McCully sums it up. “The fact that the consumer’s equity will be eaten up more slowly is a very positive outcome for the borrower and ultimately for the industry for the following reasons: The duration of the asset extends so it will be outstanding longer because the roll-up of interest is slower. Because of that, there will be fewer foreclosures; there will be more equity remaining in homes at the time of death or move out; there will be fewer assignments to HUD; there will be fewer debenture interest shortfall issues, there will be fewer cross-over losses. Those are all hugely positive for HUD, for HMBS issuers and ultimately, for the consumer.”
Some also point out that the changes make the HECM look more bank-like, which could encourage new lenders to enter the market.
“I think this opens the door for additional distribution sources,” says Kent. “Banks might look at this and say, ‘You know what? It’s starting to look a lot like what our forward FHA loans look like.’”
Some also say that the changes could breathe life into the proprietary market, inspiring much-needed product innovation from the private sector.
“This positions the HECM to be competed against by the private market much more effectively, with existing jumbo products getting competitive with HECM at a 20-25 percent lower home value, and also brightening the opportunity for the first conventional conforming reverse mortgage,” says Lunde. “That last idea has never happened before so I'd not hazard a timing idea, but it's more realistic than ever before.”
McCully agrees. “Once there’s pricing validation in the capital markets for non-agency securities execution, we’ll start to see further refinement of the proprietary product. And the lower HECM PLFs make the proprietary LTV curve more competitive. “These changes will drive proprietary product design and a corresponding increase in origination volume.”
Kent says this development would be a major positive. “I think it’s critical that the private sector gets into the reverse mortgage space in a competitive manner, so things like this don’t throw us off kilter. We’re a single-product industry subject to a government program that has to be renewed every year or it’s not there.”
In all, McCully says he sees this as a plus for an industry that has struggled for years to realize its full potential. “Whatever we were doing before wasn’t working,” he says. “Here’s an opportunity to take improvements to the program and reposition it as a much more consumer-friendly product and maybe make up for lost profit on a per-loan basis with aggregate volume from banks and other originators that source new customers who are comfortable with a more stable, lower-cost version of the product.”