$798 Million Subsidy: Time to Change the FHA Insured Reverse Mortgage Program?

As the reverse mortgage industry faces a $798 million subsidy request, there is plenty of discussion from industry leaders and politicians about how to change the program to ensure its success and viability.   

The knee jerk reaction from most is to cut the principal limit to ensure that no subsidy is needed for the government insured reverse mortgage product.  The House has already passed its version of the Appropriations Bill which requires that HUD adjust the program to operate at a net zero subsidy rate.  The Senate’s current version also includes provisions which would lower the principal limits. 

At a time when many seniors find their home values down drastically, it will clearly limit the amount of people who could benefit from the program.  According to an analysis of three major lenders’ portfolios by the National Reverse Mortgage Lenders Association, nearly 21% of current borrowers would have come up with too little cash from the reverse mortgage to pay off their existing indebtedness if principal limits are reduced by 10%.

Most would agree that the HECM is far from perfect and many feel now might be the right time to make some needed adjustments to the program.

One of those is Joe Kelly from New View Advisors, a Capital Markets and Investment Banking consultant based out of New York, NY.  As part of a three part series on the HECM program, Kelly starts off with The Trouble with HECMs: FHA’s Bumpy Road to Grandma’s House, where he says that:

The Trouble with HECM is that the program encourages senior homeowners to borrow a very high percentage of their home value, which not only increases FHA’s losses, but also unnecessarily drives up costs to borrowers, lenders and investors. The lack of a more efficient, low-cost alternative has also discouraged many senior borrowers who might otherwise benefit from a HECM loan, but are discouraged by the size of the upfront fees.

In his final installment, Kelly writes that “a new approach is needed, one that lowers the senior borrower’s cost, lowers FHA’s risk, while still providing sufficient proceeds to the senior.”  The article describes the “HECM II”, low cost alternative reverse mortgage product with no upfront MIP, no servicing fee set aside, a 75 basis point (0.75%) annual premium, and sensibly lower LTV ratios.

Kelly’s argument for eliminating the upfront MIP is that the same fee is charged to both 62 year old and 99 year old borrowers alike and is the main driver for calling these loans “high cost”.  Sounds great, but is that really possible? 

Kelly feels that the ongoing MIP should be increased from 50 basis points to 75 basis points per annum.  The fee of 75 basis points would be charged to the loan balance, not property value, and would keep borrowers LTVs greater than 40% and provide sufficient revenue to FHA to insulate it from further losses.

By keeping the monthly MIP, Kelly writes that “FHA’s risk is aligned with the borrower fees it collects, and the borrower pays for the risk she creates and the duration of the benefit she receives.”  He provides a principal limit table for the HECM II which provides LTV’s in the 50-60% range. 

Raising the MIP is something that has been discussed at length but Kelly proposes something that I’ve yet to hear about, which is replacing the SFSA with a taxes and insurance escrow set aside.

The Servicing Set-Aside (”SFSA”), a concept unique to HECM, is the subject of some controversy. It basically quantifies the present value of the servicing fee, a flat monthly dollar amount that is added to the HECM loan balance each month. The SFSA is disclosed to the borrower as a reduction in the Principal Limit, which gives it the appearance of yet another initial cost. Suffice to say that many reverse mortgage lenders and borrowers find it to be a confusing and unnecessary concept. On the other hand, no set-aside or escrow provision is required for payments of property taxes and insurance (“T&I”). Servicing fees, which total less than $400 per year per loan, can easily be paid by the investor to the servicer, but T&I payments can run into thousands of dollars. If not paid, T&I delinquencies can ruin the value of a HECM loan by causing it to lose its first lien status and therefore its FHA insurance. The reverse mortgage industry is currently grappling with the issue of rising T&I delinquencies and losses.

In other words, FHA created the wrong set-aside. The HECM program was first introduced in the late 1980s, and most features have never been updated. FHA should use the clean slate of a new product design to replace the SFSA with a T&I set-aside. The T&I set-aside could take the form of a fixed dollar amount equal to six months of taxes and insurance payments. This amount would be deducted, or “set-aside” from the Principal Limit at origination. The servicer would then have the ability to cure T&I defaults by paying those expenses directly and adding the payment to the loan balance.

While many might say this is un-necessary, it can also be seen as another level of protection that is provided to seniors who decide to take out a reverse mortgage.

Another idea of of how to cure the rising number of T&I defaults came from Meg Burns, director of the FHA’s Single Family Development Program, at the National Reverse Mortgage Lenders Association’s policy conference in Washington, DC.  Burns said that FHA was running a pilot program in Michigan which allows HECM borrowers to receive a subordinate lien through a government program to help keep borrowers up to date on T&I.

Burns also said that HUD was discussing a HECM "mini", which would offer borrowers a way to withdraw only what they want and the max claim would be adjusted accordingly.

As the $798 million subsidy request hangs over our industry, everyone needs to be ready for the HECM program to change.  If the principal limits are lowered, changing the MIP structure to resemble something like Kelly’s “HECM II” or even offering it as an alternative to the HECM currently available could help change the publics perception of reverse mortgages being high cost loans.

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