The Federal Housing Administration’s reverse mortgage product, the Home Equity Conversion Mortgage, is an amazing product, maybe even ahead of its time.

Developed 22 years ago, the product has been maturing into a viable option just as 10,000 baby boomers are starting to turn 65 each day.

But some in the industry feel the HECM program has lost its way and no longer serves those whom it was designed to help. To understand why, one only needs to look back at the last four years.

In 2009, the Department of Housing and Urban Development was forced to cut principal limits by 10% to make sure the program broke even. A year later, additional principal limit cuts were made along with an increase in the insurance premiums charged to borrowers.

Only a few years after that, the changes seem to be paying off, but the program looks a lot different. An independent actuarial report released earlier this year shows the program is back on track after a couple of challenging years financially.

There is no doubt the changes made over the past four years have made it more difficult for seniors to qualify. Many of those who took out reverse mortgages in 2008 wouldn’t be able to obtain them today.

Taking it a step further, HUD will roll out HECM Underwriting 2.0 during 2012, a move that is guaranteed to increase the number of seniors who can’t qualify for the program a time when so many are struggling financially and really could benefit from it.

Reverse Mortgage Underwriting 2.0
The need to expand beyond what has historically been primarily an asset-based underwrite comes as recent data from HUD estimates there are 46,000 borrowers in some form of default on their reverse mortgages.

The hope is that by performing a limited financial assessment during underwriting, HUD will be able to limit the future occurrences of default from failure to pay taxes and insurance.

Knowing that rule making at the agency can take some time, Carol Galante, acting FHA Commissioner published a letter in October stating that lenders have the ability to perform an underwrite of reverse mortgage borrowers today.

MetLife decided to move first by releasing its guidelines last month. The news itself was expected, but the guidelines went further than what most had anticipated.

“It is ensuring applicants can responsibly meet the obligations of the HECM loan, but also that they can responsibly age in place and meet the essential expenses of living. That was the spirit of financial assessment to us,” said Craig Corn during an interview with RMD.

If we determine after analysis that someone has $100 a month left over, maybe a HECM is not the right thing for this individual. Maybe we should look at other options.”

Whether or not HUD’s guidelines will be as “strict” as MetLife isn’t clear, but it will mean fewer borrowers will qualify for the program.

During conversations with lenders, the majority feel that MetLife’s guidelines go beyond what is required to ensure borrowers can pay their taxes and insurance. Personally, I think MetLife should do what it feels is right and if originators don’t approve of them, there are plenty of other places to send their business.

Rather than adopt the policy implemented by MetLife, many hope HUD takes a less aggressive approach by looking at borrower credit history—failure to pay taxes and insurance in the past—and define specific triggers that would require those borrowers to go through a deeper underwrite.

Off the record, issuers and servicers say that implementing such simple practices could lower the number of taxes and insurance defaults by as much as half, according to their estimates.

It also wouldn’t require all reverse mortgage applicants to go through a full underwrite.

HUD’s Difficult Balancing Act
In the next year, those managing the program at HUD have to strike a delicate balance by issuing guidelines that lower the amount of defaults, but not go so far that they limit access to the program to only those with “perfect” financial characteristics.

It’s unlikely that HUD will go overboard, but history shows us the agency is willing to do what is necessary to ensure the long term viability of the program.

“These agencies would rather risk slowing market growth while ensuring the United States reverse mortgage program will continue to remain a viable option for all participants versus pushing for rapid market growth,” said a research note from Cantor Fitzgerald that was sent to clients earlier this year.

Those who believe the HECM product should be used as a last resort may not like all the changes, but making sure the HECM program is a viable option for everyone—FHA’s insurance fund included—is critical, especially during a time when the U.S. will be forced to cut back on spending to deal with its massive debt.

Lets not forget about the 77 million baby boomers that haven’t been saving for retirement. According to the Vanguard Group, one of the largest mutual fund providers, the median 401(k) retirement savings plans for older people was only about $60,000 in 2011.

If HUD can prove FHA’s reverse mortgage product can make it through the worst economic downturn since the Great Depression, it’s hard to argue the HECM product won’t be around for quite some time.

Just think, if HUD can develop a simple way to limit the amount of defaults, maybe the mythical proprietary reverse mortgage product that so many claim will compete with the HECM program will finally appear.

As my man George Strait sings, “I’ve got some ocean front property in Arizona and if you’ll buy that I’ll throw the golden gate in for free.”

The program needs to be sustainable. Period. Long live HECM 2.0.