Remember when you were a kid and your favorite cereal box said new and improved? New Reverse Mortgage is a fair description because the government frequently makes changes to the program that are designed to protect seniors and tax payers. This October saw one of the biggest changes ever.
The first reverse mortgage was given to Nellie Young in Portland, Maine in 1961. Almost thirty years later the FHA-insured HECM (Home Equity Conversion Mortgage) program was authorized by the Housing and Community Development Act of 1987.
The government got involved because it understood demographics enough to see that large numbers of Americans would be retiring and they'd need a safe way to access the largest portion of their wealth – the equity built up in their homes. Having that ability enabled them to remain self-sufficient and not look to the government for assistance.
Most people, including financial advisors, trust attorneys, and CPAs, are not aware that reverse mortgages have been regulated by the government (FHA / HUD) for almost 30 years. And the government has been fine-tuning the program ever since.
Program or rule changes are designed to protect two audiences: 1) seniors, their spouses, and heirs; and 2) the government's Mutual Mortgage Insurance fund, which protects lenders from losses in the event borrowers default on their FHA mortgages. This second audience really represents us as tax payers.
Some changes the government has made are consequential, affecting all would-be borrowers, and some go unnoticed by the general public; affecting only lenders or servicers (those who keep track of the loan and mail monthly statements).
Two of the biggest reverse mortgage rule changes have occurred in the last 2-1/2 years. April 2015 saw the introduction of Financial Assessment and October 2017 saw another substantial change.
In 2015, Financial Assessment mandated income and credit eligibility requirements. Before that, a homeowner simply needed to be 62+ and have enough equity in the home to get the loan. No longer. Since April 2015, borrowers need good credit for the previous two years and they also must prove they have enough monthly income to cover property expenses, debt, and meet residual income requirements.
We have lost track of how many prospective clients have not been able to get a reverse mortgage because of reasons relating to credit and income. Since Financial Assessment, we’ve had loans denied because:
- Late HOA payments on a previous house within the previous two years
- Co-signed car loan for granddaughter with late payments
- Late property tax payment in the previous two years
- Disability income that didn’t have 3 years remaining
- Insufficient monthly income
Some experts estimate Financial Assessment reduced reverse mortgage loan volume by 30%; meaning 3 out of 10 people that would have been able to get a reverse mortgage could not do so after April 2015. On the positive side, the policy change to require financial assessment/underwriting of credit and income has reduced tax and insurance defaults by nearly three quarters and serious defaults by almost two-thirds. This was FHA's objective and it appears to have succeeded.
The October 2nd, 2017 change that just occurred is likely to have an equally adverse impact on how many reverse mortgages are completed. But it's not all bad. Some changes will help borrowers. I’ll explain below why I think the government made these changes. If you'd like to learn how much you can borrow after the government rule changes, click the reverse mortgage qualifier button below.
The reverse rule changes in Mortgagee Letter 2017-12, which went into effect October 2nd, are twofold:
- Changes to FHA mortgage insurance rates
- Principal Limit reductions (Principal Limits are the amount a homeowner is eligible to borrow)
FHA Mortgage Insurance
Reverse mortgage borrowers pay two types of mortgage insurance: a one-time upfront charge and an ongoing annual charge. The premiums for both types of FHA insurance were changed on October 2nd and for most borrowers the change is to their advantage.
Upfront Mortgage Insurance
Upfront mortgage insurance, sometimes referred to as UFMIP is paid at closing. It is charged based on what the house is worth, not how much one borrows. Before this recent change, upfront FHA mortgage insurance was tiered. Those borrowing less than 60% of what was available paid 1/2% of the Maximum Claim Amount (value). But if they took more than 60% they were charged 2-1/2%. Now everyone pays 2%, even if they take no money at closing; i.e., a zero draw on a reverse line of credit.
Example 1 – borrowing less than 60% of Principal Balance
- Home value = $600,000
- Principal Limit (how much they can borrow based on their age) = $315,000
- New loan amount = $185,000
For those with small initial loan amounts, this change will be much worse than before; i.e. four times more expensive. This change will have an adverse impact on people who set up a reverse mortgage line of credit and take a minimum or no initial draw.
Example 2 – borrowing more than 60% of Principal Balance
- Home value = $600,000
- Principal Limit (how much they can borrow based on their age) = $315,000
- New loan amount = $190,000
When the initial draw is over 60% of the available limit, the new rules save the borrower 20% in upfront mortgage insurance expense.
Most of our clients take more than 60% of what they’re eligible for at closing. Usually they are paying off existing mortgages and/or debt. The truth is they are not really paying off debt because a reverse mortgage is itself debt. What they’re doing is restructing debt to eliminate its monthly payment, which improves their cash flow and lifestyle.
I recently heard a CEO of a major reverse lender say he expects HUD may go back to risk-based pricing; i.e., tiered upfront insurance premiums. However, he did not expect that change any time soon.
Annual Mortgage Insurance
The on-going FHA reverse mortgage insurance (known as the annual MIP) is based on the reverse mortgage loan's balance. Before October 2nd, the annual charge was 1.25%. The government has a complicated way of calculating the monthly amount.
Going forward, the FHA annual mortgage insurance premium has been reduced from 1.25% to 0.5%.
This change is a big benefit to all reverse mortgage borrowers.
HECM Premiums vs. Traditional Mortgages
As a point of reference, traditional FHA and VA loans, the type people use when they buy a home with a small down payment, have the following mortgage insurance rates:
- FHA: upfront fee is 1.75% of loan amount; the annual premium is 0.80% to 1.05% of balance
- VA: funding fee is 1.25% to 3.30% of loan amount; there is no annual premium
The annual FHA mortgage insurance premium is lower on a reverse than on a forward loan.
The big difference between mortgage insurance rates on government-backed forward mortgages (the kind that have a monthly payment) and reverse mortgages is this: forward mortgages have upfront premiums that are based on the loan amount; whereas with a reverse mortgage, the premium is based on the home’s value.
This is often a trivial distinction because most people take out a government-backed forward mortgages because they want to minimize their down payment. In those cases the loan amount and the home’s value are nearly the same anyway.
Principal Limit Reductions
Principal limit represents the amount a homeowner can borrow, at a given age, and expected interest rate. Unfortunately, that amount has gone down with this rule change.
Calculating a principal limit (how much someone can borrow) is accomplished by multiplying a principal limit factor (known as a PLF) by the home's value (subject to certain rules). You're probably familiar with factor tables; think school where a score between 90-100 gets an A, 80-89 gets a B, 70-79 gets a C, etc.
Reverse mortgage loan amounts (for home values below the FHA lending limit of $636,150) are calculated by multiplying the home value by the following PLF factors. The amount varies based on the youngest borrower's age and the expected interest rate. Previously, a borrower age:
- 62 could get 52%
- 70 could get 56%
- 80 could get 61%
Now, the numbers have dropped. At the risk of getting too technical, there has long been an idiosyncrasy in the government's tables for calculating loan amounts. When the expected interest rate was less than 5%, the percentage you could borrow was the same no matter how low a rate you chose. This was called a floor rate - any rate below the floor rate was treated the same.
And, rates are rounded to the nearest 1/8th percent. Thus 5.06% gets rounded down to the floor rate of 5%. Once an expected rate rose above 5.06% the percentage of how much the homowner could borrow dropped.
Since rates have been low for a long time, no one even realized that higher interest rates would reduce the percentage that could be borrowed. Now, post October 2nd, the floor rate has dropped to 3%. This has a material impact on how much borrowers can get.
|Age||Expected Rate||% Available Before||% Available Now|
I recently spoke to a prospective borrower who was planning on using a reverse mortgage to buy a home. We hadn't spoken in a while and she was unaware of this October 2nd rule change. She said she found a home she wanted to make an offer on. When she learned that she could no longer get 56%; now she was looking at 46%, she said that would force her to re-think her strategy because it means she'll have to bring more cash to closing.
Reverse purchases are usually done with fixed rate loans. The example above illustrates that to maximize loan proceeds, prospective buyers may have to look at adjustable rates with low margins. This is admittedly more complicated than it used to be and it underscores the value of good advice.
Here is another example. The September 2017 numbers represent values before the October 2nd changes known as Mortgage Letter 2017-12. In the hypothetical scenario below, the maximum loan amount dropped by $68,400.
The following graph shows the differences across the age spectrum for a given value and expected interest rate. Results vary by house value and loan margin (which affects the expected rate). The left side shows the maximum loan amount (known as the Principal Limit) when the youngest borrower on title is 62. Moving right reveals the maximum loan amount as borrowers age.
The green line (Sep-17) shows how much someone with a $600,000 house could borrow when the expected interest rate was 5%. The blue line (Oct-17) shows how much someone can borrow now, after the rule change. You can see that loan amounts have dropped considerably.
It would be easy to get deep in the weeds unpacking the impact of this rule change. For example, expected rates are not really the interest rate on the loan. It is a construct or guess at the average rate of the loan and it is only used to calculate a Principal Limit.
Here is what you need to know. Expected rates are a function of the loan's margin. This quickly gets complicated but realize that reverse mortgage loans can have different margins. The lower the margin, the lower the expected rate and the greater the Principal Limit (higher loan limit).
If you chose a lower margin, you’ll get more money - the blue line will move up closer to the green line. However, there are two potential drawbacks to lower margins:
- Less money available as a lender credit to offset loan fees
- Lower line of credit growth rate
Higher loan amounts are possible if the borrower takes a lower margin. Then the conversation shifts to paying for the upfront mortgage insurance since lower margins mean smaller lender credits.
The whole reason we created our unique 6-step process was to provide clients with a sense of direction, clarity, and capability. It is more important now than ever to have competent guidance. Step four in our process is called The Loan Evaluator™, which is the essence of what we’re talking about here: optimizing equity and managing the many trade-offs between loan choices.
Working with the right lender and dealing with a knowledgeable reverse mortgage professional is now more important than it has ever been before. If you'd like a free analysis of what you're eligible for, click here.
Reverse mortgages have gotten safer, but they are harder to get and more complicated to structure. One thing that hasn't changed is that they are an excellent tool to allow people to safely access some of their wealth to increase cash flow and reserves in retirement.
The Government’s Motive
None of us really know all the thinking that went into this recent rule change. It took everyone in the industry by surprise. Most FHA/HUD changes are telegraphed 6-12 months in advance. Typically, lenders, consumer groups, trade associations, and others are invited to review and comment on proposed changes. This change was rolled out in 5 weeks, with no warning or comment period. Here is the government’s official position:
FHA is committed to its fiduciary responsibility to taxpayers and ensuring its mortgage insurance programs remain viable and effective in the long term. To help sustain the HECM program as a viable financial resource for aging homeowners and to strengthen the Mutual Mortgage Insurance Fund, FHA has made changes to HECM MIP rates and the PLFs.
As a Certified Reverse Mortgage Professional® (CRMP®) and a student of the industry, I have my own opinions on what was behind these changes. Remember, the government has twin objectives:
- Ensure survivability of the HECM program (make it revenue neutral to avoid tax payer bail outs)
- Help seniors safely access some of their wealth and remain self-reliant.
Before we talk about why they changed the mortgage insurance premiums, let's review what the insurance covers. FHA mortgage insurance benefits lenders and borrowers. If a borrower owes more than the house is worth at the end of the loan, the insurance fund pays the shortage to the lender/investor. That’s why reverse mortgages are called non-recourse loans. If it wasn’t for this guarantee, lenders wouldn’t make these loans.
FHA mortgage insurance also benefits borrowers by guaranteeing that promises made will not be cancelled later, even if the lender goes out of business. These promises include: not being responsible for any shortfall at the end, timely monthly checks if that option is chosen, a credit line that cannot be frozen or reduced, and growth of the unused portion of the reverse line of credit. These features and guarantees make a home equity conversion mortgage a unique and powerful financial instrument.
Higher upfront mortgage insurance premium – Survivability
The government funds the HECM program by charging upfront and ongoing mortgage insurance premiums. Previously, when someone set up a reverse mortgage line of credit (RMLOC) and took no initial draw, the borrower paid a low upfront premium (0.5%) and no annual premium – because annual premiums are based on the loan balance.
So, the government is on the hook for a potentially large future loan amount but collects almost no money to manage that risk. Raising the upfront mortgage insurance on cases like these does two things: 1) discourages people from using the product like this; and 2) better funds the risk being taken by the government.
Lower annual mortgage insurance premiums – Help seniors
Because more money is being collected upfront, the government’s actuaries must have concluded that they could charge less on an ongoing basis. This is a win for consumers.
Principal Limit Reductions – Survivability
The reason I think the government reduced how much borrowers can get with a reverse mortgage is twofold; they are concerned about:
- The rapid rise in home values
- People living longer
Home prices have been increasing much quicker than household income has risen. In the medium term, when house prices increase faster than wage growth, problems occur.
When the government insures reverse mortgages, they limit the amount of equity the borrower can access so the growing loan balance doesn’t exceed the value of the home for as long as the borrower is expected to be in the house.
Example 1 below is roughly what is supposed to happen with a home equity conversion mortgage when there is a healthy housing market and house prices appreciate at a reasonably stable rate, say 4%.
Notice the borrower’s equity is nearly stable. In time, the loan, which is growing faster than house is appreciating, will consume the equity. This usually happens somewhere between years 10 to 20 depending on how much is taken out initially. When there is equity in the house, the government’s risk or exposure is minimal. The balancing act is between preserving equity and maximizing how much the homeowner can access.
These days, I have a hunch, the government is concerned that house prices have risen too quickly and if people take out a reverse mortgage when prices are artificially high, loan balances, relative to value, will be too big when prices fall back down.
Sometimes, an extreme example makes it easier to illustrate a point. Pretend home prices double and then fall back to their original value. That phenomenon occurred in some neighborhoods in CA, AZ, NV, and FL in the last cycle – not over four years but we’re trying to illustrate a point.
Fictitious example 2, below, shows house prices doubling and then falling back to their starting point. In this case, the loan is taken out in year 1. Even though the loan was taken out before the wild appreciation, notice how the equity (which is a reverse mortgage’s cushion) drops in year 4.
Example 3, below, is similar (prices double and then return to their starting amount) but the loan is taken out in year 2, after the house has gone up in value.
Notice all the equity is gone and the loan actually exceeds the home’s value. If the borrower passes away or sells, the government will take a loss. And it is worse than -$24,720 because that number doesn’t take into account repairs, legal expenses, and selling fees.
Example 3 is not far from what happened in the 2005 to 2010 period. This caused billions in losses to the FHA mortgage insurance fund. Those losses continue to influence today’s thinking and decisions by government regulators. Some argue that the October 2nd rule changes are the government fighting yesterday’s battles; however, a look at the following graph suggests they may be right to be concerned and make changes.
The chart below is from the Federal Reserve Bank of St. Louis and it shows how quickly home prices have appreciated in the past 5 years.
When a borrower moves out of their home and the reverse mortgage loan balance exceeds the value of the home, FHA’s mortgage insurance covers the shortfall. When the insurance fund underestimates the aggregate risk, and needs a bailout, it is the US tax payer who covers that mistake.
Actuaries must worry not only about house price behavior, but also how long people might keep their loan. Advances in modern medicine continue to extend longevity; thus how long they might live in a home with a reverse mortgage.
Since FHA has little control over house prices or longevity, it’s only response to mitigate risk is to dial back how much it will lend as a percentage of house values. Taking such a step helps ensure the long-term viability of the home equity conversion mortgage program, despite frustrations it causes borrowers who want to access more of the wealth trapped in their home.
Today’s reverse mortgage looks nothing like the reverse mortgage of even three years ago. In that sense, you can call it The New Reverse Mortgage.
Making it safer has made it more complicated and more difficult to get. When structured properly, a reverse mortgage is a powerful financial tool that supports income and lifestyle in retirement.
Those who are eligible (good credit and adequate income) must determine if it is suitable. If it is suitable, what is the optimal balance between: loan amounts, index & margin, interest rate caps, financed closing costs, loan origination fee and lender credits?
Most Loan officers cannot explain these variables, let alone analyze a homeowner’s needs and properly structure the best loan.
If you would like to consult with a Certified Reverse Mortgage Professional® to learn how much you can get with a reverse mortgage, click the Reverse Mortgage Qualifier button below.
Post Script: to learn how these changes affected the reverse mortgage industry, click New Reverse Mortgage Rules - Better or Worse.
About the Author
Kent Kopen earned his Reverse Mortgage Specialist credential in March 2007. In 2016 Kent earned the CRMP® (Certified Reverse Mortgage Professional®) designation. There are less than 150 CRMP designees in the United States. Mr. Kopen also provides education, tools, and strategies to professionals who offer financial and legal advice to others. "Our resources help financial advisors, CPAs, and estate planning attorneys help seniors optimize their home equity to provide greater security and peace of mind."