FHA Reverse Mortgage Restrictions Lie Ahead

For a number of years the reverse mortgages insured by the FHA were a successful product in the sense that borrowers got their cash and the FHA had few claims.

However, the FHA reverse mortgage program does not work in isolation — it actually requires rising home values. The typical reverse mortgage is outstanding for about six years and with home prices generally 15.7 percent lower than in 2007 many reverse mortgages are now producing big claims against the FHA.

Why does this happen?

With a reverse mortgage the borrower does not make monthly payments for principal and interest so the loan is actually a negatively-amortizing mortgage. That means the loan debt goes up over time. The loan ends when the borrower sells, moves or dies. When the loan ends the property can be sold to pay off the debt or it can be refinanced by the heirs if they want to keep the property. Since a reverse loan is non-recourse financing there are no claims against the estate or the heirs, other than the house.

However, the amount owed by the borrowers is limited to the value of the property. If the size of the debt is great than the fair market value of the property FHA insurance kicks in to protect the lender.

HUD Deputy Assistant Secretary Charles Coulter has told US News & World Report that to stabilize the reverse mortgage program there are “four fundamental changes that are required: restricting the amount of the up-front draw; implementing a financial assessment process to ensure seniors are equipped to meet their long-term financial obligations; requiring some combination of a tax and insurance set-aside and/or borrower escrow account; and addressing complications resulting from non-borrowing spouses. (See:┬áTime to Rethink Home as Retirement Nest Egg, Feb. 6, 2013)

In other words:

  1. Limit the amount of cash that can be taken out at closing.
  2. Institute financial qualified standards to assure that borrowers have the capacity to pay for property taxes and insurance, a borrower responsibility which has always been required.
  3. Require escrow accounts to actually collect property taxes and insurance.
  4. Figure out how to handle spouses who are not on the mortgage when the borrower dies. Typically this happens when the borrower is age 62 and older while the spouse is younger.

Are the Coulter proposals a trial balloon? Perhaps.

However, HUD under Secretary Shaun Donovan has been very straight-forward regarding it’s intentions. There is little reason to believe that the Coulter proposals are either implausible or impractical.

Lender Responsibilities

Notably missing from the Coulter list is a reduced level of risk for HUD. When lenders make loans which are insured by the VA or with private mortgage insurance (MI) companies they do not get 100 protection against loss. With the FHA they do. The most–obvious way to lower HUD’s risk is to tell lenders that from this point forward federal insurance only covers 95 percent of the risk.

What will then immediately happen is that there will be fewer home equity conversion mortgages — HECMs, the term used by HUD to describe reverse mortgages. The reverse mortgages that are made will have a higher quality. Combine the two results and HUD will have a lot less risk.

As always with reverse mortgage products, speak with several lenders and an HUD-approved housing counselor as well as an attorney who specializes in elder law and a fee-only financial planner. Why so much research? Because reverse mortgages are complex and they are part of the overall process of retirement, financial and estate planning.

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