Loan Modification

FHA Reverse Mortgage Program Shows Weakness

By Gina Pogol

If ever a loan program appeared bulletproof, it was FHA’s Home Equity Conversion Mortgage (HECM). Consider that a typical borrower with a home valued at $300,000 is allowed to borrow about $150,000 against it (amount depends on borrower’s age, interest rates, and the home’s value) and that the lender collects $6,000 in fees plus another $6,000 in upfront mortgage insurance, plus monthly premiums. In addition, the borrower typically pays a variable interest rate, eliminating a large portion of risk for the insurer (taxpayers). Add in the home’s appreciation, which creates another safety net. Finally, the loan can be repaid from the proceeds when the property is sold, so the borrower’s credit isn’t even an issue. Why ever would the program lose money?

Well, HUD has been paying out record claims on its reverse mortgages, and here’s why. Consider that almost no one pays the upfront costs out of pocket; they are instead deducted from the proceeds borrowers can receive. The interest is likewise added to the loan’s balance. And (here’s the biggie), the profitability of an individual HECM loan depends on home appreciation.

A 2008 study of HECMs found that the probability of losing money on such a loan ranges from 2.7% to 8.9% (depending on how long the senior keeps the loan before moving from the home or dying) as long as there is home appreciation of 4% per year. However, once homes stop appreciating, the risk of loss increases to a range of 43.2% to 65.4%! Imagine a borrower takes that $150,000 HECM against a $300,000 home in 2007. But home values across the country have fallen by one-third in the last three years, so that property may well be worth only $200,000. And it’s worse in states like California, Florida, Nevada, Arizona, and Michigan. The home may only be worth $140,000 if it’s in Stockton. Meanwhile, the balance on the loan continues to increase.

Right now, four large loan servicers have about 13,000 HECMs in default because the borrowers have stopped paying their property taxes and homeowners insurance. The loans total over $2.5 billion. Analysts fear this is just the beginning.

Would you feel comfortable making a commitment to covering the losses on loans in this scenario? Like it or not, Mr. and Ms. Taxpayer, you have.

Full post as published by FHA Mortgage Guide on September 10, 2010 (boomark / email).