Should We Pay $800 Million For FHA Reverse Mortgages?

by Peter G. Miller
July 8th, 2009

On Capitol Hill last week, the US Senate Special Committee on Aging looed into the matter of  Reverse Mortgages: Leaving Seniors and Taxpayers on the Hook? The real subject, of course, is FHA-insured reverse mortgages since the FHA program has a virtual monopoly in the field.

Peter Bell, president of that National Reverse Mortgage Lenders Association (NRMLA),  testified that “a reverse mortgage must occupy the primary lien position on a property. All other liens must be satisfied with reverse mortgage proceeds. If some of the proceeds available from the reverse mortgage are diverted to a tax and insurance escrow, in some cases, there would not be enough money left to satisfy the liens. In such cases, the homeowner would not be able to obtain the reverse mortgage – and probably be forced to give up the home.

“Instead of simply imposing an escrow, HUD (in partnership with a NRMLA Task Force on tax and insurance issues) is looking at utilizing the financial assessment tool to determine if the lender and counselor should work with the borrower to establish an escrow, amend the draw-down schedule, limit payment options, disallow a lump sum payment or take other steps appropriate to help protect borrowers from tax and insurance defaults. One obstacle here is that the HECM statute requires all five payment options available under the program to be offered to all borrowers, restricting HUD and lenders’ ability to take appropriate action.”

You can understand that while the intention here is good the potential outcome is troubling. The idea of not allowing seniors to get a lump-sum withdrawal from an FHA-insured reverse mortgage — what HUD calls a home equity conversion mortgage (HECM) — smacks of paternalism, or maybe some form of inverse paternalism since seniors are tyically the parents….

One solution, which is advocated by Mr. Bell, is more and better counseling for potential reverse mortgage borrowers. Counseling, however, does not resolve the basic problem, the reality that reverse mortgages at this time are a risky product to insure.

Speaking earlier in June, Comptroller of the Currency John C. Dugan said that “while reverse mortgages can provide real benefits, they also have some of the same characteristics as the riskiest types of subprime mortgages — and that should set off alarm bells.”

The reason to worry about reverse mortgages is because the FHA program pays lenders if such financing goes bad. Unlike regular “forward mortgages,” a reverse mortgage is essentially a huge negatively-amortizing loan — the loan balance increases because borrowers are not making monthly payments — it follows that if the loan balance increases and the value of the property declines then the FHA can be stuck with big insurance claims.

HUD has asked Congress for $800 million to beef up reverse mortgage reserves. Given the current risk represented by reverse mortgages it might be wise for Congress to reject the HUD request. The problem is that these are not usual times and some reverse mortgage borrowers are using their lump sum payments to pay-off forward mortgages and avoid foreclosure. That’s a use we ought to applaud.

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