An Overview of FHA's HECM Reverse Mortgage Loan Program

Posted by Edward Seiler, Ph.D. on 3/9/17 2:01 PM

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On November 15, 2016, The U.S. Department of Housing and Urban Development (HUD) published the Actuarial Review of the Federal Housing Administration Mutual Mortgage Insurance Fund HECM Loans for Fiscal Year 2016. This review, prepared by HUD's independent actuary, contained several major methodological changes from the previous (FY 2015) version of the review. Those changes resulted in the economic value of the HECM portion of the Mutual Mortgage Insurance Fund (MMIF) falling to negative $7.7 billion from positive $6.8 billion the year before.

In these blog posts, two of Summit’s housing experts—Dr. Edward Seiler and Andrew Netter—provide an overview of the HECM program and its mechanics and summarize the drivers of the changes between the 2015 and 2016 HECM Actuarial Reviews.

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What is the HECM program?

The Federal Housing Administration (FHA) provides insurance for reverse mortgages obtained from FHA-approved lenders through its Home Equity Conversion Mortgage (HECM) program. Congress introduced the HECM program in 1987 under the National Affordable Housing Act (NAHA) to assess the demand for HECMs and to learn what types of reverse loans best served elderly borrowers’ needs. HECM became permanent in 1998.

How is HECM different from other loan programs?

The FHA designed the HECM program to enable senior homeowners to “age-in-place” by converting the equity in their homes to cash with no requirement to make monthly mortgage payments. Borrowers receive HECM loan proceeds on a payment plan they choose. Unlike a traditional mortgage that is repaid over time, a reverse mortgage is repaid in a single payment after the borrower dies or no longer occupies the property as a principal residence.

Because a HECM is a non-recourse loan, the borrower or estate will never owe more than the value of the mortgaged home and no assets other than the home are used to repay the loan. The principal limit, the amount that a borrower can receive from a HECM, is based on the value of the property, the borrower’s age, and interest rates. (To understand these factors in detail, see Edward Szymanoski’s 1994  Real Estate Economics article “Risk and the Home Equity Conversion Mortgage”.)

One can think of the HECM insurance contract as a put option on the value of the home, where the strike price is equal to the outstanding balance of the mortgage and the expiration date is uncertain. If home prices fall or fail to appreciate enough to exceed the outstanding balance of the mortgage at termination, then FHA experiences a shortfall claim or a lower recovery amount. In the first years after Congress made the HECM program permanent, the number of loan terminations with a claim was relatively small, because most were “out of the money”, where property sales yielded positive recoveries. However, following the 2009 housing and economic recession, however, many HECM terminations have been “in the money,” resulting in more claims for FHA.

How has HECM changed?

The HECM portfolio has experienced notable changes in recent years, including a higher proportion of younger borrowers in the portfolio with higher property indebtedness, an increasing number of tax and insurance delinquency defaults, and more borrowers electing lump-sum distributions at closing rather than payments over time. Those changes have contributed additional risks to the MMIF and resulted in higher insurance claims payouts.

Consequently, FHA has made several updates to the HECM program to reduce risks to the MMIF and protect the viability of the program. These updates include limitations on the amount of mortgage proceeds that the borrower can withdraw during the first year after closing, new initial mortgage insurance premium (MIP) pricing options, and a reduction in principal limit factors (PLFs). Additionally, effective March 2, 2015 (per HUD Mortgagee Letter 2014-22), borrowers complete a financial assessment to evaluate their willingness and capacity to meet their financial obligations and their ability to comply with mortgage requirements.

Now that you know how HECM came to be and recent updates to the program, we’ll next focus on the mechanics of a HECM loan. Stay tuned for our next blog post.

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