Executive Summary
The reverse mortgage marketplace has been through a rollercoaster in the past decade, as the number of loans grew by more than 100% from the mid-200s to the peak in 2009, only to fall by almost 50% in the years since then. While everything from the declining availability of home equity to more restrictive reverse mortgage rules have been blamed for the decline, it seems that in reality the primary factor has simply been the fact that reverse mortgages are more popular when "traditional" mortgage options are unavailable (e.g., in the depths of the financial crisis), and become less appealing as credit conditions improve.
Accordingly, this suggests that reverse mortgages may soon become even less popular as new rules just taking effect further reduce their availability, compounded further by a financial assessment that will begin to apply in early 2014, and the coincidental lapse of the FHA's "temporarily increased" maximum property value from $625,500 down to only $417,000 at the end of the year after 2014. The end result - reverse mortgages are facing their own "tightening credit conditions" during a time when traditional lending options have become more and more relaxed - which may mean clients and their planners are less interested than ever in considering a reverse mortgage, even while reverse mortgage strategies like the standby line-of-credit or refinancing a forward mortgage into a reverse remain as valid as ever.
For those who are interested in a prospective reverse mortgage, though, the time may be now to act, as the tighter limits taking effect in 2014 means that clients may never again be able to borrow as much on a reverse mortgage as they can through the end of December. Even for those below the FHA property limits and who won't otherwise be affected by the changes taking effect next year, the simple fact that reverse mortgage borrowing limits decline by approximately 20% for every 100 basis point increase in interest rates means that there may be no better time than right now to get a reverse mortgage line of credit in place. In the long run, though, it remains unclear whether the reverse mortgage industry will be able to weather the storm it faces as reverse mortgages become relatively less appealing compared to available alternatives, or whether reverse mortgages will simply remain used in limited situations as a loan of last resort (to the extent still possible), or simply for older clients who advanced age still allows for more useful higher borrowing limits.
The Rise And Recent Fall Of Reverse Mortgages
Although reverse mortgages have existed in some form for decades, the reverse mortgage marketplace was fairly dormant until Congress passed the Housing and Community Development Act of 1987 that established a Federal mortgage insurance program for the so-called "Home Equity Conversion Mortgage" (HECM). Growth in the early years was slow (the original legislation only authorized FHA to insured 2,500 HECM loans anyway), but grew through a combination of rising home equity, expanded authorization for FHA to insure more loans, and then more recently exploded forth with a combination of baby boomers approaching retirement and the real estate boom of the 2000s.
Of course, not surprisingly, as the real estate boom turned to a bust - along with the economy overall in the midst of the financial crisis - reverse mortgage loan volume fell dramatically, and is still running at only 50% of its peak, as shown in the chart below.
Source: Michael Kitces; data from Computerized Homes Underwriting Reporting System
In response to the falling loan volume, in 2010 the FHA and HUD announced the "HECM Saver" loan, with 10%-18% lower borrowing limits but also a significantly lower upfront cost (reducing the initial Mortgage Insurance Premium {MIP} from 2% to 0.01%). The goal was to reinvigorate the declining reverse mortgage marketplace with a lower cost version of the loan.
Unfortunately, though, HECM Saver loan volume never really took off, and in the meantime a disturbing trend began to emerge - a rising pace of reverse mortgage defaults from traditional HECM standard loans, especially those that were done with a fixed-rate full lump sum withdrawal at the time the loan had closed. Simply put, people were taking out reverse mortgages, blowing through the lump sum funds that were extracted, and winding up being unable to pay their property taxes and homeowners' insurance just a year or two later, resulting in rising defaults.
In turn, this series of rising defaults led to a number of industry responses. First, the fixed-rate HECM Standard loan itself was eliminated, as that was the loan type driving the greatest volume of defaults. However, that was not entirely enough to stem the tide of defaults and the impacts it was having to the FHA's insurance fund, and accordingly HUD and FHA put through even more significant changes this fall to try to pull them back from being a "loan of last resort" that results in significant defaults. The adjustments included the elimination of the recent HECM Saver loan, consolidating all reverse mortgages into a single loan type with a tiered upfront MIP depending on the amount of funds drawn in the first year; in addition, the lending limits were adjusted, and new financial assessments were introduced (to take effect in early 2014) that may force reverse mortgage borrowers to have their property taxes and homeowners insurance premiums escrowed directly from their reverse mortgage proceeds if certain thresholds are not met.
Why Is Reverse Mortgage Volume Declining?
While the reverse mortgage industry has taken several steps in recent years to stem the rising defaults and to reinvigorate declining loan volume since the 2009 peak, the question arises: if there are more and more baby boomers facing retirement, why aren't the number of reverse mortgages increasing every year? After all, it's not as though the economy has so dramatically rebounded that today's retiree crisis has been solved. To the contrary, with the earliest baby boomers just starting to reach their Social Security normal retirement age of 66 in 2010 and now reaching retirement age on the order of 10,000 per day, in theory the number of reverse mortgages should be exploding. Yet they're not.
The commonly blamed culprit for the decline in reverse mortgage volume is the decline in available home equity as a result of the bursting of the real estate bubble. Yet this does not appear to be a valid explanation. For instance, the chart below graphs annual reverse mortgage loan volume against the Federal Reserve data on owners' equity in real estate; as the chart reveals, home equity levels actually peaked in 2006 and were already in decline by 2008 (troughing in 2009-2010), while reverse mortgage loan volume was just exploding in 2006 and peaked in 2009 at the same time home equity was at its nadir! It was only after the real estate bottomed out that reverse mortgage activity begin to decline, and notably the rebound in available home equity since 2011 and done little to help; in fact, reverse mortgage volume is down 20% since 2011, despite the associated rise in home prices!
Source: Michael Kitces; data from Computerized Homes Underwriting Reporting System and FRED database on owners' equity in real estate
Instead, the reality appears to be that much of the explosion of reverse mortgages in 2007-2009 was not a result of changes in available home equity; instead, it was a response to the tightening of subprime and nontraditional mortgage lenders. Accordingly, the chart below graphs reverse mortgage volume since 2007 against the net percentage of banks tightening standards for nontraditional mortgage loans. The activity aligns almost perfectly, with reverse mortgage volume exploding upwards as 40%-80% of banks were tightening standards for nontraditional mortgage alternatives, and then leveling out once return conditions returned to neutral over the past few years.
Source: Michael Kitces; data from Computerized Homes Underwriting Reporting System and FRED database on Net Percentage of Domestic Banks Tightening Standards on Nontraditional Mortgage Loans
In other words, the reality for reverse mortgages seems to be that they are driven as much by the availability of alternative nontraditional (or traditional or prime) mortgages as they are available home equity or other factors. To the extent that it's easy for homeowners to borrow against home equity without a reverse mortgage, many seems to choose to go that route; when alternative ways to tap home equity dry up, reverse mortgages become more popular again. In turn, this means that one of the primary factors clients may consider when evaluating a potential reverse mortgage is the cost and availability relative to other lending alternatives (traditional mortgages, interest-only or negative amortization forward mortgages, home equity lines of credit from banks, etc.).
Tightening Credit Conditions In Reverse Mortgages
Given that reverse mortgages seem to be impacted so significantly by the relative cost and how tight/loose lending standards are for reverse mortgages compared to the available alternatives, the changes just implemented and coming soon to the FHA's HECM reverse mortgage may dramatically and adversely impact the use of reverse mortgages going forward.
As discussed previously on this blog, the new changes just implemented have reduced borrowing limits significantly relative to the "old" HECM Standard reverse mortgage; while the Principal Limit Factor (PLF) thresholds only declined slightly from the old rules to the new ones, the new rules also stipulate that borrowers can only extract 60% of the new PLF amounts in the first 12 months. For those who were looking to heavily tap their home equity, this represents a drastic decline in available home equity for immediate borrowing. Even at today's low interest rates, a 65-year-old borrower would not be able to tap more than about 32.5% of their home equity via a reverse mortgage, in a world where a traditional lender might offer a forward mortgage anywhere from 80% to 95%+ of the value.
If the individual was going to refinance a traditional mortgage into a reverse mortgage - arguably a more effective way to carry mortgage debt in retirement! - the lending limit is higher, but is still only approximately a maximum 54% loan-to-value ratio, and would require a whopping 2.5% mortgage insurance premium based on the value of the property (which would actually amount to about 4.6% of the loan balance!) in addition to other closing costs. Consequently, retirees who already had a higher loan-to-value ratio couldn't refinance into a reverse mortgage even if they wanted to, and those who could may still well balk at the substantial upfront closing costs that may amount to nearly 5 points more than a traditional loan (even before accounting for any different in the ongoing borrowing rates).
For others, the preferential strategy might be to use a standby reverse mortgage, as researched by Salter, Pfeiffer, and Evensky - the strategy has been shown to enhance retirement sustainability by having a HECM-guaranteed line of credit available to tap for spending when markets decline (to be replenished after the market recovers). Unfortunately, though, with the elimination of the HECM Saver, those who now wish to implement the standby reverse mortgage strategy will have to pay an upfront MIP of 0.5% (instead of only 0.01%) of the appraised value of the property (in addition to other closing costs); while an updated version of the Salter et. al. study shows that the strategy still "works" even with the higher initial closing costs, from a practical perspective clients may be more likely to balk and choose to open a traditional HELOC instead. Although the traditional HELOC is not guaranteed to remain available, nor guaranteed to have the line of credit grow - both features of the reverse mortgage line-of-credit option - the fact that such HELOCs can often be obtained with virtually no closing cost may still make them far more appealing.
And of course, this is before acknowledging that for some borrowers, the standby reverse mortgage strategy will be impossible; if the borrower does not meet the new financial assessment rules to take effect in early 2014 (the exact timing is unclear, as the assessments were originally supposed to begin January 13 but have now been temporarily delayed), then some or all of the reverse mortgage borrowing limit will be crowded out by the set aside for future property tax and homeowners insurance payments. Though such set asides would still improve the retiree's cash flow - as those payments would no longer need to be made outright - they still represent a restriction on the use of funds and a tightening of the credit standards for reverse mortgages.
Further compounding the issue is that coincidentally, the FHA's maximum lending limit - which was temporarily increased to $625,500 several years ago in the aftermath of the financial crisis - is scheduled to lapse back to $417,000 at the end of the year at the end of 2014, after receiving another 1-year extension under Mortgagee Letter 2013-43. This threshold is used not only for many types of traditional FHA loans, but also to determine the maximum property value that can be used to calculate the borrowing limit for a reverse mortgage. Thus, any clients with properties valued between $417,000 and $625,500 will find that their available reverse mortgage amounts will be reduced after the end of the year 2014. Those whose properties were already above the $625,500 threshold - and were already limited in their borrowing power - will find themselves even more restricted as well. For instance, a 65-year-old borrower is limited to only 54.1% of the property value - to be capped at $417,000 - and can only obtain 60% of that up front. If the actual value of the property were $800,000, the maximum initial cash advance from a reverse mortgage in the first year would be only $135,358, a mere 16.9% of the property value (in a world where a traditional mortgage might be obtained for 3-4 times that balance or more)!
Last Chance For Flexible Reverse Mortgage Higher Lending Limits?
The bottom line to all these prospective changes is that, for clients who do have any interest in establishing a reverse mortgage - either to refinance a traditional mortgage, or perhaps to set up a standby reverse mortgage line of credit - the time is now, through the end of the year, to put the loan in place, and for those who wait additional pressure will apply if they have properties with a value in excess of the looming $417,000 threshold (unless the higher limit is extended again!). Unfortunately, the "old" HECM Saver rules are already gone as of the end of September, but the lower FHA maximum property value does not take effect until December 31st of 2014.
And notably, the availability for reverse mortgage borrowing is not likely to improve anytime soon. Not only will lower maximum property limits apply in 2014 2015, along with the new financial assessment in early 2014, and all the changes that have already taken place, but the reverse mortgage borrowing limits will be further curtailed in/when interest rates rise further. Above a 5% minimum threshold (including LIBOR or other rate index, plus the lender's margin), every 1% increase in interest rates results in a decrease in borrowing limits of approximately 20%. Given the overall lending limits - including the maximum property value included in the assessment, and the limit of only 60% of the loan proceeds in the first place outside of mandatory obligations - is interest rates rise enough, the reverse mortgage may be so restrictive as to simply not be worthwhile for most.
On the other hand, if the reverse mortgage is established sooner rather than later, the maximum lending limit is locked in at the time of the loan, and rising interest rates would simply allow any remaining line-of-credit borrowing power to increase even faster. Accordingly, for those who have any interest in a reverse mortgage, now or in the future, the incentive is to establish the loan by the end of the year to lock in today's borrowing limits, before the remaining rules changes take effect and interest rates potentially rise.
In the long run, though, it still remains unclear how popular reverse mortgages may become. While the recent changes have attempted to curtail its use as a "loan of last resort", the higher costs, lower loan limits, and general tightening of credit standards suggest that reverse mortgage loan volume may drop significantly more in 2014, not "just" because the loans are more restrictive but because lower cost, higher borrowing limit traditional mortgages will seem all the more appealing as an alternative. Ironically, this may mean reverse mortgages will end out only being used for older clients, not as a loan of last resort, but simply because the advanced age represents a shorter prospective time horizon and therefore affords a higher borrowing limit that allows the reverse mortgage to remain appealing against other alternatives. In the meantime, though, if a reverse mortgage is appealing for a client with a longer time horizon, there may truly never be a better time than right now.
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