FHA loan fallout extends its reach to reverse mortgages

Loans insured by the Federal Housing Administration are changing – and not just for “forward” first mortgages.

As of April 1, reverse mortgages will change, too, thanks to the queasy condition of FHA’s Mutual Mortgage Insurance Fund (MMIF) – the pile of cash used to back the loans.

A reverse mortgage historically has enabled senior home owners to convert part of the equity in their homes into tax-free funds without having to sell the home, give up title, or take on a new monthly mortgage payment. Reverse mortgages are available to individuals 62 or older who own their home. The maximum amount of funds received is based on age, current interest rates and a current home appraisal. Funds obtained from the reverse mortgage are tax-free.

FHA insures the most popular reverse mortgage product called a Home Equity Conversion Mortgage (HECM). It has been available both as a fixed-rate product and as an adjustable-rate product. The HECM Standard has more up-front fees but borrowers can take out more of a percentage of their home equity while the HECM Saver has fewer up-front costs but limits the ceiling on how much cash borrowers can receive.

The HECM Standard will still be available after April 1, but consumers will be limited to an adjustable interest rate. So, borrowers will still be able to pull out the maximum amount of equity but they will be asked to take on the risk of rising rates.

According to a recent letter to lenders, all fixed-rate reverse mortgages assigned a FHA case number on or before March 31 may be processed as either a HECM Standard or a HECM Saver. Any fixed-rate HECM Standard loan must close on or before July 1.

The move has been anticipated for months and lenders have been preparing customers with the new guidelines. FHA deemed the move necessary for a variety of reasons, not the least of which was that seniors would withdraw all possible funds, spend them too quickly and then not have enough remaining to pay property taxes and insurance, let alone future living needs.

Not only do many seniors take comfort in the reliability of fixed-rate loans, but they also are used to them. Most had fixed rates on their “forward” mortgages years ago. They also were eager to retrieve as much money as they could from their home equity as soon as possible – hence the popularity of the HECM Standard.

“The elimination of the fixed Standard product will ultimately benefit all parties and, in particular, our senior clients,” said Marty Taylor, president of the reverse mortgage division of Axia Home Loans. “The need to keep the insurance fund solvent, coupled with ensuring clients’ equity preservation, will prove beneficial.”

The concept behind the HECM Saver – charge less up-front fees but limit the amount of cash seniors can take – is more in line with the original intent of the loan. Reverse mortgages were meant to supplement and work in conjunction with a senior’s other assets – Social Security, savings, individual retirement account, pension – not as a primary retirement fund.

But the problem with the fund goes far deeper than FHA having to pony up for several hundred problem reverse mortgages that needed to tap the insurance fund. The pressure on the fund comes from the overwhelming number of forward loans that FHA is asked to insure that were never in the master plan.

Five years ago, when money was tight and jumbo mortgages became so difficult to find, FHA became a sort of safety valve for many mortgage professionals. Some lenders reported that FHA loans suddenly made up nearly 40 percent of their business. In 2005, FHA had about 3.5 percent of the forward market.

The government’s answer was to balance the problem by giving lenders more money so that they could lend it back to consumers and small businesses. The cash never really came back in a way it was designed. So, FHA continued to take on thousands of loans that the “conventional” market did not absorb. Greater volume means a greater number of problem loans hammering away at the MMIF.

“By getting back to the basics of considering equity preservation by focusing on the fixed saver and adjustable rate products, we move back to supporting the original fundamentals that insures a financially sound insurance fund so critical to this program,” Taylor said.