The Federal Housing Administration has recently reshaped its most popular reverse mortgage product, the standard fixed-rate Home Equity Conversion Mortgage (HECM). Read on to learn more about federally-backed reverse mortgages, what changes were made to the government’s reverse mortgage program, and why those changes were made.
How Reverse Mortgages Work
With a reverse mortgage, homeowners are able to tap into the equity in their homes to provide cash to help meet expenses, such as medical costs. Reverse mortgages are only available for homeowners who are:
- 62 years of age or older
- occupy the property as a principal residence, and
- own the home outright or have significant equity in the home.
A reverse mortgage is different from a traditional mortgage in that it does not require the borrower to make monthly payments to the lender to repay the loan. Instead, loan proceeds are paid out to the borrower as a monthly payment, line of credit, or a lump sum (or a combination of these options). The amount of the loan is based on the equity or sale value of the house.
The reverse mortgage loan becomes due and payable when you:
- sell the property
- permanently move out (for example, to a nursing home)
- do not meet the obligations of the mortgage (such as paying taxes and insurance), or
For more information about reverse mortgages, see Reverse Mortgages for Retirees and Seniors.
Understanding the Home Equity Conversion Mortgage (HECM)
The Federal Housing Administration (FHA) created one of the first types of reverse mortgages, called the Home Equity Conversion Mortgage (HECM). A HECM is the only reverse mortgage that is insured by the federal government. It is the oldest and most common reverse mortgage product available, accounting for around 90% of the total market.
There are two types of HECMs available:
- HECM Standard, and
- HECM Saver.
Historically, the most popular type of HECM has been the standard fixed-rate version because it yields the greatest amount of money (often hundreds of thousands of dollars) in one lump sum, though it can be expensive due to high upfront costs. The HECM Saver, on the other hand, costs less, but pays out a smaller amount than would be available with the standard fixed-rate HECM.
Homeowners Must Pay for Taxes, Insurance
With reverse mortgages, including HECMs, the borrower remains responsible for:
- property taxes
- hazard insurance premiums
- mortgage insurance, and
- home maintenance costs.
However, when reverse mortgage borrowers immediately take a large amount of cash out, this leaves them with less money in later years to pay for taxes, insurance, and home maintenance costs. In some cases, homeowners end up defaulting on the loan when they can’t afford the taxes, insurance, and upkeep, which then leads to foreclosure.
(Learn more about the foreclosure of reverse mortgages.)
Reverse Mortgage Defaults Are Increasing
Approximately 58,000 loans (around 10% of HECM loans) were in default for reasons such as unpaid taxes and insurance in 2012, up from 2% ten years ago. As a result, the FHA says it faces some $2.8 billion in losses because of the HECM reverse mortgage program. In fact, President Barack Obama has announced that it might be necessary to provide the FHA with a $943 million bailout, largely because of the large losses associated with its reverse mortgage portfolio.
Increasing Defaults Led to Program Changes
The increasing number of defaults has caused the FHA to revamp the program by halting the standard fixed-rate HECM as of April 1, 2013. By eliminating the standard fixed-rate HECM, the FHA hopes to prevent more defaults in the future.
Instead, borrowers can consider the HECM Saver (which offers a fixed or adjustable rate) or the HECM Standard with an adjustable interest rate structure, both of which yield less immediate cash thus substantially lowering the risk to the FHA insurance fund.
The FHA also asked congress for authority to make additional changes to the HECM program to reduce defaults. Under the new rules, which went into effect on September 30, 2013, borrowers are not able to access as much of the value in their home compared to the maximum amount available before this date. (Homeowners can access around 85% of what was previously available.)
Additionally, the rules also limit the amount that can be taken out in the first year. For example, a homeowner who is eligible for a reverse mortgage totalling $200,000 would be allowed to get only $120,000 (60% of the total) in the first year (subject to a few exceptions, such as if the borrower's existing mortgage, for example, exceeds the 60% limit). The goal of these changes is to encourage people to access their home equity slowly and steadily over the years, rather than all at once.
Other changes, which go into effect January 13, 2014, include:
- requiring the use of a financial assessment in making a reverse mortgage loan to ensure that homeowners can afford the taxes and insurance payments, and
- establishing a set-aside account for taxes and insurance if a lender determines that a homeowner may not be able to keep up with these payments (or the lender can pay these charges through disbursements from the line of credit or by withholdings from the monthly disbursements.)
For More Information
It is highly recommend that you proceed cautiously if you are thinking about taking out a reverse mortgage. Be sure that you know the risks and watch out for reverse mortgage scams. (Learn more in our article Reverse Mortgage Scams.)
For more information on reverse mortgages, visit the AARP’s reverse mortgage webpage at www.aarp.org/revmort.
To learn more about HECMs, go to www.hud.gov and enter "Home Equity Conversion Mortgage" in the search box to find a list of relevant links.