The Home Equity Conversion Mortgage (HECM) program from the Federal Housing Administration (FHA) lets seniors tap into their $7 trillion in housing wealth to help them pay for living expenses that many have difficulty affording. But this program has proved very costly to the FHA, prompting the FHA to narrow the eligibility of the program, resulting in decreased participation.
These changes have left the program struggling with lower volume and negative net worth. Rather than continuing to narrow eligibility—and decreasing participation further—the FHA should focus on reducing costs. Addressing losses on assigned loans would be the best step in that direction. This servicing issue is one of the biggest drivers of losses in the HECM program.
The FHA’s reverse mortgage program should have much greater participation
The FHA’s HECM program offers homeowners ages 62 years and older the ability to borrow against their home equity through a government-insured reverse mortgage. A reverse mortgage is essentially a loan against the home, where the borrower receives a single or monthly payment, which is paid back when the home is eventually sold.
In an era when seniors are sitting on a mountain of housing wealth and having anxiety about their finances, this should be a well-used program. Instead, despite a growing number of seniors, participation has dropped from 73,112 mortgages in fiscal year 2011 to 48,327 mortgages in 2018.
Over this same period, the FHA narrowed the eligibility of the program, increased upfront costs, and reduced the amount that can be taken out upfront, all of which reduced participation. And the program remains in poor fiscal health.
How assigned loans lead to losses for the FHA
HECMs are complicated instruments. They are generally pooled into Ginnie Mae securities and sold to investors. When the value of the loan reaches 98 percent of the initial home value (the maximum claim amount), the servicer must pull the loan out of the Ginnie Mae pool. At this point, the loan goes one of two ways:
- it’s assigned to the FHA, in which case the loans are placed on the FHA’s balance sheet, and servicing is transferred to the FHA’s servicer, or
- it’s held by the reverse mortgage servicers on the servicer’s balance sheet.
Assume a borrower takes out $120,000 upfront on a home valued at $200,000 in 2010, with an interest rate of 5 percent. In just over 11 years, that mortgage would have reached 98 percent of the maximum claim amount (in this case, $196,000). At this point, the loan must be pulled out of the Ginnie Mae pool, and the servicer would have the option to assign the loan to the FHA, if it qualifies. Loans that qualify are generally assigned, as holding these loans on the servicer’s own balance sheet is very expensive.
A loan cannot be assigned (as in, it does not qualify) if it has tax or insurance delinquencies or if the servicer is working with the borrower on loss mitigation, the home is being foreclosed upon, the borrower is in bankruptcy, or the loan is inactive because the borrower has died or has moved out. If the loan cannot be assigned to the FHA, the servicer will hold and service the loan through resolution. Actuarial studies indicate (PDF) that close to 60 percent of the loans are not assigned.
Servicing transfers are inherently disruptive. Borrowers are often confused when they receive a note that their servicer has changed. There’s also no standardization in servicing data, and errors can occur in the transfer process.
The FHA loses much more on these assigned loans than is necessary
This is evident when comparing the losses on the assigned loans, where the servicing is transferred, to the losses on loans that are not assigned and continue with the original service.
Assigned loans have a loss rate of roughly 42 percent. This includes the difference between estimated value and sales price, the costs of sale, and the costs of maintaining the properties until they are sold. Pinnacle, the Mutual Mortgage Insurance Fund (MMIF) actuary, estimates that the latter two costs total 25 percent of the sales price. This 42 percent total should be compared with a 12 percent loss rate when the loans remain with the original servicer; that is, when they are not assigned.
The 12% loss rate calculation is based on Moody’s estimate of these losses at about 7 percent of the appraised value of the property. On top of this estimate, we add servicer expenses of about 1.75 percent per year for 18 months to maintain the property, including tax and insurance payments and foreclosure expenses of 2 percent of the sales price, or $4,500.
When servicers keep the loans that cannot be assigned, the losses are much lower than those incurred on assigned loans because
- FHA policies do not maximize the value of the properties, and
- servicers’ incentives, in combination with their specialized knowledge, reduces losses.
For example, the FHA does not foreclose on properties with tax and insurance defaults, even though they are entitled to do so. If the borrower is not paying their taxes and insurance, they may not be maintaining their home, resulting in the need for more proactive servicing in order to mitigate losses. If the home is vacant, it can also be detrimental to its value, yet it’s unclear how closely the FHA monitors vacancies.
Servicers are also better at monitoring the properties, often reminding the borrower to make the tax and insurance payments to avoid foreclosure. Faster disposition is important because the servicer will usually lose money if the house is vacant and decaying.
By contrast, contractors from the US Department of Housing and Urban Development (HUD) are often less experienced than the original servicers. The contract terms they operate under often lack strong performance measures and penalties, which hamper the FHA’s ability to take action for poor execution.
Reducing losses on assigned loans
If HUD could continue to accept assignment of HECM loans but allow servicing to be performed by the current servicers, it could improve the health of the MMIF without impacting the program’s scope. The loans would sit on the FHA’s balance sheet. Servicer performance could be monitored by comparing the loss severity of the loans they assign with those they don’t assign.
Another possible alternative is to develop a securitization program to repool loans after they have reached 98 percent of the maximum claim amount and can no longer be included in the current Ginnie Mae HMBS program (HMBS, as the mortgage backed securities are backed by HECMs). This new securitization product (referred to as HMBS 2.0), would lower the funding cost for the servicer and provide an incentive not to assign the loans to the FHA. This alternative deserves closer study; the gains to the MMIF need to be quantified.
The evidence clearly indicates that the FHA is suffering greater losses than necessary by transferring servicing when loans reach 98 percent of the initial home value. If the FHA were to allow existing servicers to retain the servicing for the rest of the life of the loan, it would stem these unnecessary losses. This is critical to the future viability of this valuable program for seniors.