An industry at the crossroads
An industry at the crossroads
Editor's note: This is the first of a five-part series.
A reverse mortgage is a secured loan to an elderly homeowner on which the borrower's debt rises over time, but which need not be repaid until the borrower dies, sells the house or moves out permanently.
The "forward" mortgages that are used to purchase homes build equity, which is calculated as the value of the home less the mortgage balance. Borrowers pay down the balance over time. Reverse mortgages, in contrast, reduce equity because loan balances rise over time.
The reverse mortgage meets the needs of elderly homeowners who don't have enough income to do what they want to do, and who have no qualms about not passing a debt-free house to their heirs.
Reverse mortgages before 1988
The history of reverse mortgage programs goes back to the 1970s, but none of the early ventures lasted, and none provided a model for others to follow. Despite the need, reverse mortgages were a hard sell because the instruments were complicated, the sponsors were usually unknown, and elderly homeowners were fearful of making a mistake that might cost them their home. Some of the early programs reinforced these fears because they did not provide adequate consumer protections.
Growth of HECMs: 1988-2008
The landscape began to change in 1988 with the development of a federal program under the FHA authorizing the Home Equity Conversion Mortgage (HECM). The borrower protections built into this program, along with the imprimatur of the federal government, paved the way toward increasing acceptance by elderly homeowners. Lenders were attracted to the program because FHA assumed 99 percent of the risk, meaning that if the loan balance on a HECM was larger than the recoverable value of the home when the borrower died, FHA took the loss.
Under the HECM program, the maximum amount the homeowner can withdraw is called the "net principal limit," or NPL. The NPL is determined by:
1. The lower of the FHA national loan size limit, the appraised value of the home, and the sale price if the HECM is used to purchase the home.
2. The ages of the borrowers, which determine their expected life.
3. The expected interest rate on the HECM, which determines how fast the borrower's debt will grow.
4. The upfront mortgage insurance premium set by FHA.
5. Origination fees set by the lender subject to ceilings set by FHA.
6. Other settlement costs set by title insurers and others.
The number of new HECMs rose slowly until 2003, then accelerated, reaching a peak of 114,000 in 2009 (year ending in September). During this period, private programs that worked in much the same way arose to meet demands from borrowers with higher-value homes whose borrowing power under the HECM program was limited by legal ceilings on FHA loan amounts. In 2007, I counted seven private programs offering "jumbo" reverse mortgages.
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