In the aftermath of the financial crisis, the decline of real estate prices has been a distress not only to traditional mortgage borrowers and lenders, but also the Federal Housing Administration (FHA) and its reverse mortgage program. As a result, the Department of Housing and Urban Development (HUD) has taken several steps to make the program somewhat more restrictive, reducing borrowing limits and increasing the insurance premiums to borrowers that back the program.
In a big announcement this month, HUD has announced a new round of changes that will consolidate HECM Saver and Standard loans, change the principal limits that impact the maximum consumers can borrow, and generally increase costs once again for reverse mortgages. In addition, the HECM reverse mortgage program will become much more restrictive in how much can be borrowed at once, and early next year will introduce a new financial assessment process to further ensure that reverse mortgage borrowers have the means to maintain their property taxes and insurance to avoid defaulting on the loan.
From the financial planning perspective, these changes are arguably a good step to help curtail some irresponsible borrowing, and ironically may have little impact to the clients of financial planners who already tend to be somewhat more affluent and more proactive in their retirement strategies (while the impact will be more significant for those already in dire financial straits). On the other hand, the new higher costs for many types of loan approaches, and the new limitations on principal limits - which can be particularly constraining to affluent individuals with pricier homes - may make reverse mortgages somewhat less appealing for financial planners, even as the reverse mortgage industry shifts to focus more on the types of clients that planners typically work with.
Changes Coming To Reverse Mortgages
Last week, HUD issued new guidelines that will alter several key provisions of reverse mortgages going forward. As detailed in Mortgagee Letters 2013-27 and 2013-28, key changes to the FHA's HECM reverse mortgage include:
- Consolidation of HECM Saver and HECM Standard loans into a single standard loan
- Adjustment of the upfront Mortgage Insurance Premium (MIP) to 0.50% of the assessed value (previously 0.01% for Saver and 2.0% for Standard loans)
- Limit of accessing only 60% of the principal limit at closing or in the first year
- Exception allowing more than 60% to be borrowed if "mandatory obligations" including closing costs, amounts of existing liens being refinanced, delinquent Federal debt, and other items exceed this threshold (in which case the maximum amount is capped at these mandatory obligations plus an additional 10%, up to the PLF threshold)
- Additional upfront MIP of another 2% (bringing total up to 2.5%) if, pursuant to mandatory obligations, more than 60% of the available Principal Limit is drawn upon at closing or within the first 12 months
- New Principal Limit Factor (PLF) tables that are more favorable than current PLFs for HECM Saver but less favorable than HECM Standard
The effective date for these new rules is the end of September, and will apply to any new loans starting on/after September 30th. Therefore, any reverse mortgage borrowers who wish to qualify under the existing HECM Standard and HECM Saver rules must apply and have an FHA case number assigned (which also means they must complete requisite HECM Counseling) on or before September 28th (since September 29th is a Sunday and FHA systems are unavailable to assign case numbers that day).
In addition to the above rules changes, effective next January 13th of 2014, HECM reverse mortgage borrowers will also be required to undergo a financial assessment. The purpose of the assessment is to determine whether the borrower is reasonably capable of maintaining the requisite property tax and homeowners insurance payments given their other income, assets and liabilities, and credit report. If it is determined that the borrower will not reasonably be able to support these payments, then it will be required for these payments to be drawn from the reverse mortgage itself and escrowed; notably, given the dollar amounts and time horizons involved (possibly for the borrower's entire life expectancy!), this may effectively mean that the entire reverse mortgage borrowing amount is consumed by just the obligation to potentially maintain property taxes and homeowners insurance for life.
Practical Implications Of New Reverse Mortgage Rules
The basic goal underlying the new reverse mortgage rules is relatively straightforward: to reduce how often reverse mortgages are used as a loan of last resort for people who are already financially distressed, such that they just end out depleting the money and winding up defaulting into foreclosure anyway. While reverse mortgages can't be foreclosed upon for the failure to make loan payments - as there are no payments - a foreclosure can still be triggered if the borrower fails to maintain the property and pay property taxes and homeowner's insurance, which is an unfortunately probable scenario if the borrower is already highly financially distressed; in fact, as previously discussed on this blog, the decision earlier this year in Mortgagee Letter 2013-01 for HUD to limit lump-sum HECM Standard loans was also done to address the rising rate of reverse mortgage defaults. In essence, the intention of the new rules is to shift reverse mortgages from being used as a last resort, to being used more proactively and earlier in the retirement process as a part of a coherent strategy; in other words, as a part of a more comprehensive financial planning approach.
Unfortunately, though, in practice the application of the new rules may also make reverse mortgages less appealing or feasible for some financial planners, for two primary reasons. The first is the new 0.50% upfront MIP cost (in addition to other closing costs); in the past, financial planners were often wary to use reverse mortgages because of the hefty 2% upfront MIP, and the introduction of the HECM Saver a few years ago with virtually no upfront MIP (a charge of only 0.01%) had made the loans far more appealing, as detailed in the October and November 2011 issues of The Kitces Report. The consolidation of HECM Standard and Saver loans into a single loan with an upfront 0.50% MIP eliminates the option for planners to use a HECM Saver early and reduce the upfront cost, which can be significant given that the MIP is based not on the loan amount (like an origination fee) but on the assessed value of the property (up to a maximum claim amount of $625,500 in 2013); in other words, if you borrow $100,000 from a property worth $500,000, the 0.50% upfront MIP is not 0.50% of the $100,000 loan amount, but 0.50% of the $500,000 property value, or $2,500 (which is actually 2.5% of the loan amount in this example!)
The second challenge is that not only is the upfront MIP higher (for planners who typically would have used a HECM Saver loan), but the effective loan limits to face "only" a 0.50% MIP are dramatically lower. For instance, under the "old" rules the HECM Saver PLF for a 70-year-old assuming a 4% rate was 0.548, which meant if that individual had a $300,000 property he could borrow up to $164,400. Under the new rules, the PLF will be a more favorable 0.564 for a maximum borrowing amount of $169,200. However, as noted earlier, the 0.5% MIP applies only if the borrower draws no more than 60% of the maximum loan amount, which means securing the 0.50% MIP loan as an upfront draw (or using a fixed rate loan, which requires a full upfront draw) limits it to only $101,520, a whopping 38.2% drop in the loan amount on top of an increase in the MIP from 0.01% to 0.50%. In other words, to actually get access to "just" the 0.50% upfront MIP on a fixed rate loan or another scenario that requires a full draw up front, the borrower effectively can only borrow 60% (the limit) of 56.4% (the PLF) of their assessed value, or a mere 33.84% of the value of the home.
Fortunately, the "full" $169,200 maximum loan amount remains available for those who intend to use it towards a tenure payments-for-life option, or to apply the reverse mortgage as a line of credit (though unfortunately they will be "stuck" required to use a floating interest rate loan!). Nonetheless, for those who intended to use the loan for an upfront draw, perhaps to refinance a current mortgage to be relieved of the cash flow obligations, the loan limits are dramatically reduced to get "only" the 0.50% MIP, and to refinance the same $164,400 as the HECM Saver after the new rules take effect will boost the upfront MIP from 0.01% to a whopping 2.5% (because the mandatory disbursement to refinance the existing loan will be more than 60% of the PLF!)!
The third challenge is the simple fact that the overall principal limits for maximum lending are lower. For those who were willing to pay the old 2.0% upfront MIP for a HECM Standard loan, the "old" PLFs for a 70-year-old at 4% were 0.663, while the new PLF is again only 0.564. To put that in actual dollar terms, the individual with a $300,000 property can only get a reverse mortgage of $169,200 instead of $198,900 under the current rules, a decrease of about 14.9% in the borrowing limit. The good news is that for those who don't need the full amount up front (and can conform to the 60%-of-PLF-in-first-year limitation), the loan will at least be cheaper, with an MIP of only 0.50% (new rules) instead of 2.0% (old HECM Standard rules); on the other hand, for those who want to borrow the maximum, for instance to help refinance an existing mortgage above the 60%-of-PLF threshold, the borrowing limit is 14.9% lower even while the upfront MIP is increased from 2.0% to 2.5%.
Immediate (And Limited) Opportunities Before New Rules Take Effect
Given the rather tight timeline until the new rules take effect - reverse mortgage applications must be submitted in just the next few weeks - the time window is limited for those planning situations that may be most impacted by the new rules. Leading planning opportunities to be considered include:
- Refinance traditional mortgages into HECM loans. For those who wish to relieve themselves of the mortgage cash flow in retirement without liquidating a portfolio to pay down the mortgage, a reverse mortgage is very appealing. However, some clients may be unable to refinance using a reverse mortgage when the new, lower PLFs come into place, and for those whose refinance would be more than 60% of the new PLFs, the loan should be underway before the new rules take effect to avoid the significant 2.5% upfront MIP.
- Use reverse mortgage for purchase. Although the timing may be limited simply because of when a new property purchase may be closing, anyone who intends to use the HECM to help finance the purchase of a retirement home may seek to get the loan underway by September 28th to ensure the current PLFs and upfront MIP costs (under the HUD rules, as long as the loan process starts by September 28th, it can close as late as December 31st).
- Establish a "standby" reverse mortgage line of credit. Recent research by Salter, Pfeiffer and Evensky have shown how using the reverse mortgage as a "standby" line of credit to fund retirement expenditures in years when the market is down (and then repay the line of credit after the market recovers) can enhance retirement income sustainability. Those who are interested in the strategy would have typically used the HECM Saver loan, so the new PLFs may actually allow a higher line of credit for the approach (as the new PLFs are higher than the old Saver PLFs), but completing the loan prior to September 28th will allow clients to avoid the new 0.5% upfront MIP.
- More favorable lifetime income payments. For those who are interested in using the reverse mortgage "tenure" payments that provide income for life, completing the transaction before September 28th either allows the lifetime income to be obtained cheaper (for those meeting the HECM Saver loan limits with only a 0.01% MIP) or for greater income (for those using the HECM Standard with higher costs but also higher PLFs).
Notably, the reality is that in the past, many users of the reverse mortgage programs have not been as focused on some of the costs, including the upfront MIP, in no small part because the closing costs (including the MIP) are often wrapped into the loan itself, and many borrowers seeking out reverse mortgages in the past were in dire financial straits and had few (if any) alternatives anyway. Instead, the focus was simply on borrowing the maximum amount possible. In addition, some have suggested that borrowers were being inappropriately "encouraged" to take maximum full draws because of demand from secondary market bond buyers (who found government-guaranteed reverse mortgage bonds to be appealing compared to other risk-free alternatives!).
Going forward, though, to the extent that reverse mortgages are intended as a more proactive tool - fitting well within the financial planning process - the increased costs and the elimination of the HECM Saver option may make the tool a little less appealing for many financial planners, especially if the goal was to simply use it as a standby line of credit that may not even be used anyway. This presents both an immediate planning opportunity - to take advantage of the current rules before they change - but also means that reverse mortgages with higher costs will have to be weighed more carefully in the future. On the other hand, principal limits will at least be slightly higher (albeit at higher cost) for planners who would have previously recommended HECM Saver loans.
On the other hand, given that financial planners tend to work with somewhat more affluent clients anyway, and engage in a proactive planning process that addresses the client's ability to fund their retirement goals, it's likely that the new financial assessment rules will have little impact on reverse mortgage eligibility for most financial planning clients. In addition, for some clients who may be impacted, their primary goal may have simply been to use the reverse mortgage to cover their property taxes and homeowners insurance anyway - to help manage their overall retirement cash flow - which means even with the financial assessment, the outcome will merely be a requirement to use the reverse mortgage how it was intended to be used anyway. However, many "traditional" users of reverse mortgages may find the new financial assessment rules in 2014 to be more restrictive, which may even lead some reverse mortgage lenders to focus even more on working with financial planners whose clients can qualify and use reverse mortgage strategies more proactively as they wish, even as planners may be slightly more resistant due to the higher costs.