Reverse mortgages just got more complicated.
As part of the Reverse Mortgage Stabilization Act, which went into effect Sept. 30, 2013, the Federal Housing Administration (FHA) placed strict limits on loan sizes and raised mortgage insurance premiums designed to encourage slow, steady home equity withdrawals.
Additional changes will take effect in January that include conducting credit checks and requiring certain borrowers to set aside a portion of their loan proceeds in escrow accounts to cover future property taxes and insurance.
As a group, the changes could make the loans a less-effective tool for quickly retiring the debts of the most cash-strapped consumers.
The changes were designed to combat high default rates. In 2012, default rates on reverse mortgages hit a record 9.4 percent -- almost double the default rate on traditional mortgages -- and an increase from 8.1 percent in 2011, according to a report issued by the Consumer Protection Bureau. Offsetting the cost of the defaults would require taxpayer subsidies of $789 million.
Unlike traditional mortgages that go into default when homeowners fail to make their loan payments, borrowers aren't required to make monthly payments on a reverse mortgage until they move out of the house or die. Reverse mortgages go into default when homeowners fail to pay their property taxes and insurance, which are required under their loan terms.
Smaller loans, more restrictions
Previously, borrowers could choose from two types of reverse mortgage loans (known formally as Home Equity Conversion Mortgage loans): a standard loan or a saver loan, each with its own loan limits and fees. As of Sept. 30, the loans were combined into a single HECM loan.
Lenders will continue to calculate maximum loan values based on the age of the borrower, their home value and current interest rates, but the FHA has placed limits on the maximum size of reverse mortgage loans. Peter Bell, president and CEO of the National Reverse Mortgage Lenders Association, notes that the amount borrowers can withdraw under the new rules is about 15 percent less than the equity available through the former HECM standard loan.
Borrowers also face additional restrictions in accessing their equity.
To prevent homeowners from taking a lump sum payout and spending the funds (leaving them without the means to pay their property taxes and insurance), borrowers will only be allowed to withdraw 60 percent of their equity during the 12 months following reverse mortgage approval. For example, homeowners who qualify for $50,000 reverse mortgages will only be allowed to withdraw 60 percent of their equity ($30,000) during the first year.
Homeowners whose mortgage balances and mandatory debt obligations, such as federal student loans or unpaid taxes, exceed 60 percent of their equity will be able to tap additional equity to cover those responsibilities. But credit card balances are not considered mandatory obligations, which could leave some of the most cash-strapped borrowers with the largest credit card balances unable to fully retire those debts.
A higher cost to borrow
In addition to smaller loan amounts, the combined HECM loan product also comes with higher fees.
Borrowers were charged a 2 percent mortgage insurance premium through the former HECM standard loan and 0.001 for HECM saver loans; the new premiums have increased to 2.5 percent for borrowers who withdraw more than 60 percent of their equity in the first year of the loan and 0.005 percent for borrowers who withdraw less than 60 percent of their available equity.
Credit checks to qualify
Starting in January, borrowers will be required to undergo a financial assessment to be approved for a reverse mortgage.
Until now, "there was a zero cash flow exam," notes Gregg Smith, president and COO of One Reverse Mortgage, a mortgage lender affiliated with Quicken Loans. In other words, borrowers did not need to provide documents essential for a traditional mortgage application, including tax returns, bank statements or credit scores.
As part of the assessment, lenders will review mortgage debts and payment histories and confirm that homeowners are current on their property taxes and have up-to-date insurance policies. The assessment will also check for unpaid liens against the property and delinquent or defaulted debts owed to the federal government.
Credit scores will not be used to determine eligibility.
Depending on the results of the financial assessment, borrowers may be required to set aside funds to cover property taxes and insurance for the life of the loan through a Lifetime Expectancy Set Aside account, which is similar to an escrow account.
The "set asides" will ensure that at-risk borrowers maintain cash reserves to keep them from defaulting on their reverse mortgage loans. For some borrowers, the requirement will have a significant impact on the amount of equity they can access.
Most reverse mortgage lenders applaud the financial assessment and set-aside requirements.
"It's a reasonable ask," notes Smith. "A reverse mortgage is still a loan and we need to be sure that borrowers will be able to [repay] it."
But critics fear that lenders may pressure homeowners into applying for loans before the financial assessment requirement is implemented in the New Year.
"There seems to be a lot of pressure to close [the reverse mortgage loan] before the changes take effect and some people might get a loan without fully understanding the trade-offs," explains Erin Rearden, a mortgage services program supervisor for Solid Ground, a nonprofit HUD-approved mortgage counseling agency in Seattle. "It's a big decision and it needs to be well thought out."