Insights on Reverse Mortgage Default
Researchers at Ohio State University recently completed an analysis of default risk in the Home Equity Conversion Mortgage (HECM) program. This analysis, an example of evidence-based policymaking at HUD, was funded through grants from the MacArthur Foundation and HUD. The HECM program enables homeowners over the age of 62 to withdraw equity from their homes to supplement existing income, finance home improvements, or meet unanticipated expenses. Under certain circumstances, seniors may also use HECMs to purchase a primary residence. Reverse mortgages such as HECMs convert home equity into a monthly income stream or a line of credit for homeowners, who continue to live in their home and retain the title to their property. HECM borrowers also continue to be responsible for the upkeep, taxes, and homeowner’s insurance on their property. As the only federally insured reverse mortgage product on the market, HECM offers borrowers two significant benefits over other reverse mortgages. First, the HECM program limits loan costs by prescribing the amount that lenders can make available to borrowers along with a cap on origination costs. Second, the Federal Housing Administration (FHA) guarantees that lenders will meet their obligations to the borrower and make the funds available in a timely manner. These two benefits have been especially valuable to seniors given the financial turmoil caused by the bursting of the housing bubble and the Great Recession, and most reverse mortgages made in recent years have been HECMs.
However, the housing crisis has not left the HECM program unscathed. Default rates on HECMs have risen sharply — to between 8 and 10 percent in the years since the crisis —calling into question the viability of both the program and the Mutual Mortgage Insurance Fund. These high default rates have also placed more seniors at risk of foreclosure, creating significant personal and community impact. To address this crisis, FHA now requires that prospective HECM borrowers receive housing counseling and education about the program. Additional changes that either have been implemented or are in the works include new underwriting requirements, new principal limit factors, limits on initial disbursement, and limiting or eliminating the availability of certain product types. The challenge for policymakers in this area is that neither FHA nor any other HUD program office has collected information about the financial condition of HECM borrowers because HECM has not had any underwriting requirements other than a minimum age for the borrower. The Ohio State University study bridges the information gap about the financial condition and motivations of HECM borrowers at the time of origination by creating and using a unique dataset. This dataset combines confidential data on households receiving reverse mortgage counseling from ClearPoint Credit Counseling Solutions (formerly CredAbility), a large nonprofit housing counseling organization. The dataset included detailed HECM loan transaction and performance data from HUD for the period from 2006 to 2011.
Dissecting Risk and Simulating Risk Reduction
The study finds that multiple risk characteristics affect the rate of default on taxes and insurance, including the borrower’s credit score, prior delinquency on mortgage debt, the presence of a prior tax lien, and the property tax burden (which is the property tax bill as a share of income). Controlling for these risk characteristics, the study also finds that the initial amount withdrawn by a borrower is an important factor predicting default.
The study also conducted simulations to identify the effect of various policy changes and underwriting criteria. The researchers found that although limiting the initial withdrawal of funds is effective in reducing the rate of default, it would also substantially reduce program participation. Instead, the study suggests that a similar reduction in default rate could be achieved by either setting a minimum FICO score or requiring households with negative credit risk characteristics to set aside funds at the time the HECM is issued (that is, a life expectancy set aside) that will be used to pay the cost of future property taxes and hazard insurance.
Policymakers at HUD are using the findings of this study to design a proposed financial assessment for seniors seeking HECMs and to change certain program parameters, such as the limit on the initial disbursement.