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Reverse Mortgages: The Next Subprime?

Reverse mortgages are for seniors who don’t have enough spendable income to meet their needs but do have equity in their homes, which they don’t mind depleting for their own use rather than leaving it for their heirs.

For reasons not clear to me, reverse mortgages are being badmouthed by an unlikely source: consumer groups who are supposed to represent the interest of consumers in general, and perhaps seniors in particular.

Reverse mortgages have always been a tough sell. Potential clients are elderly, who tend to be cautious, especially in connection with their right to continue living in their home. Fears about losing that right were aggravated by some early reverse mortgage programs, which did allow a lender under certain conditions to force the owner out of his or her house.

These are reasons why, until recently, reverse mortgages never caught on.

In 1988, however, Congress created a new type of reverse mortgage called the Home Equity Conversion Mortgage (HECM), which completely protects the borrower’s tenure in his or her house. So long as he/she pays the property taxes, maintains the property and doesn’t change the names on the deed, he/she can remain in the house forever.

Furthermore, if the reverse mortgage lender fails, any unmet payment obligation to the borrower is assumed by the Federal Housing Administration (FHA).

The HECM program was slow to catch on, but has been growing rapidly in recent years. In 2009, about 130,000 HECMs were written. Feedback from borrowers has been largely positive. In a 2006 survey of borrowers by AARP, 93 percent said that their reverse mortgage had had a mostly positive effect on their lives, compared with 3 percent who said the effect was mostly negative.

Some 93 percent of borrowers reported that they were satisfied with their experiences with lenders, and 95 percent reported that they were satisfied with their counselors. (Note: All HECM borrowers must undergo counseling prior to the deal.)

But while all is well for almost all HECM borrowers, some of their advocates in consumer organizations, alarmed by the program’s growth, are badmouthing it. I hasten to add that there is a major difference between badmouthing and educating.

Legitimate issues exist regarding when and who should take a HECM, and seniors also face hazards in this market, as in many others. Advice and warnings to seniors from authoritative sources on issues such as these are useful. I try to provide useful advice and warnings myself.

What is not useful is needlessly and gratuitously fanning the flames of senior anxiety about losing their homes. In its September 2009 issue of Consumer Reports, Consumers Union warned of “The Next Financial Fiasco? It Could Be Reverse Mortgages.” The centerpiece of their story is a homeowner who is “likely to be evicted” because of a HECM loan balance he can’t pay off. How is that possible?

It was his wife’s HECM, not his, and when she died, ownership of the house reverted to the lender because the husband was not an owner. At the outset of the HECM transaction, he was too young to qualify so he had his name removed from the deed so that his wife could qualify on her own. She could have lived in the house forever, but as a roomer in her house, he had no right to remain.

This is painted as a reverse mortgage horror story, but it is nothing of the sort. HECMs are for owner-occupants, not roomers, which is what the husband had made himself into. The correct moral is that the program should not be misused.

Even less useful are spurious claims that growth of the reverse mortgage market has major similarities to the growth of the subprime market, and could lead to the same kind of “financial fiasco.” The major source of this nonsense is an October 2009 monograph by Tara Twomey of the National Consumer Law Center entitled “Subprime Revisited: How Reverse Mortgage Lenders Put Older Homeowners’ Equity at Risk.”

In fact, the two programs could hardly be more different, and there is no chance of a similar fiasco.

Subprime loans imposed repayment obligations on borrowers, many of whom were woefully unprepared to assume them, and which tended to rise over time. The financial crisis actually began with the increasing inability of subprime borrowers to make their payments, with the result that defaults and foreclosures ballooned to unprecedented heights.

In contrast, reverse mortgage borrowers assume no repayment obligation at all. Their only obligation is to maintain their property and pay their property taxes, which they have to do as owners whether they take out a reverse mortgage or not.

They cannot default on their mortgage because the obligation to make payments under a HECM is the lender’s, not the borrower’s. There are no reverse mortgage foreclosures.

Subprime foreclosures imposed heavy losses on lenders and on investors in mortgage securities issued against subprime mortgages. Such securities were widely held by investors, which included Fannie Mae and Freddie Mac. Losses by the agencies on their subprime securities played a major role in their insolvency.

In contrast, no lenders have suffered or will suffer losses on HECMs because they are insured against loss by FHA. FHA assumes the losses when HECM loan balances grow to the point where they exceed property values. However, this is an expected contingency against which FHA maintains a reserve account supported by insurance premiums paid by borrowers.

It is true that the unprecedented decline in property values over the last few years has increased losses and eaten into FHA’s reserves. But FHA has responded to that by reducing the percentage of home values that seniors can access. According to a recent study by New View Advisors, who are seasoned experts on HECMs, this should allow FHA to break even over the long run.

In sum, the current state of the HECM market has no resemblance whatsoever to the conditions in the subprime market that led to disaster.