On Aug. 9, President Obama signed into law the Reverse Mortgage Stabilization Act of 2013. The new legislation paves the way for tighter government regulation of reverse mortgages backed by the Federal Housing Administration (FHA), which are also known as Home Equity Conversion Mortgages (HECMs).
The Reverse Mortgage Stabilization Act of 2013 doesn't in itself change HECM regulations; it allows the FHA to introduce new rules. Although these are yet to be written, regulators have already signaled some of their intentions.
Interest on Interest
Reverse mortgages resemble home equity loans in that they allow homeowners to trade some of their equity for cash. However, they're very different in that no payments are due from borrowers as long as they remain in residence.
While no payments are required from the borrower, interest continues to be charged and the reverse mortgage balance grows over time.There are obvious potential dangers here. Even with today's ultra-low mortgage rates, interest that's rolled forward and calculated cumulatively adds up. That can result in fewer proceeds than expected when the homeowner or heirs eventually sell the property.
Reform #1: Caps on Withdrawals
To help borrowers avoid this, the FHA is proposing caps on initial withdrawals. Borrowers can encounter later financial problems if they withdraw a large lump sum as soon as a reverse mortgage is in place. So new rules may limit the amount that can initially be taken. This could result in consumers being steered toward lines of credit, or "tenure" or "term" payment plans that provide fixed monthly incomes, either (respectively) for the entire time people remain in their homes, or for a previously agreed fixed period.
Reverse Mortgage Foreclosure
While no payments are required of reverse mortgage borrowers, they are obligated to maintain the property, which is the collateral for the mortgage, and keep up their homeowners insurance and pay their property taxes. Failure to do so has caused lenders to foreclose and evict the homeowners.
Last year, Consumers Union quoted figures about borrowers getting into trouble with their FHA-backed HECMs: an estimated 54,000 were in default, mostly because they failed to keep up with those associated costs. That's a whopping 9.4 percent of all HUD's reverse mortgage borrowers.
Reform #2: Financial Fitness Tests
Small wonder, then, that regulators are thinking of making a financial assessment mandatory for all applicants for these loans. That means homeowners without the means to honor their collateral-related obligations may not be granted HECM loans.
Reform #3: Escrow Accounts
Escrow accounts, or impounds, have been a staple of traditional mortgages for a long time. Money is collected monthly in addition to the borrower's mortgage payment, and the lender uses that to pay the homeowners insurance premiums and the property taxes as they come due. In the case of HECMs, which require no payments, money for taxes, insurance and other mandatory fees would be withheld from the proceeds of the loan.
Reform #4: Creditworthiness Tests
Currently, a borrower's credit score is not considered relevant to a reverse mortgage application. However, a new rule could make credit checks a necessary part of the loan-approval process. Such a regulation might pose problems for some. Many seniors shun credit as they grow older, and as a result lose their once impressive scores -- while often remaining creditworthy. Some might hope that an overview of an applicant's financial situation could, in appropriate circumstances, override the absence of a current credit file.
Widely Welcomed Reforms
Many Americans are distrustful of all government regulation. However, this new law is the legislative equivalent of a confirmed sighting of a creature previously believed to be extinct: it's a bipartisan initiative that's successfully emerged from a recent U.S. Congress.
It appeals to the fiscally conservative because it limits the exposure of the public purse to the risks of unsustainable home loans. The Mortgage Daily trade journal recently claimed that the FHA's HECM program faces a $5.25 billion deficit.
Meanwhile, it's equally attractive to consumer advocates because it protects some of America's most vulnerable citizens from potentially damaging borrowing. Unlike younger people, seniors rarely get a chance to recover when major financial decisions go bad.
In spite of the current uncertainty over the new rules' details, even lenders widely welcomed the changes. Reverse Mortgage Daily, another specialist trade journal, greeted the bill's passing with the headline, "Reverse Lenders Applaud Program Reform, But Impact Unknown," and quoted industry insiders who enthusiastically supported the new law.