A Brief History of Reverse Mortgages in the U.S.
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Reverse mortgages have a relatively short history in the United States, beginning in a bank in Maine in 1961. The federal government systemized reverse mortgages through the Home Equity Conversion Mortgage (HECM) Program under the auspices of the U.S. Department of Housing and Urban Development (HUD) as part of the 1987 Housing and Community Development Act.
I will focus on HECM reverse mortgages, which are tightly regulated and represent the bulk of reverse mortgages. Two other options, which we will not discuss in depth, are programs offered through local governments to provide liquidity for a more limited purpose, and proprietary reverse mortgages which may appeal to those with homes worth more than the $625,500 FHA lending limit on home values. An HECM can be obtained on homes worth more than $625,500, but the funds available through the reverse mortgage will be based on the lesser of the home’s appraised value and $625,500.
In recent years, HUD has frequently updated the administration of the HECM program to help ensure that any problems are corrected and reverse mortgages are used responsibly. As a result, descriptions of the program can quickly become outdated, even if they are only a couple years old. While older materials may explain the concepts adequately, they might be missing key changes.
Lender standards have tightened and the number of new reverse mortgages issued per year has declined after peaking at about 110,000 per year in 2008 and 2009. Many borrowers at the peak were financially constrained and unable to keep up with taxes, insurance, and home maintenance. Many opted to take out the full available initial credit amount as a lump sum. After spending this down quickly, their household was left with no other assets to use, leading to a number of foreclosures. On top of that, falling home prices meant more loan balances were exceeding the value of the home as collateral when repayment was due, putting greater pressure on the mortgage insurance fund.
Many resources on reverse mortgages describe two versions: the HECM Standard and HECM Saver. The HECM Saver was introduced in October 2010 as a contrast to HECM Standard. It provided access to a smaller percentage of the home’s value, substantially reducing borrowers’ mortgage insurance premiums. It was a step toward encouraging less upfront use of reverse mortgage credit, but it was rarely used by borrowers.
By September 2013, the Saver and Standard were again combined into a single merged HECM option. The newly merged program provided an initial credit amount that was slightly larger than that of the HECM Saver but substantially less than the HECM Standard. Principal Limit Factors (more on these later) were recalculated to lower available borrowing amounts.
The government also sought to encourage deliberate, conservative use of home equity. If more than 60% of the initial line of credit was spent during the first year, the borrower was charged a higher upfront mortgage insurance premium on the home’s appraised value (2.5% instead of 0.5%). For a $500,000 home with a $237,500 principal limit, the initial mortgage insurance premium jumps from $2,500 up to $12,500 if more than $142,500 is spent from the line of credit in year one—a $10,000 incentive to lower spending.
Borrowing more than 60% of the principal limit is now only allowed for special qualified mandatory expenses like paying down an existing mortgage or using the HECM for Purchase program. These changes were made to discourage overuse of available credit in order to ensure mortgage insurance premiums are sufficient to provide the necessary protections.
Before September 2013, the HECM Standard mortgage had an initial mortgage insurance premium of 2% of the home value, so the upfront costs for opening a reverse mortgage dropped significantly after HECM Standard and Saver merged for those who could stay under the 60% limit. Yet it still paled in comparison to the HECM Saver, as the new 0.5% upfront mortgage premium was quite a bit higher than the previous 0.01% value.
So while the new rules were designed to encourage more gradual and deliberate HECM use, the costs for setting up this opportunity relative to the HECM Saver increased. Note that for homes worth more than $625,500, the mortgage premiums and principal limit factors only apply to the first $625,500 of value.
Two important additional consumer safeguards came into full effect in 2015. The first relates to new protections for non-borrowing spouses who don’t meet the minimum age requirement of 62. In the past, when one spouse was not of sufficient age, the remedy typically involved removing that spouse from the house title. This created a problem when the borrowing spouse died first and the loan balance became due. Without sufficient liquidity or ability to refinance, the non-borrowing spouse could be forced out of the home.
HUD implemented new safeguards for non-borrowing spouses in 2014 and 2015. In spring 2015, HUD clarified their August 2014 rules on when spouses can stay in the home after the borrower has left. Non-borrowing spouses must be the spouse when the loan closes, must be named as a non-borrowing spouse, and must continue to occupy the property as a primary residence and maintain the usual taxes, insurance, and home upkeep.
Non-borrowing spouses now have the right to stay in the home after the borrower dies or leaves. The loan balance does not need to be paid until after the non-borrowing spouse has also left the home. To be clear, while the non-borrowing spouse may stay in the home, they are not borrowers. Once the borrower has left the home, there is no further ability to spend from the line of credit, and any term or tenure payments stop. Interest and mortgage insurance premiums continue to accrue on any outstanding loan balance.
The most recent versions of the principal limit factors (PLFs), published on August 4, 2014, now account for non-borrowing spouses down to age 18 for non-borrowing spouses who are significantly younger than the borrower. Before these changes, PLFs were only needed for ages 62 and older. The PLF will be based on the younger of the borrower and the non-borrowing spouse. Though non-borrowing spouses cannot spend from the reverse mortgage, they may remain in the home, so initial HECM proceeds must be less to help protect against the possibility that loan balances could grow to exceed the home’s value.
The August 2014 PLFs were also revised to limit the initial amount of available credit in order to ensure that mortgage insurance premiums can cover the risk that the loan balance eventually exceeds the value of the home.
In 2015, more detailed financial assessments for potential borrowers were put in place as another new consumer safeguard to ensure the borrower can maintain sufficient means to pay their property taxes, homeowner’s insurance, maintenance and upkeep, and any other homeowner’s association dues that may apply. This safeguard is designed to help avoid foreclosure due to a homeowner not being able to meet these obligations.
If it is determined that a potential borrower will struggle to meet these obligations, they are not automatically disqualified from receiving an HECM. Life expectancy set-asides (LESAs) can now be carved out of the line of credit to cover these expenses. Interest on LESAs does not accrue until the money is spent, but they prevent borrowers from taking too much from the line of credit and failing to meet the terms required to stay in the home.
LESAs grow at the effective rate rather than the expected rate used in earlier set-asides (I will come back to this later). This matter eliminates earlier confusion created by set-asides that grew at a different rate than everything else.
Concerns should be raised about the viability of an overall retirement income plan when it requires large set-asides within the line of credit. In some cases, a reverse mortgage might simply be a source of liquidity to cover these expenses, allowing the borrower to stay in the home while using other limited resources to cover retirement living expenses.