Future Valuation Problems For Reverse Mortgages

Call it “the law of unintended consequences” – the two-year drop in home valuations currently playing havoc with seniors’ plans to get a reverse mortgage.

Like raising the speed limit on a highway while simultaneously lowering the maximum velocity a car can achieve, seniors are being appraised out of qualifying for financial aid. Many have high conventional mortgage balances at a time when lower reverse mortgage proceeds – based on “future valuation” – will not satisfy the existing lien and eliminate their mortgage payment.

“We have had appraisers admit to us that they are projecting declines out as far as 12 months and adjusting values downward in an effort to protect themselves from future claims,” says a long-time reverse originator. Seniors who need fair present value valuations, “will likely stay in their homes at least six additional years,” he predicts.

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Part of a pendulum swing toward tighter market conditions, this Florida originator registers concerns. “It is popping up all over. Counselors are over-reacting, lenders are creating guidelines far in excess of HUD’s own requirements – which means lower origination fees just as property values drop and the secondary marketing financing shrivels.”

Meanwhile, Joseph Kelly, partner, New View Advisors, notes that, “Extremely high loan amounts, with LTV ratios of 90 percent for older borrowers, are creating ‘crossover’ losses as property values decline and loan balances increase.” In an essay on the company’s website, entitled: "The Trouble with HECMs,” Kelly declares that: “The HECM program faces a potential death spiral scenario, in which senior borrowers are faced with ever-increasing costs to fund the subsidy required to continue its existence, one made more tenuous by the high costs to the borrower and the taxpayer.”

Neil J. Morse has been a communications professional working in the mortgage finance industry for more than a decade, currently specializing in the reverse mortgage sector. He can be reached at nmorse@morsecommunications.com

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  • This issue is not new. As the housing bubble grew, several of us talked about the impact of a massive downward correction in home prices. This scenario seemed so outrageous in 2005 that its relevance was scoffed at by many in the industry. Recently it was glossed over because many believed Congress would provide a total subsidy.

    Not long ago we had the “day of the jumbo.” Jumbos were like mushrooms that rose up and daylight killed. Going to some “education meetings” in those days was like entering an opium den where the opiate was heady talk about jumbos. Claims kept getting wilder and wilder about their future. It seemed like no one could see or more importantly wanted to see the gloom hanging just barely over the horizon. It was not until the gloom poured in that the “go-go” talk about “jumbos” finally died out.

    Now we have “the days of rhetorical gloom and doom.” It was surprising to see Mr. Kelly joining in the “mob” assassination of HECMs. While not a strong advocate of the HECM financial/math model, the model is based on some very strong and conservative assumptions. In reading the first part of his three part presentation, it seems Mr. Kelly puts far too much emphasis on budget projections in reaching conclusions about historical profits and losses. He also seems to mix up the cash flow issues of assignments with loss issues. From a purely intellectual point of view, the first blog was too weak on substance to be satisfying.

    Potential HECM losses are becoming more of a national issue but historically they have been a regional one. Like so many others, Mr. Kelly looks at the issue on primarily a national level. While his broad brush approach is appealing, it is also overly simplistic.

    In describing the rise in increased debt to MCA (“Maximum Claim Amounts”) at funding in recent fiscal years, Mr. Kelly skipped over one of the most important causes, increased volume in fixed rate HECMs. This product has made HECMs much more risky to HUD. Unless the home appreciation rates increase dramatically in strategic regions of the country in the next few years, the increased popularity of this product could have an ever increasingly negative impact on subsidy requests.

    Over the next few months, it is planned that many of the issues addressed in the blog by Mr. Kelly will be answered in RMD articles

  • So show us some statistics to support this Mr. Kelly. What are the REAL numbers: those folks interested in a reverse mortgage but don't have enough equity to qualify and those without enough equity to qualify and completely uninterested or unaware. The numbers they are talking about have to be very small compared to the number of folks with MORE than enough equity to qualify. Are we talking 1% to 2% of all eligible homeowners?

  • In one aspect Mr. Kelly is correct that many seniors no longer have the equity in their homes to qualify for a reverse mortgage regardless of their age. When you look at states such as Arizona and Nevada, they have the highest foreclosure rates in the country. In Maricopa county Arizona, 1 in 23 homes is in foreclosure. The impact on property values is staggering and many seniors live in those neighborhoods. They do not have the equity and are in serious trouble with no way out.

    As to misleading information, not providing adequate information to the senior, shame on those counselors and reverse mortgage consultants. All i can say to you is GET OUT of the business and leave it to the people who are honest and ethical to educate the population on a great resource for those that need it and want it and have the equity.

  • This type of analysis must be looked at under the proper optics. The analysis presented by Mr. Kelly has some interesting facts but it does have a few omissions and perhaps some flaws. First we must understand, that this analysis was published by folks who are primarily dealing with capital maket investors specifically interested in reverse mortgages as investment instruments. As we all know, private investment in the secondary market for reverse mortgages has dried up considerately, especially for proprietary reverse mortgages due in part to the credit crunch and in part to the housing crisis. These folks right now, do not have a proprietary reverse mortgage product they can offer (you still have the GNMAE HMBS,which is thriving, but investors for that market segment are different and the yield may not be has high as when we had the hey days of the jumbo product) and therefore there is need somehow, to make the HECM product as is, less appealing so that proprietary jumbo products make a come back. For example, with todays LTV and high loan limits, plus a housing valuation problem, it is unlikely that proprietary products will be attractive to the senior borrower population as compared to the HECM's LTV (ie 52-90% in HECM LTV vs 18-30%, realistic LTVs for proprietary RM products). If somehow, you could reduce the LTV of the HECMs by a significant margin, then the proprietary products do become more attractive, having a potential demand from the originating side and subsequent trickled effect to the secondary market. As well pointed out in the article, reducing the LTV will in no doubt reduce the risk to the program. However, with a reduction in LTV there will be a reduction in the demand (less seniors will qualify or find the produc appealing for the product) so making the HECM more “jumbo” like is not the necessarily the best answer. One of the main reasons that we have MI insurance is so that the borrowers can get such high LTVs.

    Another point is that the author of the article failed to mention why we have a need for a subsidy (see previous posts about that) and focus their analysis in the short term. While it is true that the Cross-Over point will get closer in time, with negative house value appreciation, the percentage of such loans that will terminate under such conditions can not be the majority. It is very easy to do the analysis for a short term and then determine that the program needs a “change”. The HECM insurance program is a long term, nor short term, program. If we continue to have a steady decline in home prices, and since we are still using a percentage, then the loan amount of new loans will be corresponding smaller (risk will be different but not overwhelmingly different). Once we get to a recovery period say in 3-5 years, the stress placed on the program will be removed. Therefore, lets say we do change the HECM program to deal with the next 2 years of crisis, and then a recover happens, then was it really worth to make a change which will be more difficult to reverse once we get to a recovery?

    As for the assumptions they make, the rating agencies have long ago revised their assumptions. For example, Standard and Poors revised the market valuation assumption collaterilizing a HECM with declines for the first 36 months of the transactions: for SF residence a AAA rating for Housing Valuation it is 34.50% (short term) negative appreciation for the first 36 month, with a overall housing appreciation rate of 3.23% (long term)over the life of the loan. See Standard and Poors- Criteria Methodology And Assumptions: US RMBS HECM Reverse Mortgage Analysis Assumptions Revised.

    There solutions of eliminating Upfront MIP and increase the T&I set aside must be looked in terms of real closing costs as a percentages of costs relative to the loan amount (not to the Max Claim Amount). Reducing principal limits by 10-30% may offset any gains from reducing the upfront MIP premium in terms of percentages of closing cost calculations. It will be interesting to compare the actual APR calculations results from the proposed model versus todays HECM program.

    All in all, I must agree with Mr. Veale statement that there is nothing new here.

  • Salt to the wound is some of these seniors are still paying taxes on the tax assessed value higher than the appraised value. Is there something wrong there? I thought the economy was turning around? It's called propoganda and pulling the wool over the public's eyes and people are starting to get sick of it!

  • Excuse me, but all of you are missing the point. Did any of you read the blog in its entirety? If you did, you should understand its conclusions are:

    (1) FHA should create a HECM product that has no upfront MIP, with the annual MIP and the Principal Limits adjusted accordingly. We posted a complete set of LTV ratios showing what these new Principal Limits might look like in a product we call “HECM II”, with a 0.75% annual MIP.

    (2) The existing standard HECM should NOT be eliminated in favor of this new product.

    (3) FHA should use the occasion of creating a new product to incorporate other changes, for example, replacing the servicing set-aside with a T&I set-aside.

    (4) If the HECM program is indeed forced to adopt lower housing price appreciation assumptions, then the standard HECM will either have to reduce its Principal Limits or else request a subsidy every year. If the lower Principal Limits are chosen, they would still be higher than HECM II. If the annual subsidy were ever denied, the HECM program would have to be capped, cut back, or even eliminated.

    (5) Our cash flow model validates and agrees with FHA's model. The HECM program (with the old Principal Limits) breaks even at about 4% annual home price appreciation (“HPA”); at about 3% HPA it loses $798 million. These models are not based on “overly conservative assumptions”; they are based on the accepted assumptions and empirical data of nearly two decades of experience. Both examine the entire life span of a vintage of annual HECM production; both look at the short term and long term.

    The changes we propose will:

    (1) Remove the need to request annual subsidies, therefore removing the political risk to the program.

    (2) Stop the incessant criticism, mentioned in virtually every press article, about the upfront costs to the borrower. Instead, it would give the industry good publicity: more products with lower fees.

    (3) Give a choice to seniors: low-cost HECM II or standard HECM with higher proceeds, thereby increasing the total HECM market. (I don't expect you to understand the finer points of the capital markets, but do you understand selling? Do none of you see the advantages of having a low-cost product? )

    If you think there is nothing new there, you are not paying attention.

    Tell me which of these conclusions or goals you disagree with. From your responses, you say you have been talking about this for a long time, but have you done anything about it? All of your echo-chamber talking amongst yourselves does not appear to have persuaded anyone in the government or the media. With the budget request, the time of reckoning is at hand. The industry cannot click its heels three times and say “There's no place like 2006”.

    Mr. Veale, you should mind your own intellectual substance: your criticism is comprised mainly of non sequiturs and unsupported assertions. For example, your remark about fixed rate mortgages: do you advocate the elimination of fixed rate HECMs? Don't you think a lot of seniors prefer a fixed rate? Adjustable rate HECMs carry their own considerable risk: if interest rates rise, they can reach their crossover point very quickly. Are you saying that fixed rate HECMs are riskier because borrowers borrow the full Principal Limit, or in other words, Principal Limits are too high? You really must finish your thoughts to be intellectually satisfying. Your statement that “Potential HECM losses are becoming more of a national issue but historically they have been a regional one … ” manages to be an assertion and a non sequitur simultaneously.

    Mr. Torres, you wrote: ” … eliminating Upfront MIP and increase the T&I set aside must be looked in terms of real closing costs as a percentages of costs relative to the loan amount … ” I agree: the Upfront MIP then looms even larger and the HECM II looks even better. By the way, the size of the T&I set-aside could be roughly equal to or less than the Servicing set-Aside.

    Regarding the rating agencies, you confuse assumptions with criteria, but in any case S&P's AAA HPA criteria has never changed since they established it for the first RM securitization in 1999. I find it odd that you cite it as some sort of comfort, especially since recent events validate this criteria and invalidate your “short-term/long-term” argument. The “short-term” decline of 34.5% over 3 years, followed by an increase of 3.23% per annum, means that a property does not recover its full value for over 16 years! Short term events can have long-term consequences: remember what the blog says, Mr. Torres: history is a bumpy road. The majority of the 2005, 2006 and 2007 loans can and probably will have crossover losses, but even a minority of loans can cause an entire loan pool to go into the red. If the HECM program is to be a long-term program, it needs to be sustainable, and not stick the taxpayer with huge losses every time there is a downturn in the housing market. With its excessively high LTVs, the HECM program was bound to generate losses. In 3 to 5 years, the program could come under more stress, not less, from the crossover losses on old vintages, and a weaker than expected recovery. Your suggestion, which seems to be do nothing and hope for the best, puts the whole program at risk.

    A number of you veered off into a bizarre direction regarding proprietary, or jumbo, reverse mortgage loans. The theme throughout the string of comments is “Ha Ha! We can't be fooled! You really want a revival of the jumbo loan — that's why you advocate a competing product with higher LTVs than jumbos, lower interest rates than jumbos and no upfront MIP! We will foil your plan by clinging to a one-size-fits-all product with high upfront costs!” I don't think this “Us vs. Them” attitude is helpful. Don't you want reverse mortgages to appeal to the secondary markets? Do you want reverse mortgages to rely indefinitely solely on government insurance?

    Come to think of it, the era when a thriving secondary market existed for reverse mortgages (jumbo and HECM) was not like a revival meeting. It WAS a revival meeting. A previously small and unprofitable industry met a group of innovative investors and was revived. These new changes we propose will revive the HECM program. You are all invited to the next revival meeting, in which you may repent of your sins, and be saved.

    • Mr. Kelly,

      In the response the questions arise if I “advocate the elimination of fixed rate HECMs” and if I “think a lot of seniors prefer” them. What does advocating the elimination of the fixed rate HECM or its popularity among seniors have to do with whether or not the fixed rate HECM adds a substantial and disproportionate amount of risk to the HECM insurance program? This product either adds or does not add significant disproponent risk. Instead in the response there is an emotional appeal all but warning that the commentator is potentially advocating the elimination of the product, quickly adding a refutation to the question of risk by appealing to the popularity of the product among seniors. As intended these “questions” merely detract from the comments made.

      Evidencing oversimplification on adjustable rate HECMs is the following statement: “if interest rates rise, they can reach their crossover point very quickly.” Unfortunately the term “crossover point” is never defined in the blogs or in the response. But it seems based solely on the first blog the crossover point is where the balance due equals the Maximum Claim Amount. If this is not the meaning, please indicate.

      Each adjustable rate HECM is unique. Some have high percentages of balance due to MCA; others, much lower. Some have interest rates currently accruing at lower than 2%; others, at over 3%. Currently the greatest part of the note interest rate on an adjustable rate HECM is the lender margin in effect at the time the loan was funded — not its index. There are far too many variables to begin to claim how and when adjustable rate HECMs will reach their crossover point even if indices are ten times what they are today. While it is very easy to make many reasonably accurate generalizations about fixed rate HECMs, it is not so with adjustable rates as a group.

      As to risk the MCA has marginal value other than at origination through endorsement. Current fair market value on the other hand is a significant risk factor throughout the life of any HECM.

      Let us take a healthy look at the relevance of a “crossover point” tied to the MCA. Last year the lending limit in Los Angeles, CA was $362,790, then it rose to $417,000 and now it is $625,500. Now the MCA for a home with an appraised value of between $700,000 and $800,000 throughout this time would be $362,790 if the loan closed on October 31, 2008 or $417,000 the next day or $625,500 just over 90 days later. At the same time many areas had MCAs much lower than even $300,000 on September 30, 2008. So how is this standard of the crossover point so relevant in a refinance situation where home values exceed lending limits? In a HECM for purchase transaction the MCA is the lowest of the purchase price, the appraised value or, the lending limit. So using the same example with mom and dad are selling their home for $200,000. How can one rationally discuss the importance of the crossover point in terms of the MCA and its significance in evaluating risk in this situation?

      As another example, today two homeowners close fixed rate HECMs with identical terms but the current appraised value of one was $625,600 and the other, $2,200,000. The lower valued home is located in Phoenix, AZ and the other, in Malibu, CA. Please explain why the crossover point is as meaningful in one case as in the other? It seems far more factors than the crossover point come into play. The MCA is a stagnant number which has little to do with true risk to the HECM program ten years from funding. Please explain the relevance of the “crossover point” to actual risk.

      Now we come to the point on principal limits. Please point out just 1,000 fixed rate HECMs endorsed over the last twelve months where the borrower has not taken the entire net principal limit at funding. Has a senior ever received the “full Principal Limit” at funding; please provide that evidence. Such a distribution would be in violation of HECM standards.

      So that it is absolutely clear to even the least experienced reverse mortgage professional reading this comment, at least some of the available proceeds must always be set aside for servicing fees. It may seem to be intellectually dishonest not to finish this thought but most readers understand that some of the proceeds are unavailable for the direct use of the borrower at the time of funding and may never become part of the balance due.

      To grasp the validity of the assertion of the statement that “Potential HECM losses are becoming more of a national issue but historically they have been a regional one …”, one simply has to look at the endorsement information provided by HUD monthly and look at the regions of the country where price values have fallen. Please provide the information that disproves this assertion. Certainly the quoted statement is an assertion but whether or not it is a non sequitur in light of the assertion made about adjustable rate HECMs and crossover points seems mute.

      Somehow it is believed that the financial model being cited in the three blogs is substantially valid. Several may lack this confidence without evidence of independent verification in light of the experience of the unwarranted reliance on faulty financial models used in designing insurance coverage for mortgage backed securities not that long ago.

      Finally, as an auditor one must determine potential risk as to specific financial assertions and then design and/or verify audit procedures to validate or dispute such assertions. Far beyond mere compensation, the partners of a CPA firm bear substantial risk for professional liability from the opinions they render. Responsible concern over professional liability builds discipline in writing and rendering such opinions among both staff and partners. Such discipline is severely lacking in many opinion pieces.

    • The following is taken from a comment I made today on the August 27th RMD article by admin titled “$798 Million Subsidy: Time to ….”:

      “Mr. Kelly,

      The things you address in your blogs are fundamentally important both now and for the future of our industry; I applaud you for taking them on. I also believe the product you propose could have its place. Unfortunately some seek to stifle free discourse and reasoned opinions on such matters.

      I apologize if some of my remarks about your first blog (related to the RMD article by Mr. Morse on August 24, 2009) appeared to be overly strong; they in fact were. I am passionate about seniors and this program as I know you are also.”

      This is not all of this comment. The remainder can be found at the RMD article referenced above.

  • I have to say that, after taking some time and reading the New View Advisors blog, there is some very intriguing “food for thought.”

    Whether you agree or disagree with their ideas, it is refreshing to see someone putting themselves out there with new ideas and new ways to approach some of the issues that have hounded this industry in terms of negative press. Primarily, the high up-front costs associated with the initial MIP payment to HUD.

    As a servicer of this product, I can tell you that the most difficult issue we face – after the loan is closed – is preventing and managing tax and insurance defaults. NRMLA’s servicing committee (which I am a member of) has been working closely with HUD and industry leaders to develop a long-term solution to this problem. There have been very good ideas brought to the table as a result of those discussions. However, none of us are naïve enough to think that we are the only ones with the answers. New View Advisors' suggestions regarding this topic are welcomed – and thought provoking.

    Mr. Kelly is a very knowledgeable member of this industry and his unique perspective from the capital markets side of this business is valuable to all of us. He is able to provide insight from an investor’s point of view about the HECM product. In addition, what can be improved to make it even more attractive – with the end goal to bring more investors (outside of just Fannie Mae and Ginnie Mae) to the table.

    My only piece of advice is take the time to read through the blog and keep an open mind. You don’t need to agree with New View Advisors on their ideas, but I don’t think we should criticize them for sharing their thoughts.

  • I, for one, am in support of more options for our senior customers. The first priority should be to ensure the ongoing viability of the HECM program. The addition of a HECM II product and measures to make the HECM more attractive on the secondary market will ultimately benefit us all — seniors and the lending community alike.

  • Mr. Kelly,

    First of all, thank you for taking the time to respond the questions and or comments presented in the blog.

    I would strongly suggest that you should modify or make it absolutely clear that you are proposing an additional product under the HECM program, rather than a modification of the existing one. If all of us missed that very key point, then as a writer you must realize that your message is not clear enough. I certainly understood that you were advocating for a change in the HECM product rather than for the creation of new product.

    As for your comments or questions:
    “T&I set-aside could be roughly equal to or less than the Servicing set-Aside” : Well the HECM servicing is based on a sinking fund formula and usually it is between $3000-$6000 over the life of the loan roughly speaking. T&I are functions of geography (property taxes are state or municipality based, insurance rates are also based on state regulations) and I dont think that would be enough to cover T&I set aside. Also T&I set aside is available in the current program. Now if you combine a mandatory T&I setaside in conjuction with lower PL factors then I am afraid the HECM II product wont be as appealing to seniors as the original HECM product.

    “Regarding the rating agencies, you confuse assumptions with criteria, but in any case S&P's AAA HPA criteria has never changed since they established it for the first RM securitization in 1999”: Well I am just quoting the report from S&P directly, I even gave you the source.The reports quotes the following : “”Criteria Methodology And Assumptions: U.S. RMBS HECM Reverse Mortgage Analysis
    Assumptions Revised,” published April 11, 2008, presents revised repayment speeds, home value
    appreciation/depreciation assumptions, technical defaults assumptions, and foreclosure and property
    liquidation assumptions that Standard & Poor's uses when modeling HECM reverse mortgage cash
    flows.” Indeed they are assumptions but these are used in the modelling HECM cash flows.By the way, would you show what source from 1999 you are talking about? S&P have assumptions for both Jumbo and HECMS. As I understand the assumption, they model home appreciation with a 34% drop for the first 3 years so that at the time of termination you end up with an OVERALL appreciation of 3.23%. I dont think they mean what you interpreted, otherwise you are right, the model would take for ever to recover. In another words, setup an equation for house appreciation where you would have those losses for the first 3 years, yet when you calculate the appreciation average over the life of the loan you have 3.23% year over year.

    “Us vs. Them” attitude is (NOT) helpful. Don't you want reverse mortgages to appeal to the secondary markets? Do you want reverse mortgages to rely indefinitely solely on government insurance? My personal opinion is that I am all for proprietary reverse mortgages and the associated secondary market. In fact, we do have a large number of borrowers who reside in Coops right now who would be benefit from a proprietary product. Now here is one question for you: since the HECM II offers a lower LTV, would the program be sustainable for higher loan limits than the current HUD limit of 625,500? No doubt higher loan limits will increase the risk but the HECM II will have its own niche. The operating space of the proprietary loans was always the higher end homes valuated at much higher values than the existing HECM limit, beside ofcourse properties that were off limits by statute (coops, 2nd homes, etc).

    Dont get me wrong, I understand your points and I am very happy that someone from the secondary market has joined in the discussion. We need to know your point of views too. It is key for the industry to have a secondary market, and even more importantly having proprietary reverse mortgages have an key niche for helping some seniors. However, your HECM II product is still government insured and that is a main differentiator with respect to the old proprietary products.
    As a side note I did offer a hybrid model here:

    http://rmdaily.wpengine.com/2009/08/12/sena

    Mr. Veale also proposed an alternate model there. So we are not just talking about it, but proposing ideas. Your analysis indeed is complete, although I would like to see a break down of the assumptions and a sample calculation, just as Szymanoski and others have done for a given age cohort. One question to ask is: are you using the same probability models that are used in the HECM model, specifically the geometric Brownian motion process used for the calculation of the conditional expected property value, which is used on the calculation of expected losses??

    As a final point, the discussion about changing the HECM program etc may take a new turn, with the very recent upbeat news about the housing market. Like I have always said, this is a long term program. In risk analysis you must look at the long term trend. It is very easy to fall into the trap of taking short term real losses and make the assumption that these lossses are going to be valid for the long term. If in fact, we do have the end of the crisis and some type of recovery then the future doesnt look so gloomy. The news should be a welcomed relief for folks in the proprietary reverse mortgage business. The question is , do you still need to make any changes, if the downturn and recovery may be already underway??

    I dont advocate not doing anything but I do advocate dont fix what ain't broken. If all of us have some patience may be what we thought needed fixing wasn't broken after all. This is what Szymanoski and others advocated when they setup the HECM program.

    As for the your comments about revival, the problem here is that Lehman is no longer around. That company was the engine who moved the proprietary secondary rm market. Right now, you would need another set of visionaries to step in. I certainly hope you do find them.

    • Mr. Torres,

      You are so correct especially on one very critical issue. This program is designed to be self sustaining over its life, not year by year.

      It seems from recent legislative proposals Congress has abandoned the self sustaining concept and is bent on adjusting the program with little input from the program designers. It seems they have lost faith in its design. This is an unfortunate turn of events with so little empirical evidence that the program will not self correct. What a potential blow to seniors who need and will need this program.

      • Thank you Mr. Critic for the comments.

        My message is for patience and for folks not to jump to quick “adjustments” or modifications without a full understanding of the HECM program mechanics and particularly how the assumptions and limitations made by the designers are still valid( may be not a 100%). In my humble opinion, as a former engineer and risk analysis designer, I find that the analysis performed by the HECM developers was very clever and conservative enough to withstand the up and downs of the housing market and other risks such interest risks etc OVER THE LONG HAUL. The changes in accounting that came later were not built into the system and not part of the assumptions. In my opinion, if we had a government insurance program that had to be break even on a yearly fiscal basis, then most likely there would not have been a HECM program. This is why I emphasize that our industry lobbists must understand and stand up to the challenges presented by thoses who want put the HECM program under such dark clouds without a good quantitative analysis.
        As more news of recovery comes our way, then more vindication will be given to the designers of the HECM program.

  • The definition of the Cross-Over Point according to S&P “Reverse Mortgage Criteria” is the point at which the principal outstanding together with accrued interest for a loan exceeds the home value and is therefore where a loss or point of diminished returns occurs. This metric is an important driver of course, and more so to investors and issuers in the proprietary rm market arena. Remember that in a HECM there is mortgage insurance and the lender can recoup the loss in case the balance of the loan exceeds the sale value of the house if the balance has not exceeded 98% of the maximum claim amount at loan termination. Of course, we all know that if the loan balance equals or exceeds the MCA then the lender files an insurance claim to HUD, gets the MCA amount and the loan is assigned to HUD who then will deal with the possibility of the loan reaching theCross-Over point if the borrower lives long enough (however, the HECM PL algorithm calculates the PL with the probabilities of termination and loan balance exceeding home values assuming certain home value appreciation profile so the worst case scenario is accounted for). In the proprietary loan arena, no such cushion exists for the lender and investors so that cross-over point becomes a very important event and the prediction of the cross over point drives the calculations of risk and pricing.

    As for the argument that Fixed Rate HECMS are riskier than Adjustable Rate HECMS it is important to remember that the PL factor is calculated assuming a single lump sum at origination. The HECM PL algorithm is therefore conservative in this respect in the sense that no matter what HECM type of payment is used, the worst case scenario (in term of initial loan balance)is always used. Now, it is true that looking at actual data and with current lower housing values, adjustable rate mortages with smaller outstanding balances (because the borrowers have significant funds in the line of credit or have use tenure payments or have not completed enough term payments) and thus it is possible that such loans will not end in loss claims to HUD. One thing to keep in mind if we start having a recovery, is that most fixed rate HECMs have been endorsed only recently and that if home values make a comeback then the cross over point scenario is less likely to happen.

    • Mr. Torres,

      To quote from the blog:

      “FHA insures the investor against “Crossover Loss,” that is, the risk that the negatively amortizing HECM increases to the point where it “crosses over” the value of the home securing the reverse mortgage. FHA insures the HECM investor against crossover loss by purchasing the loan (at par plus accrued interest) from the investor when the HECM loan balance causes the HECM to reach a 98% loan-to-value ratio (“LTV”). The value used as the denominator in this formulation is called the Maximum Claim Amount (”MCA”), equal to the lesser of the property value or the FHA lending limit at the time the loan is originated. When the investor exercises this put, FHA effectively steps into the shoes of the investor and bears the crossover risk. When the loan finally does pay off, FHA’s losses are equal to the excess of the loan balance over the net property value.”

      One cannot say with any certainty that “FHA effectively steps into the shoes of the investor and bears the crossover risk,” unless the loss crossover point in the context of the blog is the market value from the appraisal used in determining the MCA for the HECM. For example, many homes securing HECMs in San Bernardino County, California have lower market values than the unpaid balance due on the HECM and yet the balance due has not yet reached 98% of the MCA. When the lender assigns the loan to HUD, no doubt the crossover point will have been reached for at least the first time months if not in some cases years before. In fact with fluctuation in home values over the next several years, it is possible that some HECMs in that county might see the loss crossover point (if the current home value is the definition of the crossover point) reached again and again before the unpaid balance on the loan reaches 98% of the MCA. Surely the author of the blog knows of such situations.

      I believe your response is correct. The problem I have is with reconciling the quoted statement from the blog with the idea that the crossover point is the market value of the home at some date following funding. I am simply attempting to justify what I am reading without disapproving. If you can help to that end, please do.

      • Mr. Veale,

        The analysis of the cross over point risk for a HECM is a little different, than say to the analysis of cross over point risk for a proprietary rm loan.
        In the HECM program, the lender basically gets a risk free pass as long as there are no sizeable losses from T & I defaults. The loan bears risk to the lender for the situation where either the loan is not assignable or properly insured or when the outstanding balance has not reach the 98% of the maximum claim amount and sale of the home doesnt satisfy the outstanding balance. If the latter happens then at this point you have a cross over point while the loan is still assigned to the lender. Of course in this situation the lender files an insurance claim and gets reimbursement for the loss (diff between balance minus sales price of the home). The lender files either a Type 21 – Foreclosure or Deed-in-Lieu or a Type 23 – Borrower's Sale insurance claim (in the language of the HECM servicing jargon) to HUD. So in this sense HUD is covering the risk if the loss occurs before assigment(ie balance equals or exceed 98% of MCA).
        Once the condition for assigment to HUD happens, the lender files a Type 22 – Optional Assignment claim for the total MCA (that is why it is called the maximum claim amount, because it is the largest it can be and only on an assigment). In this case there still could be a cross over point in the future too, but this time HUD is carrying the loan and the loss is beared by the government directly and the lender is home free of any risk. So in both cases the lender is covered. Of course if for some reason the loan was not insured (HUD insurance certificate not issued) or the loan is un-assignable then the risk is on the lender no matter what.

        The MCA is really a delimiter in time for when a loss can happen during the lenders watch and where HUD takes over the loan.

        Also for folks to keep in mind, the HECM PL algorithm assumes the worst case scenario too as it only looks that the expected loss no matter when it happens (ie before or after assigment).

        The recent discussion about T & I defaults reflects the fact that those payments have to be covered by the lender, and in assigment option case, the lender still has to wait for the 98% of MCA to be reached by the outstanding balance. So a loss to the lender may be real in this case.

        You statement about the temporal behavior of house prices is correct. If the rate of housing appreciation changes sufficiently fast, you could have the situation that a given loan may be in “loss” situation at some time now, but say later a few years afterward with a hefty recovery in housing values, then the loan wont be in “loss” state. However, the “loss” is only realized if the trigger event happens ie the loan becomes due and payable. At the time of an assigment, HUD simply reimburses the lender for the MCA, keeping in mind that HUD may or may not lose money when the loan becomes dues and payble at some later time.

        I hope I made it a little clearer. If not please let me know.

      • Mr. Torres,

        Since the quoted paragraph had absolutely nothing to do with any reverse mortgages other than HECMs, there is no reason to address that issue. Thus we return to the question of the crossover point in relation to the quoted paragraph.

        It is good you pointed out the risk to investors (and in limited situations, servicers) regarding the risk of insurance and taxes which are not paid for by the borrower and there is insufficient net principal limit remaining to pay them in full. With most fixed rate HECMs, the net principal limit following funding disbursements is at best de minimis only adding to this particular type of risk to those who purchase these HECMs. However, this risk of loss and the others you name (due to insurability and lack of assignability) have little to do with “crossover risk” itself, i.e., the risk of the loss that arises solely from the balance due on the HECM exceeding the value of the security, i.e. the home.

        “FHA insures the HECM investor against crossover loss by purchasing the loan….” The crossover risk itself as to FHA before the 98% MCA crossover point is reached seems to be materially no different than after it is reached. One can discuss the mechanics of reimbursement before the HECM can be assigned but that is simply a procedural matter not an investor risk.

        “… FHA effectively steps into the shoes of the investor and bears the crossover risk.” The crossover risk was always borne by FHA in such cases; it did not receive it on for the first time through assignment. Unless the author is being intentionally or unintentionally redundant, what is the significance of the quoted statement?

        If you have any insight on how the crossover risk itself changes or increases as a result of assignment, please advise. If not, then what is the relevance of the crossover concept in the two quotations above?

        One of the main benefits assignment provides the investor is liquidity. Obviously it also means that the investor will avoid suffering any realized or contingent loss as a result of the balance due exceeding the value of the home but of course that was also true from funding until assignment. All other risks of loss (such as unpaid taxes and insurance) also pass with assignment.

  • Mr. Torres:

    I would be pleased to answer your questions; we might not want to engage in a discuss of Brownian motion here, though. You can find our contact information on our website.

    • Mr. Kelly,

      I agree with your statement. Talking about such technical terms are better discussed over lunch or a separate forum. By the way, you are located in NY (and so am I) and so perhaps we can talk about the analysis you have presented in more details. I will try to shoot you an email when I get a chance

  • Mr. Torres,rnrnSince the quoted paragraph had absolutely nothing to do with any reverse mortgages other than HECMs, there is no reason to address that issue. Thus we return to the question of the crossover point in relation to the quoted paragraph.rnrnIt is good you pointed out the risk to investors (and in limited situations, servicers) regarding the risk of insurance and taxes which are not paid for by the borrower and there is insufficient net principal limit remaining to pay them in full. With most fixed rate HECMs, the net principal limit following funding disbursements is at best de minimis only adding to this particular type of risk to those who purchase these HECMs. However, this risk of loss and the others you name (due to insurability and lack of assignability) have little to do with u201ccrossover risku201d itself, i.e., the risk of the loss that arises solely from the balance due on the HECM exceeding the value of the security, i.e. the home.rnrnu201cFHA insures the HECM investor against crossover loss by purchasing the loanu2026.u201d The crossover risk itself as to FHA before the 98% MCA crossover point is reached seems to be materially no different than after it is reached. One can discuss the mechanics of reimbursement before the HECM can be assigned but that is simply a procedural matter not an investor risk.rnrnu201cu2026 FHA effectively steps into the shoes of the investor and bears the crossover risk.u201d The crossover risk was always borne by FHA in such cases; it did not receive it on for the first time through assignment. Unless the author is being intentionally or unintentionally redundant, what is the significance of the quoted statement?rnrnIf you have any insight on how the crossover risk itself changes or increases as a result of assignment, please advise. If not, then what is the relevance of the crossover concept in the two quotations above? rnrnOne of the main benefits assignment provides the investor is liquidity. Obviously it also means that the investor will avoid suffering any realized or contingent loss as a result of the balance due exceeding the value of the home but of course that was also true from funding until assignment. All other risks of loss (such as unpaid taxes and insurance) also pass with assignment.rn

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