Decline in Home Prices Has Significant Impact on Value of HECM Portfolio

The current economic crisis and burst of the housing bubble has had a significant impact on the reverse mortgage guarantee provided by HUD on HECM loans according to an article by Jonathan Glowacki and Mike Jacobson of Milliman on Friday at Mortgage News Daily.

The extremely technical article on the economic basis for the future of the HECM program explores three scenarios. In the first, home prices experience a one-time decline of 30% after which they appreciate at 4%. In the second, home prices experience a one-time decline of 45% followed by an appreciation of 2%, following a model similar to that which occurring in the Japanese economy from the 1990s through 2009. In the last, the two scenarios are averaged.

For the purpose of the study, calculations were made using a 75 year-old borrower with a $100,000 initial home value and an expected interest rate of 6%. The study was also interested in whether the reduction in principal limits could help the program return to its zero-subsidy self-funding status.

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While no scenario painted a rosy picture, a 4% appreciation rate in home values after the crisis as accounted for by the yearly assumed appreciation of home value already built in to the HECM program is less dire than the scenario where the appreciation rate is 2%. Still, Glowacki and Jacobson’s study shows that all HECM loans have been effected by the housing crisis, even those going back as far as the program’s inception in 1989. As such, the authors are concerned and unsure if the HECM program will be able to withstand the pressures of the deteriorating economy—especially in its current state.

Impact of the Economic Crisis on the HECM Program

Write to Reva Minkoff

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  • Carelessly written articles are despicable especially when their primary purpose is to induce fear. Even the most uneducated originator can see right through the Glowacki article. The HECM principal limit factor they use is not based on an expected interest rate of 6% as is declared at the beginning of their example but rather 10%. That is a very significant difference to a “simpleton” like me.

    Is a 10% expected interest rate a reasonable assumption? If so, when? Greenspan once called asset values as based on irrational exuberance. I would use a similar concept to describe the rational for using 10% as a reasonable expected interest rate. It is at least reaching.

    This study like a similar one to it is based on a “black box” model. While Glowacki claims their model is similar to the HUD model, who has independently verified that assertion? When the central example has problems, how can one trust that other information is not just as faulty? “Fool me once shame on you; fool me twice ….”

    Notice the study never emphasizes even one positive position, only negative ones. This is the most effective marketing in bad times. It is also based on fear.

    Upon coming into this industry, we were admonished to avoid fear based marketing to seniors. The same admonition should be given to advisors of this ilk.

  • The bottom line from the analysis seems to be that HUD's new principal limits breakeven (the program's stated goal) at 3% annual home price appreciation instead of the old 4% assumption.

    • Mr. Lunde,

      New View Advisors, LLC arrived at that same conclusion months ago. It seems that there is a general abandonment of the long-term view of the HECM program among “advisors.” This study is but another example of that trend.

      It is interesting that these “advisors” have nothing to lose by changing the focus to the short-term and everything to gain. Unfortunately the change from the GI category to MMI in the budget has given this view more credence which some of us believe is fundamentally contrary to the nature of the HECM program.

      At least one advisor is recommending a long-term move to a much less generous (principal limit wise) HECM product. The concept has rightfully gained popularity because of its lower upfront cost structure and expected overall lower MIP cost. If there is a way to credit the MIP costs against the MIP required to a step up to traditional HECMs that would be good but only if it can clearly be shown that the overall MIP is sufficient to provide the amount of protection needed by FHA.

      If the goal is the eventual elimination of traditional HECM products, then that is an entirely different issue and hopefully support of a HECM II will quickly and substantially wane.

  • Once again someone has shown they can be more cynical than I. While I generally agree with the findings of The Critic, I am not so sure their motive is quite as dark although it is suspicious when they are using a 10% expected interest rate and it is labeled 6%.

    While it is one thing to use a 10% as the expected interest, it is totally different to use that rate as the note rate throughout the period of the HECM. Once the crossover point is reached higher note interest rates result in much bleaker projections than lower note interest rates. When was the actual HECM note rate ever 10% for anything other than perhaps the annual adjustable rate HECM? Even then how long was that?

    Findings based on spurious assumptions are faulty at best. While it is reasonable to believe that the IBM actuarial study, the HECM model, and the HUD audit report are sufficiently reviewed by the supervisors and management before issuance, the same cannot be said for articles and studies of this nature.

    While I am no optimist, expecting the Japanese model to apply to the current cyclic crisis is a little difficult to swallow. So their middle scenario seems a little skewed.

    I will hand one thing to Glowacki, he was honest enough to discuss some limitations on his analysis; other studies providing similar analysis failed to address such weaknesses. Absolutely, no real estate market is based on national averages. Since HECMs are indeed disproportionately distributed throughout the country and that disproportionateness is significant, then no model that does not take this into consideration can be reasonably relied upon in the short run. The HECM model has limited application and to the credit of HUD, HUD has not tried to promote its use beyond its inherent limitations.

  • Critic, I must be blind as a bat. Can you point me to the 10% you state they used? All I could find in the article was this:
    Borrowerage: 75
    Expected interest rate: 6%
    Principal limit factor (Before Oct. 1, 2009):41.60%
    Principal limit factor (After Oct. 1, 2009): 37.40%
    Initial home value: $100,000

    Thanks!

    • Copied from the article:

      We will use a single-loan example to test the impact of the above three scenarios on the HECM portfolio. The single loan will have the following characteristics:

      Borrower age: 75
      Expected interest rate: 10%
      Principal limit factor (Before Oct. 1, 2009): 41.60%
      Principal limit factor (After Oct. 1, 2009): 37.40%
      Initial home value: $100,000

      • REVGUYJIM,

        In between the time this article was posted and the time you copied the information from the linked article, the linked article was edited to correct the 6% error. Whether it was my first post or some other observer who pointed out the issue directly to the author, it was wrong.

        Let's assume Glowacki was right in the first place. Is it reasonable to use a projection based on a 10% compounding interest rate? Since the vast majority of all HECMs today are fixed rate and are under 6%, the 10% is not representative of the current market. If one assumes that the adjustable rates of prior years will rise to 10%, when will that occur? On top of that is it rational to believe that the balances due on those HECMs will be close to 10% compounded from the crossover point to termination? These are highly unlikely scenarios.

        Bias is clearly reflected in the expected interest rate. The only rational basis why advisors would be engaged by HUD is if the HECM program needed adjustment. Using unreasonable interest rates is one way to make that case.

  • Wow. What the heck is going on? I copied and pasted from the article, (see my comment above). It stated 6% and that's why i went back and asked the question in the first place! Someone has changed the post at Mortgage News Daily. Now I wonder which was used!

  • REVGUYJIM,rnrnIn between the time this article was posted and the time you copied the information from the linked article, the linked article was edited to correct the 6% error. Whether it was my first post or some other observer who pointed out the issue directly to the author, it was wrong.rnrnLet’s assume Glowacki was right in the first place. Is it reasonable to use a projection based on a 10% compounding interest rate? Since the vast majority of all HECMs today are fixed rate and are under 6%, the 10% is not representative of the current market. If one assumes that the adjustable rates of prior years will rise to 10%, when will that occur? On top of that is it rational to believe that the balances due on those HECMs will be close to 10% compounded from the crossover point to termination? These are highly unlikely scenarios.rnrnBias is clearly reflected in the expected interest rate. The only rational basis why advisors would be engaged by HUD is if the HECM program needed adjustment. Using unreasonable interest rates is one way to make that case.

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