Chart of the Day: HECM Fixed Attracts Younger Borrowers, Increases Risk to FHA

The latest in our Chart of the Day series comes from Reverse Market Insight and shows how younger borrowers are turning to the HECM fixed product more than the adjustable rate reverse mortgages.

According to RMI, the average age for adjustable rate borrowers was 73.6 compared to 71.7 for fixed rate borrowers in 2009.  With younger borrowers withdrawing all of the proceeds upfront through the fixed rate product, are they increasing the risk to the Federal Housing Administration?

“If I was HUD, I would be worried about the fixed rate product’s full draw requirement distorting the market to begin with,” said John Lunde, President of RMI in an email to RMD.  “The principal limit factors are set assuming that people don’t take all upfront, but draw over time as they historically have.”

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As of January 2010, fixed rate reverse mortgages grew to 68.28%, up from only 3.9% of endorsements a year earlier.  A previous Chart of the Day showed how the products are dominating the marketplace.

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For a larger version of the chart, click here.  To see more analysis click the link below.

Reverse Mortgage Borrower Analysis, Part 2

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  • It's not just HUD that should worry about the impact the fixed is having on them. The pressure will continue to be on them to lower plf's for the next few years regardless what happens to home appreciation assumptions. Market players should all be worrying.

  • In late August last year when wondering what the negative impact of mandatory full draws on fixed rate HECMs might have on the HECM program, one leader responded: “…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?”

    As then, I say again requiring full pay out is a risk in itself. I am still not certain this individual yet understands that a significant percentage of adjustable rate HECM borrowers have not yet taken out all available proceeds and that the margins on new adjustable rate HECMs are many times today 75 basis points lower than at their peaks in 2009. Further indices remain low, whether CMT or LIBOR. Besides all of that most HECMs terminating today are by far adjustable rate. So the overall risk from adjustable rate HECMs is diminishing much more quickly than fixed rate.

    The leader understands risk but has trouble addressing historical accounting. Risk is the way we judge the future but this industry now has had over 20 years of experience under its belt. We are into the third year of a terrible set back in home appreciation. Although it can come, adjustable rate HECMs are not the potential risk which fixed rate are. In a matter of a few years with normal terminations, we could see the day when the outstanding number of fixed rate HECMs exceeds that of adjustable rate HECMs. With very low interest rates and significant numbers of these HECMs having less than their full draws taken, the risk of loss from the HECMs which terminate shortly is far less than if those same HECMs had been fixed rate. This is what worries some of us.

    Unlike the leader, my thoughts are more with Mr. Lunde here: “If I was HUD, I would be worried about the fixed rate product’s full draw requirement distorting the market to begin with…” However, I do not agree with Mr. Lunde on this: “The principal limit factors are set assuming that people don’t take all upfront, but draw over time as they historically have.” For some modeling purposes the last statement by Mr. Lunde is accurate but as to the budget, it is my understanding through Mrs. Margaret Burns that it is not.

    But as the leader advocated then and still advocates, we need HECM Lite now. The program needs the MIP revenues of these products and the seniors need them also. We all should be encouraging HUD on to complete this project as quickly as possible. HUD and the industry committee have done a great job to get HECM Lites to this point. However as the old adage goes: “90% of the work is in the last 10% of any project.” I really hope that Mr. Colin Cushman and his team can get this product on line by October 1, 2010 and that the secondary market will be an active acquirer of this new product from the start.

    • Jim —

      I am not sure HECM Lite (or HECM zero for that matter) will address the real issue: the mindless over-promotion of fixed-rate HECMs for short-term gain.

      Protecting the HECM insurance fund from potential catastrophic losses should be the duty of everyone in the reverse mortgage industry, especially the leaders. For as the insurance fund go, so goes the industry's fortunes.

      We should not allow the imperatives of short-term growth and profits blind us to the dangers of unchecked fixed-rate HECMs to the insurance fund.

      • Atare,

        The question we all should be asking is if there is any real danger to the HECM fund?

        Historically on a pure cash basis of accounting, the accumulated net profit picture of the HECM program is in fine shape. In its actuarial determination, IBM did not address any unusual concerns about the overall picture for the HECMs that were outstanding as September 30, 2009. Perhaps the fears of the OMB regarding the cohort of HECMs being endorsed during the current fiscal year will be reflected in the actuarial report for the fiscal year ending September 30, 2010.

        There are two principal sources of clamorous worry within the federal government: Senator Claire McCaskill and the OMB. Since the budget for the fiscal year ending September 30, 2011 (“FYE 9/30/2011”) was released, OMB has a new director. It would be wonderful if you could interview him and find out if he is of the same mind as his predecessor. Would he have released a budget showing the same positive credit subsidies for the HECM program FYE 9/30/2010 or FYE 9/30/2011? (Although it probably will not happen, I would love to read an interview between you and the Senator or Senator Kohl.)

        Let me be clear. I think the overall HECM program in the MMI fund is in a much more precarious situation than it should be. When it left the GI fund, all cumulative net profit or loss which may result to the HECMs endorsed while under the GI fund, remains in the GI fund. For the purpose of justifying the overall net profit picture of the HECM program, even though perhaps technically correct, from an equity viewpoint this is appalling and should not have been the case; both pieces of the HECM program should have been transferred to the MMI fund. Based on the IBM actuarial study there is a huge probability that the HECMs terminated and outstanding in the GI Fund will result in an overall net positive surplus.

        The overall home appreciation rates here in California and Minneapolis over the last twelve months were much better than the 4% appreciation rate used by HUD; of course most areas were much worse. I still believe the HECM program should be regionally risk weighted rather than nationally; the actual risk is. That is the way “real” insurance works.

  • Atare,

    I am 100% in agreement with your comments. There is a certain segment of the reverse mortgage market that will always want a fixed rate product. However, looking at the numbers of fixed rate loans being originated, you have to stop and wonder why, over a relatively short period of time, borrower's preference to the fixed rate (fully drawn) product has risen on a dramatic scale.

    Those involved in the Ginnie Mae side of the business have indicated that a fully drawn fixed rate HECM will get the best secondary market execution. My opinion is that the potential negative impact that the fully drawn product has on the FHA fund and the industry as a whole far outweighs the secondary gain on sale.

    It seems to me that someone is going to need to come along and figure out a way to make a fixed rate HECM work that would not require the full draw up front. I know that this concept is being considered with the HECM Lite, but there must be a way to make it work for the regular HECM as well and allow the borrower to not draw all of their money at the closing table.

    I am certainly not a secondary marketing guru, but it would seem to me that you could still get “better than average” execution on the initial loan balance that is securitized, then continue to get “better than average” execution on subsequent securitizations as the borrower draws down their funds over time.

    This would also allow those borrowers to maintain a line of credit available in case they find themselves in a situation where they have difficulty paying their taxes and insurance.

    Sure seems like a win-win-win scenario, but I don't know that anyone out there has figured out how to make the numbers work on something like that.

    • Shortly after the release of the proprietary product known as The Independence Plan (“TIP”) I became a strong proponent of a bifurcated product. Let the senior decide what the initial draw will be and on a ratio basis provide a line of credit, tenure, or other existing open end payment option. Everything other than the total initial draw(s) and upfront financed costs would be the same as the monthly adjusting HECM, while the other would have the features of a closed end fixed rate HECM.

      As you imply the fixed rate product plays into the desires of seniors. And of course many of us know it is not their desire to obtain more cash than they need at funding on which interest and ongoing MIP will accrue. Unfortunately this product is desirable because of fear of adjustable rate products, warranted or not. With borrower aversion to adjustable rate products, one would expect to see higher sales of the fixed rate products but no doubt some of the increase can be attributed to higher compensation on fixed rate products.

      The year following TIP funding, one lender approached secondary market firms about a bifurcated product. Their idea fell on deaf ears. The general view was that it would be more tainted by its adjustable rate, open end nature than viewed positive by its fixed rate, closed end features. Even if the ratio of fixed to adjustable was a specific ratio, those who looked at the idea still rejected it because of the difficulty of its ready acceptance in the secondary market. A few years ago, MetLife was also looking at the idea. It seems they received a similiar response.

      But I agree with you; maybe it is time to float the idea once again.

  • From HUD perspective, the risk for all HECM products is calculated assuming a full draw whether it is a fixed rate or adjustable rate HECM. The PL algorithm takes this into account. So saying that the fixed rate has a higher risk than an adjustable rate HECM is incorrect from a risk analysis perspective. I would recommend again for folks that really want to know to read up on the excellent treaties by Szymanoski on the HECM PL algorithm.

    Abel Torres

    • Abel,

      You are right but does the model reflect two decades of historical experience? the following remarks are limited to adjustable rate HECMs only.

      Rather than relying on an algorithm which reflects a full draw, maybe it is time to consider relecting historical data currently available from terminated HECMs. At creation, assuming full draws had no program consequences. Today being in the MMI fund, such assumptions can have a significant consequence to the positive credit subsidy making the subsidy far worse than necessary.

      We also need to review the expected interest rates. Are they historically overstated, understated, or appropriate? Is there a better index which better reflects historical experience?

      I am a baby boomer and come with an attitude that things that have been accepted as fact for decades need to be put to the test. We need to test all of the assumptions to see if they need to be refined.

      If the current assumptions result in overstating the subsidy by 10%, some believe that there would be no need of the subsidy currently being considered by the Senate.

      The model and its assumptions did not come from Mount Sinai!! After two decades, it is time to revisit the model and update assumptions for historical experience.

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