Last month, FHA announced a series of sweeping changes in the HECM reverse mortgage program, most of which have already taken effect. The changes are a response to increasing losses suffered by FHA in connection with the extensive misuse of the program. A disproportionate number of borrowers were drawing as much cash upfront as they could -- 100 percent of the principal limit (PL), which is what FHA calls the senior's total borrowing power. This left them no scope for further draws in the future.
The HECM program was originally intended to help senior homeowners remain in their homes indefinitely, not to meet short-run financial needs. Borrowers who cashed out early, furthermore, had less incentive to stay current on their property taxes and insurance, which increased losses to FHA.
The Saver Program to Discourage Cash Draws Was Unsuccessful: Several years ago, FHA had tried to encourage seniors to take a longer view by creating the saver program as an alternative to the standard program. The saver program offered a sharp reduction in the upfront mortgage insurance program to seniors willing to accept a smaller PL. The combination of reduced upfront charges and smaller draws resulted in slower growth of future debt on saver HECMs. But the prospect of slower debt growth proved no match for the appeal of cash-in-hand, and the saver program never attracted many seniors.
The Saver Program Has Been Terminated and Upfront Draws Are Now Limited by Rule: Under the new rules, borrowers can no longer draw 100 percent of the PL unless the draws are used to comply with FHA mandates. Mandatory draws include paying off all liens on the property including the senior's existing mortgage if there is one, all settlement costs, and any repairs needed to meet FHA property requirements. Cash draws within the first year for other than mandated purposes (I call these "pocket draws") are limited to 60 percent of the PL less mandatory draws, or to 10 percent of the PL, whichever is greater. The dual mortgage insurance premium feature has been retained, but now it is based on whether or not total cash draws in the first year are above or below 60 percent of the PL.
Fixed-Rate HECMs Are Less Attractive: It has always been the case that borrowers selecting fixed-rate HECMs had to draw cash at closing, they could not defer cash draws. This did not discourage use of fixed-rate HECMs so long as borrowers could draw 100 percent of their PL upfront, and virtually all those who drew maximum cash used fixed-rate HECMs. However, under the new rules limiting pocket draws, the only seniors likely to opt for a fixed-rate HECM are those with large existing mortgage balances. The total of mortgage loan balances, other mandated draws and pocket draws up to 10 percent can be 100 percent of PL.
Will Large Cash Draws Continue on ARMs? On adjustable-rate HECMs, a borrower is now subject to the new limits on cash draws at closing, but after a year they can draw the remainder of their PL. FHA seems to be assuming that the most cash-hungry borrowers will be deterred by having to go with an adjustable rate, and/or having to wait a year for a second helping. I have my doubt s about that. If the only change is to shift a chunk of the cash withdrawals forward a year, expect FHA to come back in a few years with more draconian restrictions.
Bad News, The Principal Limits Are Now Lower Than They Were: Under the new rules, borrowers of a given age and a given amount of equity in their home cannot borrow as much in total as they could. Given the limitations on upfront draws, this may or may not prove necessary to protect FHA's solvency, but they can always reverse it.
More Bad News, the HECM Program Is Now Even More Complicated Than it Was: While it is not clear whether or not the new rules will succeed in discouraging early cash draws, it is very clear that these rules have made it more difficult for seniors to sort out their cash draw and mortgage insurance (MI) options. Here are some illustrations:
- If mandatory draws are 10 percent of the PL, pocket draws can be up to 50 percent, MI is 0.5 percent.
- If mandatory draws are 50 percent of the PL, pocket draws can be up to 10 percent, MI is 0.5 percent.
- If mandatory draws are 55 percent of the PL, pocket draws can be up to 5 percent with MI of 0.5 percent, or up to 10 percent with 2.5 percent MI. The borrower has a choice.
- If mandatory draws are 61 percent of the PL, pocket draws can be up to 10 percent, MI is 2.5 percent.
If this makes your head spin, never mind, I had to master it in order to reprogram our HECM calculator, but you don't, and neither do seniors contemplating a HECM. What should matter to them is what their unique options are, and they can find that on my web site.