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FHA’s reverse mortgage program remains a threat to its financial health

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WASHINGTON — The mortgage industry is closely watching the Federal Housing Administration’s reverse mortgage program as the agency prepares to release its annual actuarial report sometime this month, which will reveal if the historically volatile program is continuing to threaten the FHA’s financial soundness.

Home equity conversion mortgages, or HECMs, helped drag down the FHA’s capital reserve ratio to 2.09% in the last fiscal year, barely above the 2% statutory minimum to cover losses.

The product presents greater risks to the agency than conventional mortgages, including higher interest rates and more borrowers defaulting on loans. As a result, FHA claims and losses have also risen, and as of last year’s report, the reverse mortgage program is projected to generate $15.5 billion in loan losses for the agency’s mutual mortgage insurance fund over the next 30 years.

Although FHA kicked off fiscal year 2018 by lowering principal limit factors for all reverse mortgages, which changed the amount a borrower could withdraw, and adjusting the initial and annual mortgage insurance premium, it’s unlikely that this year’s actuarial report — which will be released this month — will show major changes.

“The changes FHA made to the principal limit factor and the adjustments HECM premium in 2017 were designed to help, but did not and were not intended to fully solve the financial volatility of the program,” said FHA Commissioner Brian Montgomery on a recent phone call with reporters.

The HECM program is especially hard to manage because the results of policy adjustments usually don’t appear in the data for “many, many, many years,” unlike changes to the forward mortgage program, said Pete Mills, a senior vice president at the Mortgage Bankers Association.

“The fact that [FHA] has made two rounds of significant changes to the HECM program just in the past year suggest that they’re still having trouble managing that program,” he said.

The FHA declined to comment on this year’s report and challenges with the reverse mortgage program.

On the positive side, the strong economy could bode well for FHA despite the challenges of the HECM program, said Brian Chappelle, a partner at Potomac Partners and former FHA official.

“The good news is when house prices go up, that’s a positive for the fund, and then when interest rates go up, that’s a positive for the fund. Both of those things have been happening in the last year,” he said. “Now whether that adds up with the claims they’ve had on the reverse side, we’ll have to see, but at least those two macro indicators are certainly moving in the right direction, which is a positive.”

Nonetheless, this year’s actuarial report may not be set up to reap the benefits of a healthy economy. Because last year’s report did not include losses at FHA from Hurricanes Harvey, Irma and Maria as well as wildfires in California, the agency is expected to factor those in this year.

“There’s a huge exposure there, so this could be the first time we see those numbers,” said Michael Fratantoni, chief economist at the MBA.

In its fiscal year 2017 report, FHA said it anticipated future claims and losses in Puerto Rico, Florida, Texas and California from these natural disasters, but that it could not estimate the expected loss at the time. Accordingly, losses from Hurricanes Florence and Michael this year will likely be excluded from the upcoming report.

“What we’ve heard from some of our lenders is that particularly in the case of Harvey, where the city of Houston bounced back pretty quickly, some FHA borrowers impacted by the storm were really struggling coming out of that,” said Fratantoni. “The hurricanes over the last 18 months or so are really going to potentially have an impact on these numbers too.”

This year’s report also won’t factor in the most recent change FHA made to its reverse mortgage program, which went into effect Oct. 1 — the start of fiscal year 2019. Under the new requirement, lenders in certain cases will need to submit a second property appraisal when originating reverse mortgages.

Using additional collateral valuation tools in the reverse mortgage program is intended to bring “FHA in line with the rest of the mortgage industry,” said Gisele Roget, deputy assistant secretary at FHA, in a phone call with reporters last month.

After last year’s report was released, several groups including the MBA and National Association of Realtors came out in favor of reviewing whether it would be possible to remove the HECM program from the MMI fund, and are likely to do so again this year if the capital reserve ratio inches closer to 2%.

But Montgomery’s decision not to go forward with an Obama-era proposal to reduce insurance premiums suggests that there isn’t an appetite at the FHA to separate the reverse mortgage program from the fund because of the risk involved, said Michael Peretz, a managing partner at Capco.

“Because of that volatility, until you can correctly prognosticate what’s going to happen in any given year, any given time period, it would be very difficult to decouple those items from a safety and soundness perspective,” said Peretz.

While at one point, the question of whether Montgomery would go through with the premium reductions seemed up in the air, it’s increasingly unlikely that the FHA would look to follow through with those cuts. According to last year’s report, if the premium cut had gone into effect in January 2017, FHA’s MMI fund would have dropped to 1.76%, which is below the mandatory requirement.

“That margin of error makes them reluctant to consider a premium cut when they’re so close to the 2% threshold,” said Mills.

However, Chappelle argues that it is still in the FHA’s best interest to at least restructure the premium. Currently, customers pay insurance premiums for the life of their FHA loan.

“With the current structure, it hurts the taxpayer, because the taxpayers are losing that revenue because these loans are pre-paying quicker, and then it’s also got the homebuyer impact,” he said. “This policy is having a significant impact on revenue whether it’s from homebuyers not going to FHA because of the annual premium, or homebuyers getting out of the FHA loan as soon as they could.”

Data from last year showed that more borrowers are refinancing out of the FHA program and instead opting for conventional mortgages, likely due to the annual premium. Borrowers who have a conventional mortgage with a private mortgage insurer have more options to cancel insurance than FHA borrowers.

“Whenever you talk to any lender and the Realtors or anybody else for that matter, they agree that requiring the person to pay the premium for the life of the loan is a real burden on the program and is causing borrowers to leave as soon as possible,” said Chappelle.

But a premium hike or premium restructure is not likely to be on the table in the short term, said Peretz.

“In the short-term [FHA is] going to be cautious and smart about their decision,” he said. “I think also the right answer is they’re going to put this out for some opinion because I think there’s a lot of industry data here that needs to be reviewed before a decision can be made.”

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