Sustainable Growth: A Reality check for the HECM program.
There’s a saying that say’s “If it sounds too good to be true then it probably is.” That phrase lingers in my thoughts as I review the changes the Home Equity Conversion Mortgage program has undergone since 2010. First cuts in the principal limit factors in the wake of the housing buble and subsequent crash enacted in October 2010. Strangely although the lending ratios (principal limits) were reduced borrowers often received more money because the interest rate floor was lowered from 5.5% to 5.0%. Simply put as long as interest rates remained low borrowers would receive more money. Then came the introduction of the Standard Fixed Rate HECM in 2009. The product required a lump sum withdrawal driving up loan balances and future compounding interest and balances substantially. The borrower won with more funds as the insurance fund’s liability increased. In an effort to reduce risk the Saver HECM was introduced in October 2010. Borrowers would receive less funds in exchange for a substantially lower upfront Mortgage Insurance Premium (MIP).
Looking back it seems strange. Strange that the Standard Fixed Rate was released in the midst of falling home values thus increasing risk to FHA’s Mutual Mortgage Insurance Fund (MMI). Strange that the interest rate floor was lowered effectively giving borrowers more borrowing power in a low interest rate environment. It was hoped the Saver would be adopted by many cost-conscious borrowers reducing FHA’s risk exposure yet it’s market share never took off as projected. In fact in the wake of the elimination of the Standard Fixed Rate HECM borrowers overwhelming chose the remaining ‘standard’ product…the adjustable rate. It was proof that products don’t drive the market, consumer demand does. Borrowers voted with their pens proving that most are after maximum cash and are less concerned with cost.
Is this to say the original HECM program was unsustainable? Absolutely not. The original program could have never anticipated two things: a shift to younger borrowers and the collapse of home values in late 2008. Both HUD and FHA have seen the writing on the wall. Business as usual is not an option and risks must be mitigated. While many reverse mortgage professionals may not agree on all actions taken or expected changes we can all agree we need a sustainable model. One that remains to meet the needs of senior homeowners while not siphoning large sums from the insurance fund for claims.
The water is under the bridge. We cannot undue problematic loans written in the years 2005-2010 and the future liability they hold. What we can do is work toward a realistic and measured solution to insure the HECM program remains for future borrowers. Our current plight can best be described in the words of Chinese philosopher Lao Tzu “If you do not change direction, you may end up where you are heading”.
8 Comments
Great article, well done.
Shannon,
It is very strange to read: “Then came the introduction of the Standard Fixed Rate HECM in 2009.”
Where in the world do so many in the industry get the idea that the fixed rate HECM was not introduced until 2009? The first HUD Mortgagee Letter (“ML”) issued on the subject was issued on March 28, 2008 as ML 2008-08. Unlike what many many say even about this ML, it was not written for the purpose of implementing the fixed rate HECM but rather as stated in the opening paragraph of the ML itself: “Specifically, this Mortgagee Letter clarifies and reminds lenders that….”
So calling in the hound of Baskerville and putting on our Sherlock Holmes caps for a moment, let us investigate what evidence HUD itself provides on the subject. Looking at the FHA Single Family Outlook reports we find a change in format occurring on the November 1, 2007 — November 15, 2007 that reveals in the current fiscal year to date column that there were 11,757 HECMs First (today we call them Traditional HECMs) endorsed of which 11,502 were ARMs meaning that in early November 2007, fifty-five fixed rate HECMs were endorsed.
However, we must keep our Sherlock Holmes’ caps on and read the next column where we see that for the same period in the prior fiscal year there were 11,912 HECMs First endorsed of which 11,911 were ARMs. There for the period fiscal period from October 1, 2006 and November 15, 2006 we find our first clear evidence of the first fixed rate ever being endorsed.
So using the Sherlock Holmes method of deduction let us estimate the time frame our first confirmed fixed rate HECM was “introduced” (i.e. offered) for origination. Using the standard rule of thumb for endorsements, the case number would have been issued sometime in June or July 2006. Using an estimated two months as the time it takes to introduce a new product and get a case number assigned to the first endorsement, we come up with a time frame of April or early May 2006 as the most likely “introduction” periods of introduction. That is three years before most in the industry give it any recognition. One very highly respected HECM Mid-West originator wrote recently that it first debuted in 2011 (i.e., until corrected)!!!
It is by pinning down the most likely introduction date that we begin to see things more clearly. When the product was first introduced, the housing bubble was still growing in many parts of the US and in most of California, Florida, and Arizona in particular. HECM endorsement volume had just reached its highest level in endorsements ever in the history of the program as of fiscal 2005 but were only 43,131 total endorsements for that fiscal year. Endorsements for fiscal 2007, the first fiscal year of fixed rate HECM endorsements and the first fiscal year total HECM endorsements exceeded 100,000, totaled 107,558 of which only 120 were fixed rate HECMs not even 0.2% of all HECMs endorsed in that fiscal year. That record is far worse than HECMs overall, HECM Savers or even sad to say, HECMs for Purchase!!!
In conclusion, HUD allowed (not implemented) the first introduction of fixed rate HECMs sometime in the third quarter of fiscal 2006, not 2009. By then most people believed some set back in housing was nearing but few saw the magnitude of what the results of the mortgage market burst was bringing. So it is plainly unfair to ask what HUD was thinking back then but rather what were lenders thinking about back then by offering this product? None, I repeat, none of us had the slightest inkling of an idea back then that by October 1, 2008 HECMs endorsed on or after that date would be accounted for in the MMI Fund and no longer the GI Fund.
Good point. The product while ‘created’ earlier emerged much later. Thank you for the clarification. It’s an interesting history for the fixed rate product.
Shannon,
Thanks. The history of this industry is open to many views and interpretations. This is a very difficult time for our dinky and shrinking industry.
Referring back to my response to Shannon on his blog post, we can plainly see that a common myth intentionally spread by lenders, originators, and particularly some lender consultants is that seniors preferred fixed rate HECMs to adjustable rate HECMs. The total percentage of fixed rate HECMs endorsed to all HECMs endorsed in the three highest years of HECM endorsement production (fiscal years 2007, 2008, and 2009) was just 5.04%. Does that sound popular with borrowers, particularly when fixed rate HECMs were first introduced to the senior market almost six months before the start of fiscal 2007???
Using the four month rule of thumb for the period from case number assignment to endorsement, what caused the seemingly meteoric climb in fixed rate Standard endorsements in mid fiscal 2009 and later? Three events rocked our industry during late fiscal 2008 and early 2009.
The first was the mad scramble of forward mortgage loan originators to find new homes in the midst of a crumbling forward mortgage industry.
The second was HERA and its impact on the ability of FNMA to purchase HECMs. As FNMA was driven into live pricing for HECMs by the reduction requirements in FNMA mortgage portfolios under HERA, HECM lenders were driven to find a new market for their products. The result was HMBS issuance through GNMA. Suddenly during fiscal 2009 we found out that investors would pay a relatively high premium for fixed rate HECMs and soon after fixed rate Standards were climbing in endorsement numbers.
The final change also came with HERA, the very troubling lowering of the cap on origination fees since that is where a good deal of HECM lender revenue was found prior to HERA.
So here the industry was suddenly bloated with forward mortgage originators who understood all mortgages to be little different than selling most commodities at a profit and lenders who saw revenues per HECM decreasing and suddenly HECM endorsements plateau and beginning to fall without a guaranteed purchaser of funded HECMS at a reasonable price.
In less than a single fiscal year, our champion was no longer HECMs generally but fixed rate HECMs in particular. Suddenly lender and generally originator revenues were up for most lenders despite shrinking endorsement numbers. We suddenly stopped hearing that HECMs sell themselves and rather that we educate, not sell. Despite lower principal limit factors for fiscal 2010 and lower endorsement totals, as to revenues, fiscal 2010 really was not the bad year for HECM lenders that they foresaw in early fiscal 2009. Things were OK in early 2011 when it became apparent there was something fundamentally wrong with fixed rate HECMs and HECM Standards as there were clear indications that default rates for nonpayment of insurance and taxes were rising particularly among fixed rate HECM borrowers and that the HECM portion of the MMI Fund was in trouble from mandatory full draws.
Soon B of A would leave the market as well as Wells Fargo with MetLife in close pursuit as well as Financial Freedom (owned by OneWest Bank by then) and several other significant banks. But with new market share up for grabs, most lenders were still content despite falling industry wide endorsement numbers. By fiscal 2012, reality began to set in. Fixed rate Standards were in deep trouble on several fronts. In early fiscal 2013 even Republican members of Congress were tired of having the wool pulled over their eyes by the defenses of HUD about the fixed rate Standard and its impact on the MMI Fund.
So here we stand today near the end of fiscal 2013 with no fixed rate Standard and more threats of the loss of all Standards, lower principal limit factors, and perhaps the loss of the entire HECM program by the end of fiscal 2016, if not sooner. What was once the great dreams and National Conventions of the inhabitants of HECM land are slowly crumbling like leaking helium from a pricked balloon, Our days of basking in a world of what could have been are quickly turning into the haze of a thick fog whose lifting we cannot foretell. What will we find on the other side few want to say except for those ultra optimists who still clamor for 100,000 endorsements for fiscal 2013 and if not then, soon.
Don’t you think that lump sum choices are driven more by those originators who are paid on the amount drawn, rather than on the PL? The incentive is with the lender to not discuss a tenure or line.
Mr. Warner,
Yet, it is generally much better for a lender to compensate its originators based on some percentage of what the compensation is for lender than the principal limit which only has to do with how much origination fee a lender can directly charge a borrower for originating a HECM. Normally lenders generate more revenue based on the unpaid balance of the HECM at funding than the origination fee would otherwise provide (back end versus front end compensation).
Everything is very open with a very clear clarification of the challenges.
It was truly informative. Your website is extremely helpful.
Thanks for sharing!