Spotlight: Farewell to the Fixed-Rate

Written by John K. Lunde

The reverse mortgage industry has weathered many changes in the past few years, evolving from a single secondary market option on ARM loans at one margin rate (CMT 150) to a majority fixed-rate product sold into HMBS pools and then into HREMIC securitizations. Through it all, there have been countless changes to premiums, fees, principal limits, rates and regulatory requirements. New products have been introduced (Saver, Purchase) and new customer segments explored that were nice afterthoughts during the industry’s peak volume years in 2008 and 2009.

The latest change coming down the pipeline is the curtailment and potential elimination of the HECM Standard fixed-rate product. This won’t be the death of our industry, but originators will have to adjust in order to continue operating successfully and profitably.

Why?
The question that people keep asking: Why is the FHA so focused on curtailing or eliminating the fixed-rate HECM Standard product? While I can’t speak for the FHA, my firm does gather industry data that may shed some light on that question.

We’re all well aware of this first chart below, which illustrates the rise of fixed-rate reverse mortgages as overall volume declined in the past few years.

Unfortunately, fixed-rate loans became more prevalent just as the industry was starting to face a big T&I default problem. As you can see from the chart below, fixed-rate loans from 2009 showed T&I default rates only slightly higher than ARM loans. But the picture changed dramatically in 2010, as fixed-rate loans started defaulting at two to four times the rate of ARM loans from the same vintage.

The overall default rate for the 2010 vintage rose only slightly from 2009 (and both are at unsustainable levels for the industry regardless), but it was clear that the fixed-rate was displaying significantly worse default rates as time went on.

Whether eliminating the fixed-rate product entirely is the right option depends on many factors, but it is very interesting to note that if the T&I default rate is a significant part of that decision process, the HECM for Purchase is one category in which default performance is good enough to perhaps make an exception:

As you can see from the chart above, seasoned fixed-rate HECM Purchase loans had 45 to 47 percent fewer T&I defaults as of September 9, 2012, than fixed-rate HECMs not identified as Purchase loans. And indeed, each of these trends fit with common sense, too:

*ARM borrowers are less likely to take all of their proceeds upfront at origination, which leaves them with available funds down the road to pay ongoing property charges and avoid default.

*HECM Purchase borrowers are putting substantial cash into the Purchase transaction, which suggests additional financial resources are available beyond home equity and incents the borrower to protect that initial cash investment as well.

The default trends above help explain why the FHA might feel the need to curtail or even eliminate the fixed-rate HECM Standard, but there are other potential reasons as well:

*Fully drawn, fixed-rate HECMs accruing at higher interest rates are more likely to result in an FHA claim (assignment or REO) due to their higher LTV profile.

*Full-draw requirement on these loans means that in many cases, borrowers are taking cash at closing that is not being used to pay closing obligations like mortgage debt—and many are rightfully nervous that this might mean loan funds sitting in a savings account earning 25 bps while accruing 6.25 percent or more in reverse mortgage interest.

Fixed rates became the solution for a borrower spooked by adjustable-rate mortgages in the housing crash and part of the answer to increase revenues as loan volume declined. But those answers from the past create more challenges for the industry as the era of fixed-rate HECM Standard ends.

In light of these facts, the conclusion is that the fixed-rate HECM Standard was always going to be changed to address these issues—it was just a matter of time.

What It Means for the Future
Now that we’ve identified the likely reasons for action, it’s natural to ask what this might mean for the industry and the other changes that are probably coming. With respect to loan volume, it’s very likely that with additional education and counseling to mitigate fears of “payment shock” that largely drive concern about ARM loans in a forward mortgage context, few borrowers would refuse to take an ARM HECM if that is the only option available.

But even if borrower interest in closing a HECM were completely unaffected by an elimination of fixed-rate product options, industry volume is still likely to go down for two other reasons. The first is a reduction in revenue to originators that will reduce marketing budgets around the industry and the second is reduction in principal limits at some point in the future as long-term interest rates rise.

There is little to be done about a rise in interest rates (I hear the authorities are none too happy about bankers “fixing” benchmark interest rates…), so it makes sense to focus your attention on the second challenge: reducing your marketing cost per funded loan to meet the reinvigorated HECM ARM world head on.

For those who buy leads, there may be a silver lining of sorts: Fewer marketing dollars chasing leads could

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reduce lead prices somewhat as the lower average revenue per loan works its way through the origination ecosphere. I qualified the statement because it’s likely that the reduction in prices comes about only slowly through some attrition of originators who can’t convert efficiently enough at current prices in the reduced-revenue-per-loan world—act now to build extra efficiency into your system and avoid being one of the casualties.

If you haven’t taken advantage of new tools to optimize your marketing, like the additional scoring and filtering information provided by my firm (rminsight.net/retail), now is the time to explore your options for improving lead generation performance.

Last but not least, keep in mind that more changes are soon to come through financial assessment and potential T&I set-asides. These changes are more likely to mean increased costs and reduced volumes compared with the fixed-rate changes, so keep an active effort to build HECM Purchase and HECM Saver products for the financial planning segment to stay ahead of the Darwinian curve for our industry.

Remember, change is only a scary thing until you realize the alternative is becoming a fossil.

  • Pingback: HUD Eliminating Fixed-Rate HECM Standard Reverse Mortgages, But HECM Saver Option Remains - Kitces | Nerd's Eye View()

  • James_E_Veale_CPA_MBT

    Mr. John Lunde does his usual great job of providing facts and information.  Where Mr. Lunde sees the 16 ounce glass half-full, that same glass appears to have approximately 8 ounces of water in it to someone like me.  In other words, forgetting about outlooks what is the current condition of the HECM program?  

    While the T & I default rate on all fixed rate Standards is deplorable on all transaction types, it could have been easily corrected through financial assessment and mandatory set asides of taxes and insurance.  As to full draw fixed rate products, Mortgagee Letter 2013-01 does not call the action a moratorium or suspension of the product but rather a more permanent action, “consolidation.” Yet the consolidated fixed rate product provides practically no upfront MIP, just lower PLFs (Principal Limit Factors).
    FHA Commissioner Galante was never called up to the Hill to discuss either defaults or full draw products. What the Commissioner was called on the carpet for was the results of the actuarial report for last fiscal year.  After years of promising things would be better “next year,” that promise fell on many deaf years when for the first time in history the net position of the MMI Fund went negative.

    While the overall MMI Fund was in the hole by $16.3 billion, the HECM portion of that was $2,8 billion.  While active HECMs as of September 30, 2012 accounted for 7% of all FHA MMI Fund related insurance in force, the HECM portion of the net loss position of the MMI Fund accounted for over 17% of the amount that fund is in the hole.  It has been stated that the letter Acting Commissioner Galante wrote to Senator Corker last December promising to eliminate the Fixed Rate Standard was one of the key reasons Senator Corker and other Republican Senators voted to make her the FHA Commissioner.

    So why all of the fuss?  The Actuarial report is based on projections and it shows a definite and growing improvement in the HECM portion of the MMI Fund net position by 2019 (to around a negative $400 million).  Yet the law requires the MMI Fund to be equal to 2% of the insurance in force at fiscal year end.  When that is factored into the HECM portion of the projected net loss position, suddenly the difference between where the HECM portion of the MMI Fund net position should be and where it is projected to be is a difference of about $4 billion for each year through 2019.  Consider that FHA took over $2.2 billion in funds from other portions of the MMI Fund and specifically allocated it to the HECM portion during fiscal years 2010 and 2011 and now the numbers get even higher.

    Some argue that the HECM portion of the MMI Fund lost $2.8 billion last year. The truth is the net position fell from a positive $1.4 billion for fiscal 2011 (after all allocations funds from other MMI programs into the HECM portion) to a negative $2.8 billion.  That is more like a $4.2 billion loss last fiscal year.

    Some will want to argue about the accuracy of the actuarial projections but the actuaries appear to have done their job competently. Based on economic conditions at the time of their report and field work, the actuaries determined the net loss position reported as the most likely outcome for last fiscal year as well as the next seven fiscal years.   

    If by 2019, the HECM portion of the MMI Fund is still short of meeting its portion of the 2% mandated requirement by almost exactly the loss which incurred in fiscal 2012, when will the HECM portion ever fully recover?  As of September 30, 2011, the net position met the 2% requirement.

    So looking at the future how could HUD get the HECM portion under control in future fiscal years? Dumping the adjustable rates would have only worsened the situation.  The fixed rate Saver seems safe in a more accommodating housing market but then again it will be looked at in the future to see if PLFs should be reduced.

  • Brien Brandenburg

    Great article as always John.