August 27, 2021

The HECM reverse mortgage, developed by the US Department of Housing and Urban Development (henceforth “HUD”), is an ingenious instrument that has no counterpart anywhere else in the world. Its major strength is that it provides homeowners a variety of ways in which they can draw spendable funds against the equity in their homes, with no repayment obligation so long as they live in it. Yet the program has attracted only a tiny sliver of the potential market. Roughly 6,000 homeowners reach 62 every day, and fewer than 150 of them take out HECMs. The potential market is perhaps 10 times larger.

Potential borrowers are deterred by fears about complexity, and by negative PR, the sources of which include regulators. A sizeable segment of the homeowners who do take HECMs, furthermore, are in desperate financial circumstances, and end up failing to pay their property taxes and/or insurance premiums. This imposes foreclosure-related losses on HUD’s mortgage insurance reserve fund, which is in a negative position. This is a potential future claim on the Treasury, and a possible reason for Congress to kill the program.

The Reason For Dysfunction

The disappointing history of HECMs is due entirely to it being a stand-alone product, as contrasted to it being integrated into retirement plans that include financial asset management and annuities.

The stand-alone model has resulted in an excessively large proportion of borrowers drawing maximum cash in the first year, leaving nothing to cushion rising tax and insurance payments in later years. An integrated model, in contrast, would include a life annuity that would rise over time, enhancing the capacity of HECM borrowers to meet their obligations. Defaults would then become the occasional events that the mortgage insurance reserve fund was designed to cover.

Why the HECM Is a Stand-alone

It is due in large part to HUD’s antipathy to annuities. While it would be logical for HUD to require HECMs to be integrated with annuities as a way of minimizing borrower defaults, its policy is exactly the reverse. The HUD-approved counselors, who potential borrowers must consult before submitting a loan application, are instructed by HUD to warn borrowers to beware of annuities. HUD also discourages HECM lenders from having relationships with other financial institutions.

Why this perverse policy? In the early days of the HECM market, one or more HECM lenders combined with one or more annuity providers to offer loan/annuity combos at extortionate terms. In its zeal to protect HECM borrowers from over-paying, HUD largely shut the door on annuities. Paradoxically, however, it has ignored dysfunction in the HECM market.

Why the HECM Market is Dysfunctional

The HECM reverse mortgage is by far the most complex financial instrument that homeowners are likely to encounter in their lifetimes, and they must deal with it after many have passed their intellectual prime. Trying to shop HECMs on-line is an exercise in futility because lenders (with an exception noted below) don’t provide the information a potential borrower needs to compare one offer with another.

HECM borrowers can draw cash up-front, a monthly payment for a specified term, a monthly payment for as long as they reside in their home (“tenure payment “), or a credit line that can be accessed at any time. I examined the web sites of 24 HECM lenders including all the largest ones to see what information they provided on the 4 HECM draw options. I found 5 lenders of the 24 who provided information on the amount of cash draw, 3 who provided information on credit lines, and none who provided information on monthly payment options. The accompanying table shows the lenders covered.

The major objective of all the lender web sites is to obtain identifying information about the shopper, allowing a loan officer to contact them and begin a sales process. During the several days of web visits, I was bombarded with phone calls and emails from loan officers.

The HECM market can be characterized as a rivalry market as opposed to a competitive market. In a competitive market, purchaser choices are at least partially based on price. In a rivalry market, choices are based on referrals, advertisements and third-party endorsements. A consequence is that price spreads on identical transactions can be obscenely large.

An Exception: HECM Lenders Who “Dare to Compare”

There is an exception, however, consisting of 8 lenders who “dare to compare” their terms to those of others. These are All Reverse, Centennial Home Mortgage, Goodlife Home Loans, Longbridge Financial, Mid America Mortgage, Mutual of Omaha Mortgage, Retire Secure, and Signet Mortgage. These lenders report their loan terms to my two web sites (www.mtgprofessor.com and www.kosher-reverse-mortgage.com). To distinguish them from other HECM lenders, I will call them “DTC Lenders”.

The information DTC lenders provide to my sites contrasts sharply with industry practice:

 * Shoppers are not required to identify themselves until they have made a selection from among the 8 lenders.
* All 8 lenders provide rate/points/amounts for all the draw options available.

Bottom line, the shopper can find the one DTC lender that offers the best terms on the particular features of a HECM that best meets their needs.

How HUD Could Eliminate Market Dysfunction

HUD has inserted itself into the HECM market structure only by requiring that prospective borrowers be counseled by an independent advisor before submitting a loan application. This requirement may help prospective borrowers understand what a reverse mortgage is, but it does not help them shop the market for the draw option they need.

A regulation mandating that lenders provide information on the draw amounts offered on all HECM options would not help much. Every lender would provide the information differently, making it extremely difficult to compare the offerings of one lender with those of another. To convert a rivalry market into a competitive market requires that all the HECM lenders display prices and draw amounts using the same format.

One such format already exists and has been thoroughly tested over a number of years. It is the format used with the 8 DTC lenders described earlier, who now pay me a small lead fee. I would be pleased to license my system to HUD at no cost, eliminating my charge on the 8 HECM lenders that now use it.

HUD and Annuities

To enlarge the availability of spendable funds for homeowners with very limited financial assets, and replenish the mortgage insurance reserve fund in the process, HUD policy should swing from discouraging annuities to encouraging them, rising payment annuities in particular.

In implementing this policy, HUD should require that the lender offering a HECM/annuity combination provide demonstrably competitive terms on annuities. This is very easy to do because there are third party data bases that show annuity amounts offered by large numbers of insurers. The annuity amounts cited below are drawn from such a service.

Benefits of Integration

Consider the case of a male of 62 who owns a debt-free house worth $500,000 but has no financial assets. His only stand-alone option is a HECM tenure payment, which provides a fixed monthly payment. On June 21, 2021, the largest tenure payment quoted by the 8 lenders who report prices to my web site was $995, shown by the lower horizontal line of Chart 1a.

If instead of taking a tenure payment, the borrower combines a HECM credit line with an annuity on which payment is deferred 10 years, his monthly payment would be $1,122, shown by the higher horizontal line on the chart. During the first 10 years the payments would be drawn from the credit line (shown by the dotted segment of the line), after which they would come from the annuity.

The combo has two another important advantages over the stand-alone. One is that the payment on the annuity would continue until the borrower died whereas a tenure payment terminates when the borrower moves out of the house – into a nursing home, for example.

The second advantage of the combo is that the payment amounts can be graduated. This is illustrated by the two schedules on the chart that incorporate annual payment increases of 2%. Most borrowers probably would select a rising payment option, and HUD as the insurer should also prefer it. Borrowers with rising payments are better positioned to pay their property taxes and insurance.

The two rising payment schedules illustrate the importance of providing retirees with competitive annuity prices. The annuity price used in calculating the higher of the two schedules was the best of the price quotes accessed from a network of annuity providers rated A or above by AM Best. The lower rising payment schedule was calculated using the worst quoted price. The difference is substantial, although even with the worst annuity price, some borrowers would probably prefer the combo over the tenure payment.

Note that the combo transaction requires technology that generates the unique division of the credit line between the amount used to purchase the annuity and the amount retained for payments within the deferment period. This is needed to assure a seamless transition between the last credit line draw and the first annuity payment.

Concluding Comment

A major policy objective should be to enhance the retirement status of homeowners, particularly those whose wealth is largely in their homes. HUD could do this without any increase in Government funding. The key is to convert the HECM program from being a stand-alone to being part of an integrated retirement plan while assuring that the components of the plans are priced competitively.

To assure that HECMs are priced competitively, HUD should require that all the HECM lenders display prices and draw amounts using the same format. To assure that annuities are priced competitively, HUD should require that HECM lenders document the procedure used in selecting an annuity provider.

The role of loan counselors should change from warning prospective borrowers about the hazards of annuities to explaining how an annuity might enhance their retirement plan if it is priced competitively -- which the lender should document at the applicant’s request.
Short-sighted lenders will bridle at these changes, which will reduce their margins. Far-sighted lenders will recognize that these changes could expand the demand for HECMs ten-fold.