The Federal Housing Administration is taking steps to address heightened risk from mortgagees that are pushing borrowers to take maximum draws on reverse mortgages as early as possible.
FHA recently made a change to the home-equity conversion mortgage program that limited the amount of the principal a borrower could draw within the first twelve-month disbursement period.
In addition, FHA increased the initial mortgage insurance premium for HECM draws that exceed 60 percent of the principal limit.
The move was made to address an industry practice of requiring borrowers to take large initial draws on fixed-rate HECMs, FHA explained in Mortgagee Letter 2014-11.
Mortgagees were employing this strategy because of their inability to effectively hedge the interest rate risk since they didn’t know what the amounts of future draws would be.
With the recent changes, FHA said it has found that mortgagees are employing a new tactic to limit their exposure.
“One new market option strongly encourages the mortgagor to take the maximum amount available during the first twelve-month disbursement period and to take the remaining amount shortly after the expiration of the first twelve-month disbursement period whether they need it or not,” the letter states. “This is done through various pricing options, marketing and advertising.”
But the practice is undermining FHA’s objective of reducing the size of up-front draws.
FHA is also concerned that if the mortgagee defaults, it would be on the hook for future draws, interest rate risk exposure and servicing costs.
While mortgagees can attempt to hedge interest rate risk, many may find the strategy too expensive and choose to accept the risk, themselves.
In either case, FHA cannot require HECM mortgagees to mitigate interest rate risk, nor is it able to monitor such practices.
“As a result, FHA must now take steps to address these risks and protect the HECM program and the financial soundness of the Mutual Mortgage Insurance Fund,” the letter states. “The financial impact and operational difficulties posed by this statutory guarantee of payment by FHA on these products has led FHA to conclude that it can no longer insure fixed interest rate reverse mortgages that provide the mortgagor with any options for future payments.”
In Mortgagee Letter 2014-10, FHA reminded lenders that they are required to clearly explain all requirements and features of the HECM program. Prospective borrowers must be informed of all available HECM features.
Borrowers need to know that while fixed-rate HECMs are limited to single disbursement lump sum payments, adjustable-rate HECMs provide for five, flexible payment options, and allow future draws.
On adjustable-rate HECMs, the borrower needs to be aware of the ability to change the payment plan at any time as long as funds are available.
“Mortgagees are prohibited from using any misleading or misrepresentative advertising or marketing materials in connection with the HECM program,” Mortgagee Letter 2014-10 said. “Mortgagees are prohibited from making any statement or representation that could mislead a mortgagor as to his or her rights under a HECM. Mortgagees may not state or imply that as a result of their approval to participate in FHA programs that any of their products have been endorsed by FHA or HUD.”