Reverse Mortgage Lending Now in Fast Forward Brian King BenchMark Consulting International The Reverse Mortgage business has been discovered! According to the National Council on Aging, over 80% of people 65 and older own their homes, and 76% own their homes free and clear. Since over half of the net wealth of these homeowners is tied up in their homes and other real estate, many may look to leverage the equity in their homes to help pave the way to a smooth retirement, pay for long-term care or medical expenses, or simply maintain a certain lifestyle. The total home equity among seniors is estimated to be about $1.5 trillion dollars 1. Homeowners Age 65 and older Owned Free & Clear 76% Reverse Mortgage Definition A reverse mortgage enables older homeowners (62+) to convert a portion of the equity in their homes into tax-free income without having to sell the home, give up title, or take on a new monthly mortgage payment. The reverse mortgage is aptly named because the payment stream is reversed. Instead of making monthly payments to a lender, 1 Stucki, Barbara, PhD. Use Your Home to Stay at Home Reverse Mortgages. Press Briefing. National Council on Aging. 26 January 2005. as with a regular mortgage, a lender makes payments to the homeowner. The homeowner can choose to receive the money from a reverse mortgage all at once as a lump sum; as fixed monthly payments either for a set term or for as long as the homeowner lives in the home; as a line of credit; or as a combination of these. The most popular option is the line of credit, which allows the homeowner to draw loan proceeds at any time. The amount of funds the homeowner is eligible to receive will depend on the homeowner s age (or the age of the youngest spouse in the case of couples), appraised home value, current interest rates, and the lending limit in the homeowners area. In general, the older the homeowner and the greater the home equity the more money the homeowner can receive. There are no specialincome or medical requirements. The homeowner may qualify for a reverse mortgage even if money is still owed on an existing mortgage. However, since the reverse mortgage must be in a first lien position, any existing mortgage must be paid off. The homeowner can pay off the existing mortgage with a reverse mortgage, money from savings, or assistance from a family member or friend. Requirement for Counseling Counseling is one of the most important consumer protections built into the program. It requires an independent third-party to make sure the homeowner understands the program and reviews alternative options before the homeowner applies for a reverse mortgage. 2007 BenchMark Consulting International, N.A., Inc. All Rights Reserved.
Counseling is required for all reverse mortgages and may be conducted face-to-face or by telephone. By law, a counselor must review: options (other than a reverse mortgage) that are available to the prospective borrower other home equity conversion options that are or may become available to the prospective borrower the financial implications of a reverse mortgage the tax consequences affecting the prospective borrower s eligibility under state or federal programs and the impact on the estate for his or her heirs The homeowner can seek counseling from a local HUD-approved counseling agency or a national counseling agency such as AARP, National Foundation for Credit Counseling, or Money Management International. Repaying the Loan No monthly payments are due on a reverse mortgage while it is outstanding. The loan is repaid when the homeowner or the last remaining spouse (in cases of couples) dies, sells the home, or permanently moves out. The amount owed can never exceed the market value of the home. Furthermore, if the home is sold and the sale proceeds exceed the amount owed on the reverse mortgage, the excess money goes to the homeowner or their estate. Reverse Mortgage Alternatives Since the primary value driver in the reverse mortgage product is tapping the equity in the home, the alternatives to a reverse mortgage are typically selling the home or a conventional home equity line of credit or loan. Selling would be disruptive as it would require the homeowner to move, find a buyer for the current home, and typically pay realtor fees and related moving costs. While a home equity product would typically entail lower closing costs, qualifying may be more difficult. The home equity product could also pose the risk of losing the home if payments are not met. As with all financial services products, there are trade-offs and benefits to each product based on the customer s needs. Reverse Mortgage Products Home Equity Conversion Mortgage ( HECM ) Available since 1989, HECMs are insured by the federal government through the Federal Housing Administration (FHA), a part of the U.S. Department of Housing and Urban Development (HUD). The size of a HECM depends on the FHA maximum loan limit, which varies by county. For 2007, the FHA loan limits varied from $200,160 to $362,790 2. As part of the upfront closing costs, the homeowner must pay a mortgage insurance premium ( MIP ) equal to 2% of the principal limit amount plus an annual premium thereafter equal to 0.5% of the loan amount 3. The insurance premium guarantees that if the company managing the loan commonly called the loan servicer goes out of business, the government will step in and ensure continued access to the loan funds. Furthermore, the MIP guarantees that the homeowner will never owe more than the value of the home when the HECM must be repaid. In addition to the insurance premium, borrows typically pay an origination fee. With the HECM program, HUD limits the origination fee that a lender can earn to 2% of the maximum claim amount. The ongoing interest rate that the homeowner pays on a HECM is the same no matter which lender they choose. The rate is based on the 1-year U.S. Treasury bond plus a margin. The interest rate is a variable rate that can change either monthly or annually, based on the homeowner s decision. 2 Stucki, Barbara, PhD. Use Your Home to Stay at Home Reverse Mortgages. NCOA/Caresource Healthy Aging Briefing Series. National Council on Aging. 23 February 2006. 3 About Reverse Mortgages Typical Costs in Getting a Reverse Mortgage. NRMLA. February, 2007. <www.nrmla.org>. BenchMark Consulting International 2 Reverse Mortgage Lending June 2007
Fannie Mae Home Keeper & Home Keeper for Home Purchase Mortgage investor Fannie Mae developed a proprietary Home Keeper reverse mortgage as an alternative to the federally insured Home Equity Conversion Mortgage. Headquartered in Washington, DC, Fannie Mae is the nation's largest home mortgage investor and a major reverse mortgage provider, whose products include the federally insured HECM. The Home Keeper was developed to address needs that could not be met by the HECM program such as individuals with higher property values, condominium owners, and seniors wishing to use a reverse mortgage to purchase a new home. Home Keeper loans can be larger than HECMs because Fannie Mae s maximum mortgage limit $417,000 for 2007 is larger than the locally applied FHA maximum mortgage limit. A consumer may choose to receive the funds from a Home Keeper as fixed monthly payments for life (i.e., for as long as the borrower occupies the home as his/her principal residence; a line of credit; or a combination of monthly payments and line of credit. Home Keeper borrowers are charged an origination fee that may not exceed 2 percent of the reverse mortgage amount, a monthly servicing fee ($15-$30), and other closing costs. Many of these can be financed and included in the mortgage. The interest rate charged on a Home Keeper reverse mortgage adjusts monthly and is equal to a fixed spread above an index rate the current weekly average of the one-month secondary market CD rate which is published by the Federal Reserve. One interesting feature of the Home Keeper is that the homeowner can use the program to purchase a new home all in a single transaction. The transaction reduces the out-of-pocket cash needed to buy a new home, eliminates any new monthly mortgage payment, and helps the homeowner keep more of the sales proceeds from the old house or a larger amount of savings to use for other purposes. Financial Freedom Cash Account Financial Freedom, a subsidiary of IndyMac Bank, introduced a "jumbo" proprietary reverse mortgage product called Cash Account to benefit homeowners living in higher-priced homes valued above the FHA and Fannie Mae lending limits. In addition to being offered by Financial Freedom, the program is also offered by other reverse mortgage lenders. In 2004, Financial Freedom introduced the Simply Zero Cash Account, the first-ever reverse mortgage loan to eliminate all up-front costs. With the Simply Zero Cash Account, borrowers are required to draw 100% of their maximum available benefit at loan closing. All Cash Account products offer the same benefits and consumer safeguards as reverse mortgages offered by other providers. CHIP (Canadian Home Income Plan) Reverse Mortgage for Seniors The CHIP Reverse Mortgage is available to homeowners in Canada who are age 62 and older. Senior homeowners can access up to $500,000 tax-free. The amount available to the homeowners is based on the appraised value of the home, the age and gender of the homeowners, marital status, property type, and location. The proceeds from the reverse mortgage may be received as a cash lump sum or the homeowner may choose to receive a lesser amount initially and then request subsequent advances on the remaining available amount. The CHIP Reverse Mortgage does not require repayment while the homeowners continue living in the home. Also, the loan amount to be repaid is guaranteed not to exceed the fair market value of the home at the time it is sold, protecting the balance of the senior s estate. Proceeds from the reverse mortgage are received tax-free and are not added to taxable income. Because no payments are required on the reverse mortgage while the homeowners are living in their BenchMark Consulting International 3 Reverse Mortgage Lending June 2007
home, interest is added to the outstanding balance and is compounded semi-annually. The full amount becomes due upon the death of the last surviving spouse, when the home is sold, or when the last surviving spouse moves out. The homeowner may leave the home for up to 12 months before the loan is considered payable - accommodating situations where a senior requires institutionalized medical/nursing home care for a short term. Aging Population The United States population is aging, with 35.9 million people age 65 and older. Statistics show that individuals who reach age 65 have an average life expectancy of 18.2 additional years. Furthermore, by 2030, there will be about 71.5 million people age 65 and older. 4 As a result, the interest level in the reverse mortgage product is on the rise. Seniors may leverage the reverse mortgage product to provide funding for healthcare needs and to maintain their standard of living by tapping into their homes equity while staying in their homes without worrying about payments. Thanks to an average annual long-term home price appreciation of more than 5%, the aggregate free and clear home equity owned by the targeted seniors is estimated at $1.5 to $2 trillion 5. This is a substantial customer base that will attract more lenders into the reverse mortgage business. Growing Reverse Mortgage Volume The primary FHA Home Equity Conversion Mortgage (HECM) is the most popular reverse mortgage product with 90%+ of the reverse mortgage market 6. As illustrated in the next column 7, the growth of this product has been impressive. Fiscal Year End # HECM Loans Closed 2006 76,351 2005 43,131 2004 37,829 2003 18,097 2002 13,049 Source of statistics: HUD Future growth of reverse mortgages will continue at an accelerated rate. The chart below 8 projects outstanding balances based on past growth rate and the aging population. Major Lenders The National Reverse Mortgage Lenders Association ( NRMLA ) attributes the explosive growth in reverse mortgages to several factors including high home appreciation rates which allow seniors to access greater amounts of equity, more lenders offering the product, and greater acceptance of reverse mortgages as a wealth management tool. As previously noted, Home Equity Conversion Mortgage originations jumped 77% in the past year. The growth has been accompanied by an influx of lenders. The NRMLA trade group reported that its membership grew by 35% in 2006, to 500 companies 9. 4 Moulton, Jeffrey. Introduction to Reverse Mortgage. FHA/VA/USDA Government Housing Finance Conference. Washington, DC. May 31 June 1, 2006. 5 Zhai, David H., Ph.D. Reverse Mortgage Securitization: Understanding and Gauging the Risks. Moody s Investor Services. June 2006. 6 Stucki, Barbara. NCOA/Caresource Healthy Aging Briefing Series. 23 February 2006. 7 Year-by-Year Numbers. NRMLA. http://www.nrmlaonline.org/ 8 Moulton, Jeffrey. Introduction to Reverse Mortgage. FHA/VA/USDA Government Housing Finance Conference. Washington, DC. May 31 June 1, 2006. 9 Reverse Mortgage Volume Nearly Doubles From Last Year. NRMLA Press Release. 27 October 2006. BenchMark Consulting International 4 Reverse Mortgage Lending June 2007
For 2007, the leading Home Equity Conversion Mortgage producer is clearly Wells Fargo with other notable volume from Financial Freedom. Wells Fargo & Co. booked 27.1% of total originations in 2007 and second-place Financial Freedom (the IndyMac subsidiary) had a 10.5% share. Seattle Mortgage places third with a 3.2% share and Liberty Reverse Mortgage garnered a 3.0% share. The chart below illustrates the distribution of the top lenders volume. 10 30% 25% 20% 15% 10% 5% 0% 2007 Reverse Mortgage Lending Market Share Wells Fargo Financial Freedom Seattle Mortgage Liberty Reverse Mortgage In April 2007, Bank of America announced it was acquiring the reverse mortgage business of Seattle Mortgage. According to David Rupp, Bank of America Home Equity Executive, We will leverage Seattle Mortgage s industry experience with Bank of America s leading distribution channels to achieve market leadership in this growing area of the financial services marketplace. 11 It appears Wells Fargo will now have additional competition in this space. Servicing Reverse mortgages pose unique servicing challenges. The servicer isn t required to process payments and make collection calls as it does in traditional mortgage transactions. Instead, it has unique responsibilities including monitoring each property s occupancy status (to determine if a maturity event has occurred) and condition, and ensuring that payment of taxes and insurance are 10 www.nrmla.org. February 2007. 11 BofA Buying Seattle s Reverse Mortgage Business. Home Equity Wire. 01 May 2007. current. To protect the collateral, the servicer must also monitor the maintenance of the mortgaged property by the borrower. Risks and Controls As record numbers of senior homeowners use reverse mortgages as part of their retirement planning, the need for comprehensive consumer protection has escalated and been endorsed. Broader understanding of these consumer protection features is responsible for wider acceptance of reverse mortgages, leading to over 900% growth in origination volume from 2001 through 2006. Disadvantages of Reverse Mortgages Consumer Considerations Reverse mortgages tend to be more costly than traditional loans because they are rising-debt loans. The interest is added to the principal loan balance each month. So, the total amount of interest owed increases significantly with time as the interest compounds. Other disadvantages may include: Reverse mortgages also use up all or some of the equity in a home. That leaves fewer assets for the homeowner and his or her heirs Lenders generally charge origination fees, closing costs, and servicing fees. Interest on reverse mortgages isn t deductible on income tax returns until the loan is paid off in part or whole Because homeowners retain title to their home, they remain responsible for taxes, insurance, fuel, maintenance, and other housing expenses. Lender Considerations Mortality, mobility, and price risks are the main drivers of credit risk for reverse mortgages. This is indicated by the unique characteristics of reverse mortgage cash flows. Cash flows available to pay investors depend on two fundamental factors: BenchMark Consulting International 5 Reverse Mortgage Lending June 2007
The timing of the repayment which is triggered by a maturity event The net liquidation value available from the sale of the property to repay the loan A maturity event occurs primarily when the borrowers no longer occupy the underlying property either because they die or move out. The net liquidation value is the sale price of the property net of sales cost and legal expenses. The main risk for a reverse mortgage loan is the delay of repayment due to a later-than-expected maturity event and the lower-than-expected net liquidation value of the property. Even though interest accrues on the loan, the repayment amount may be capped because the amount owed at maturity may exceed the net liquidation value of the property. The price realized upon the sale of the property triggered by a maturity event may be less than expected and, therefore, miss the targeted repayment amount of the loan, causing a loss to the lender. Such a price inadequacy is defined as a price risk. These risks are the main drivers of credit risk for securitized pools of reverse mortgages as well 12. Conclusion For mortgage brokers, mortgage bankers, and consumer bankers it is time to take note of the rising level of interest in the reverse-mortgage product. With an aging population, this product is rapidly gaining momentum and will provide an alternative for tapping into the home equity of seniors to provide a useful financial planning option. For both mortgage and consumer lenders, it is time to take note of the product and carefully evaluate the offering as part of the product suite. Because of the origination and servicing complications, it may be wise to partner with or acquire an experienced firm that understands the intricacies of reverse mortgage lending. Times are changing. Success requires an understanding of the marketplace and the flexibility to adjust to make sure you are adequately meeting your customer s needs. 12 Zhai, David H., Ph.D. Reverse Mortgage Securitization: Understanding and Gauging the Risks. Moody s Investor Services. June 2006 BenchMark Consulting International 6 Reverse Mortgage Lending June 2007
J. Brian King is Senior Vice President and Consumer, Mortgage, and Retail practice manager at BenchMark Consulting International. He has extensive background in mortgage and consumer lending, strategic planning and product development. BenchMark Consulting International has specialized in improving the financial services industry since 1988. The company is a management consulting firm that improves the profitability of its financial services customers through the delivery of management decision-making information and change management services to realize the benefits of business process changes. BenchMark Consulting International s expertise is in the measuring, designing, and managing of operational processes. The firm has worked with 39 of the top 50 (in asset size) commercial banks, all 14 automobile captive finance corporations, several of the largest consumer finance corporations and many regional and community banks throughout the United States. Internationally, BenchMark Consulting International has worked with the five largest Canadian commercial banks, more than 40 European organizations in 11 different countries, in addition to financial institutions in Latin America, Australia and Asia. The company is a wholly owned subsidiary of Fidelity National Information Services, Inc., with clients in more than 50 countries and territories, providing application software, information processing management, outsourcing services and professional IT consulting to the financial services and mortgage industries. BenchMark Consulting International has dual headquarters in Atlanta, Georgia and Munich, Germany. For more information please visit www.benchmarkinternational.com. BenchMark Consulting International 14 Piedmont Center NE, Suite 950 Atlanta, GA 30305 (404) 442-4100 www.benchmarkinternational.com