Many are surprised to learn that the 100th U.S. Congress initiated the modern reverse mortgage through the Housing and Community Development Act of 1987, which President Ronald Reagan signed in February 1988.
Congress tasked the Federal Housing Administration (FHA) with designing a reverse mortgage that would protect older homeowners while also encouraging lending in the private sector.
In December 1988, the Department of Housing and Urban Development (HUD) published a notice asking potential mortgage lenders to participate in a demonstration program that would “insure up to 2,500 reverse mortgages on the homes of elderly homeowners, enabling them to turn their equity into cash.”
Through the Home Equity Conversion Mortgage (HECM) Insurance Demonstration, the modern reverse mortgage was born.
How FHA Insurance Works
The FHA addressed the need to protect both the homeowner and the lender by modifying its existing mortgage insurance program to accommodate reverse mortgage lending. Understanding how the FHA operates in traditional lending provides a helpful comparison.
Created in 1934 as part of the National Housing Act, the FHA provides mortgage insurance on loans made by FHA-approved lenders throughout the United States and its territories. The FHA insures mortgages on single-family and multifamily homes, including manufactured homes and hospitals. In 1965, the FHA became part of HUD.
At the height of the Great Depression, Congress and President Franklin Roosevelt created an incentive for lenders to provide financing to certain higher-risk borrowers by protecting lenders against loss. FHA insurance premiums were assessed on these loans and used to fund that protection.
With traditional FHA loans, homeowners pay upfront and monthly insurance premiums. These premiums protect lenders against losses if a homeowner defaults. FHA lenders bear less risk because the FHA may pay a claim to the lender following a homeowner’s default.
To qualify for FHA insurance protection, loans must meet specific requirements established by the FHA.¹
Adapting FHA Insurance to Reverse Mortgages
Insurance is based on the participation of many people to cover the losses of a few. In other words, participants pool funds by paying premiums, transferring a portion of the risk to the insurance provider.
The HECM program adopted the FHA insurance concept but modified it to accommodate the needs of reverse mortgage lending:
Insurance premiums are not paid monthly. Instead, they are added to the loan balance.
The homeowner or the homeowner’s estate is released from liability if the loan balance exceeds the home’s value.
If the home’s value does not cover the loan balance, the lender is protected by FHA insurance.
The resulting HECM program, which includes FHA insurance, is designed to encourage lenders to provide loan proceeds while protecting them if circumstances do not unfold as anticipated.
The HECM also protects homeowners and their estates if the loan balance grows beyond the value of the home. Its consumer safeguards are substantial and have continued to evolve to protect both individual borrowers and taxpayers.
Unfortunately, these HECM consumer protections are sometimes overlooked by the financial press and by financial advisers upon whom many Americans rely for information about their retirement options.
Addressing Weaknesses in the Program
Despite HUD’s continued efforts to refine the program, weaknesses emerged over time.
During the housing bubble years, HECMs were sometimes used to address financial situations that were already unsustainable. Some borrowers did not take seriously the requirement to remain current on their property taxes and homeowners insurance.
In other cases, younger spouses who were not listed on the property title were displaced when the borrower died. Some borrowers also used the HECM irresponsibly by withdrawing their entire initial credit limit at closing, leaving no cushion if home values declined.
These were serious problems that jeopardized both the program and its reputation.
In response, the 113th Congress passed the Reverse Mortgage Stabilization Act of 2013. The law was enacted to provide additional protections for non-borrowing spouses and to help restore the financial health of the FHA Mutual Mortgage Insurance Fund.
The HECM program’s insurance pool was intended to be self-sustaining, not a taxpayer bailout. However, when the housing bubble collapsed, the fund’s solvency was placed in jeopardy. HUD responded by changing its lending standards, and the HECM program was significantly revised. As a result, the fund’s financial strength began to improve.²
Additional Consumer Protections
Financial assessments are now part of the HECM loan approval process.
To reduce the likelihood of property tax and homeowners insurance defaults, formulas are used to determine whether a portion of the borrower’s available equity must be set aside to cover these expenses. These set-asides may be required when borrowers cannot demonstrate the willingness or financial capacity to meet their basic housing obligations.
Additional protections include:
Limits on how much equity borrowers can access during the early stages of the loan
Financial assessments designed to determine whether borrowers can meet their ongoing housing obligations
Set-asides for property taxes and homeowners insurance when required
Non-borrowing spouse provisions that may allow an eligible younger spouse who is not old enough to borrow to remain in the home after the borrowing spouse dies
A Program That Continues to Evolve
Rather than being a fraudulent scheme designed to take advantage of older homeowners, the modern reverse mortgage, also known as the HECM, is a program established by the United States government.
As former FHA Commissioner Brian Montgomery has said, the HECM is the “law of the land.”
Admittedly, the HECM program was not perfect at its inception. Like many financial products, however, it has evolved. HUD continues to refine the program to strengthen consumer protections and improve risk management for the FHA insurance fund.
A reverse mortgage is neither inherently good nor bad. Its value depends on how the borrower uses it.
Notes
Information about FHA program requirements and history is available through the U.S. Department of Housing and Urban Development.
The original article cited an archived Reverse Review resource concerning the HECM program and the FHA Mutual Mortgage Insurance Fund.