Tuesday, September 21, 2010

Reversal of Fortune

If we needed more evidence that we are living in a truly upside-down world, our suspicions would be confirmed by a small paragraph in the September 20, MAA newsletter--the grassroots newsletter of the Mortgage Banker's Association.  "On Tuesday, September 14, 2010, MBA attended a meeting hosted by Vicki Bott, Deputy Assistant Secretary for Single Family Programs, HUD, to strategize with mortgage servicers and housing counselors on ways to resolve tax and insurance advances made by servicers on behalf of borrowers of home equity conversion mortgages.  HUD will be issuing a mortgagee letter on how to handle these tax and insurance defaults within the next thirty days.  The meeting follows a report by the office of Inspector General highlighting the estimated 13,000 tax and insurance defaults."

For anyone unfamiliar with the term, the home equity conversion mortgage, more commonly called a reverse mortgage, is a loan which allows a home owner of over 62 years of age to borrow the equity out of his house as either a lump sum or in monthly payments, similar to an annuity. The amount of the loan is low in comparison to the value of the home because the borrower does not make any payments on the loan for as long as he or she lives in the house.  Borrowers do not qualify for this type of loan based on credit or income since they will not make any payments on it.  Rather, the entire qualification is based strictly on the value of the house and the age of the borrower. 

Reverse mortgages are an FHA product which means that FHA guarantees them.  Since I have never done FHA loans, I have never worked with reverse mortgages, but when the product was first introduced about 10 years ago I did attend a number of workshops on them.  The average reverse mortgage borrower (and target audience for this product) was a 72 year old widow who lived an average of 7 years after getting the loan.  The payments from the mortgage were supposed to supplement Social Security to make it easier for seniors to stay in their own homes while also paying for medication and meeting other living expenses.  After the borrower died, the heirs could reclaim the home by paying off the mortgage, or they could sell the home, pay the mortgage and keep the difference between the sales price and what was owed, or if they chose, they could leave the keys to the house in the mailbox and let the bank deal with the property.  Reverse mortgages were touted as great products to help seniors live better lives and ideal financial instruments for people who did not have heirs.  The only way that the loan became due and payable during the lifetime of the homeowner was if he or she had to go into an assisted living facility for more than one year.  In the case of a married couple, the spouse in better health could remain in the home and the note would not become due unless both of them went into an assisted living facility.

When reverse mortgages were introduced, they required mandatory counseling for the seniors on the benefits and responsibilities of this type of mortgage.  And that counseling was very important because although borrowers do not make any payments on the home loan, they are responsible for paying the taxes and insurance on the home.  To fail to do so places the loan in default.  But a homeowner who received his equity in a lump sum payment and spent the money may not have the funds to pay the taxes and the insurance on the house, and therefore, may ignore these two responsibilities.

Enter the Office of the Inspector General whose August 25, 2010 summary of Audit Report 2010-FW-0003 is posted on HUD's website.  According to the report, "We performed an internal audit of the U.S. Department of Housing and Urban Development's (HUD) Home Equity Conversion Mortgage (HECM) program because we found that an increasing number of borrowers had not paid  taxes or home owner's insurance premiums as required, thus placing the loan in default.  Also, we noted that HUD had granted foreclosure deferrals routinely on defaulted loans, but it had no formal procedures."  In other words, HUD had an informal policy to not foreclose on seniors with reverse mortgages, and no formal policies and procedures for how to handle tax and insurance defaults.  So, as seniors stopped paying the taxes and insurance on their houses, the mortgage companies who were servicing the loans paid the insurance and tax bills for them, but they did not bother to notify HUD.  As a result, the audit found four servicers (banks holding reverse mortgage notes) with 13,000 mortgage loans which had defaulted on their taxes and insurance.  The maximum possible losses of these loans are estimated to be $2.5 billion.  According to the audit, two of the four servicers stated that they were waiting for HUD to tell them how to deal with this problem, and in the meantime, these lenders had paid more than $35 million in taxes and insurance for the 12,958 delinquent homeowners.

Since HUD does not have a tracking system for borrowers who have defaulted on taxes and insurance, they do not have any way of measuring how many loan balances are actually increasing because the lender is adding the taxes and the insurance to the original loan amounts.  The inspector general audited loans from only four of the 16 companies that service HUD reverse mortgage loans, so the real extent of the problem is still not known, but the report reveals that if the 7,673 defaults that HUD was aware of and and the 12958 loans that HUD was not aware of all land in foreclosure, the potential cost to HUD, and ultimately the taxpayers, will be $1.4 billion.

The Inspector General's recommendation is that HUD stop deferring foreclosures for seniors behind on their tax and insurance payments and that they issue formal guidance to their 16 servicers about how to handle defaults.  They also recommend that HUD develops a plan to implement a tracking system so that HUD will be aware of defaults when they occur, and that they set up a plan to minimize the risk of defaults.

All of this means that we are going to see a lot more seniors getting foreclosed on, which is going to be a public relations nightmare for the servicers and also for HUD.  The media is going to have a field day with  photos of grandma and grandpa being kicked out of their homes because they can't pay the taxes and insurance, and a plethora of foreclosures is going to give a lot of bad publicity to a program that encouraged seniors to tap into the equity in their homes so that they could have a better standard of living in their golden years.  In one of the great ironies of our time, we will see the banks taking the homes of older Americans who were told that they would never have to make a payment on their loan.  Amazing!


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