Monday, May 28, 2007

Reverse Mortgages: An UberNerditorial

by Tanta on 5/28/2007 08:45:00 AM

I’ve never written about reverse mortgages before on this blog, in part because they aren’t usually included in the category of “toxic” mortgages. Reverse mortgages are most assuredly weird, compared to your bog-standard “forward” mortgage, and “exotic” might apply, but they aren’t “toxic” in the same way that interest only, negative amortization, and “exploding” ARMs are. I can imagine reverse mortgages becoming toxic, however, and that should concern us all. The toxicity of the IOs and OAs, for instance, is largely a matter of a product that made some required daily allowance of sense when it was offered to a highly affluent and financially stable borrower class, but that indeed became worrisome as a “middle market” mania and an outright horror as an “affordability” boost. In that sense, the claim of lenders that these are “good products” that have been misused by “bad lenders” has some truth to it, although I for one find the term “good product” disingenuous and the idea that it has been misused only by the lowest of the bottom-feeders risible.

Reverse mortgages, as they currently exist, are limited to a highly specific borrower class, which happens, not coincidentally, to be a highly vulnerable one. Unlike the other exotics, it’s not in danger of becoming predatory because it might migrate from the well-heeled to the down-at-the-heel. I’d be more worried about it becoming a target for low-skill, high-margin, under-regulated originators and brokers who think they are selling a certain “service.” The last thing you can say about the reverse mortgage target borrower class is that it can be expected to be 1) more sophisticated than anyone else and 2) “busy” enough to gain anything from an “efficient” service that trades money for time. “Buyer beware” is not an assumption on which you can safely originate reverse mortgages. They are also much more expensive to originate and service than any “forward” mortgage, which means they won’t become fully “cost-effective” until we’ve made so many of them that we can become efficient at it, which will be too damned late if it turns out to be a kind of financing that ought to have stayed expensive. But that idea won’t make any sense at all until you understand what they are.

Reverse mortgages are truly Different. They are really the first mortgage product that was “engineered” for a highly specific borrower and situation. That borrower is of retirement age or older, is on a fixed and low-to-moderate income, and is the owner of a free-and-clear home. “House rich and cash poor” sums it up. Most importantly, this borrower wishes to remain in his or her home, but struggles to do so given limited income and the escalating costs of taxes, insurance, maintenance and repair on a property that no longer carries mortgage debt. You might get one or two golfin’ grannies who really just want to buy tickets to the next AARP cruise or blow it all in Vegas, but mostly you get elderly Social Security recipients whose property tax bill, thanks to the “unqualified buyer auction” that life has become lately, is too expensive on a fixed income.

The Fannie Mae reverse mortgage is actually called the “Home Keeper,” and that really does hit the major issue: these borrowers do not wish to sell their homes to realize their equity in cash, nor do they necessarily want to do “home improvements” beyond maintenance or, possibly, retrofitting for safety or accessibility. They want to be able to tap into equity for the purpose of simply staying where they are, physically and financially. They are not looking to leverage the purchase of a home with debt; they did that 30 or more years ago and paid the thing off like they were supposed to. They “built the wealth” everyone keeps talking about, and now they have to deal with what it costs in actual cash-flow-type money to hang onto that “wealth,” which these borrowers, in their unsurprisingly old-fashioned point of view, keep thinking of as “where they live” instead of “capital gains.” The reverse mortgage is not something that these “savvy” boomers who took out a 40-year Option ARM at the age of 52 to buy the big house with the media room are ever going to have to worry about getting, I suspect.

The FHA version of the reverse mortgage, the original one, is called the Home Equity Conversion Mortgage, or HECM (which, unfortunately, is universally pronounced “Heck ‘em”). That leads a fair number of people to confuse it with a HELOC or Home Equity Line of Credit. It isn’t at all the same thing. The reason that a “forward” mortgage like a conventional closed-end refinance or a HELOC is not a good option for these borrowers is that such loans require repayment during their terms, and the fixed-income borrowers could probably handle their housing expense already if they could handle the payments on a normal mortgage. Also, a “payable” mortgage runs the risk for these borrowers that if they cannot make periodic payments before maturity of the loan, they can lose their homes via foreclosure. Certainly, any borrower who can handle a “forward” mortgage ought to get one, since they’re much cheaper.

What the reverse mortgage “reverses” is who pays whom when. The reverse mortgage places a lien on the property, as any mortgage does, that begins with no balance (beyond closing costs and fees, which are substantial, and possibly an initial disbursement), like a HELOC does. The borrower receives disbursements of funds on an annuity-like schedule or on request like a line of credit, and interest accrues on the cumulative balance. There the similarity to a HELOC ends, because the reverse mortgage is “due and payable” only on the borrower’s death, the voluntary sale of the home, or the borrower’s failure to occupy the home as a principal residence. A “forward” mortgage has a “maturity date”; a reverse mortgage has a “maturity event.” The only “event of default” that can trigger foreclosure is the borrower’s inability or unwillingness to continue to maintain the property at minimally acceptable standards or keep the taxes and insurance current. When a “maturity event” occurs, the lender is repaid from the proceeds of the sale of the home, with any proceeds over the full amount of the debt due to the borrower or estate.

The reverse mortgage obviously has some similarity to the negative amortization mortgage, since all accruals of interest and fees are added to the outstanding mortgage balance. A major difference is that while disbursements to the borrower will stop when the contractual maximum principal limit of the loan is reached, interest continues to accrue without limitation on the outstanding total balance until the “maturity event.” However, reverse mortgages cannot be “upside down” by definition: the borrower or estate never owes more than the current appraised value of the property to the lender, regardless of loan balance outstanding. The lender accepts either sales proceeds equal to the appraised value or a deed-in-lieu (i.e., the lender accepts title to the property as repayment of the debt), even if the accrued interest has long exceeded the value of the property. There is never “recourse” to other assets of the borrower or estate. The lender’s risk is “actuarial”: if Grannie lives to be 105, Fannie writes off a lot of interest income if Grannie’s house price appreciation didn’t keep up with Grannie’s longevity. Of all the many, many things to cherish about those tough old birds, the idea of them blowing a mortgage lender’s balance sheet to kingdom come just by getting up every morning has to appeal to you. It has a tendency to annoy Grannie’s heirs, but we’ll get to that.

Calculating the maximum principal amount that can be borrowed is very complex, and HUD and Fannie Mae provide special software that must be used. The programs are half negative amortization schedules and half actuarial tables. The amount that can be borrowed crucially depends not just on the appraised value of the property, but on the age of the borrower, number of borrowers, and disbursement plan selected. The younger the youngest borrower (with a minimum age of 62), the less principal that can be borrowed; the more the property is worth, the more principal that can be borrowed. All calculations take into account “scheduled” rather than “potential” negative amortization. (These loans can be prepaid in whole or in part, but it is assumed that they won’t be; any “payment” at all of principal or interest on a reverse mortgage is a “prepayment.”)

It has exactly nothing to do with the borrower’s income, other assets, or credit history, which are not considered. This is purely a “collateral-dependent” loan, with no expectation of repayment from income or other assets—that’s the point of it all—and therefore no consideration of those things as “qualification” for the loan. Certainly the suitability of a reverse mortgage for a given borrower has to depend on what that borrower’s other resources are. But there’s the big deal about reverse mortgages: they both raise the issue of predation and neatly knee-cap all the self-serving slogans of the predators who have no time for the idea of “fiduciary duty.” You can, in a sense, only “qualify” for a reverse mortgage to the extent that it is “suitable” for you. Nobody offers a “stated birth certificate” or “stated property inspection” reverse mortgage. Everybody requires extensive “homebuyer counseling,” part of which is to assure that the mortgage can do what the borrower wants or expects it to do.

What does that mean? Well, if you are 62 and female, your home is older, smaller, less desirably located and more “functionally obsolescent” than the average existing home, and your current income is both fixed and inadequate to carry the property while still allowing you to eat, a reverse mortgage isn’t likely to do you much good for very long. You may not be able to borrow enough to keep you going for the next twenty years, absent some meaningful changes to the way cost of living adjustments are made to Social Security and the way taxing authorities and insurance regulators might cap inflation for elderly homeowners. Alternately, if you are a 90-year-old male and your house has four walls and a roof, you can probably borrow enough to have a damned good time in Vegas, and as long as you are deemed competent to execute contracts in a court of law, nobody can stop you. “Suitability” in this context is not a moral judgment on what 90-year-olds have the right to do with their “wealth” if they damned well feel like it. It is a question of “making the loan work” in a way that is, truly, the reverse of the way the predators approach “forward” mortgages.

The Comptroller of our Currency observed the other day that it’s funny how lenders claim that verification of income “doesn’t matter” until they have to make a foreclosure versus workout decision; then, all of a sudden, the first thing they want to do is verify income. If you want to know how much lenders really believe in endless, faster-than-non-housing-inflation house price appreciation, go ask what a reverse mortgage lender will lend to a recent retiree. Turns out they weren’t really drunk, they were just acting like drunks.

There are largely two groups of folks who are worried about reverse mortgages. The first group is the sort of party pooper who thinks that if a 28-year-old college graduate can’t spot the problem with a “free money” pitch, or read a Truth-in-Lending disclosure or promissory note with sufficient comprehension get the part about how much it actually costs, your great aunt Euelna, who talks to dead people, owns 47 cats, and has too many cataracts to be able to see the note, let alone read its fine print, is maybe not going to “beware” of a reverse mortgage. You can bloviate about the “free market” all day long, but nobody is going to let you throw great aunt Euelna to the wolves, so save your breath.

Group number two provides the real amusement value. These are the “heirs” who blow a gasket when they find out that Grannie and Fannie between ‘em cooked up a plan to spend that “wealth” that Grannie built up with the magic of homeownership, and not on presents for the grandkiddies. Those who natter on about “wealth building” via homeownership in the context of justifying insane leverage aren’t, actually, the ones that really make me want to pull my hair out. It’s the ones who natter on about “intergenerational wealth building,” particularly when accompanied by the acknowledgement that housing is “the only way the poor can build wealth.” If the best many hard-working honest decent people have ever been able to do is end up house rich and cash poor, with the regrettably poor taste to do so while they’re still alive and “consuming,” then what, realistically, is there going to be to bequeath?

My own grandmother’s home netted enough at the estate sale, after expenses, to reimburse each of her six children’s share of the taxes, insurance, repairs, maintenance, and replaced lawnmowers and appliances they’d all ponied up for over the years, reverse mortgages not having been available back then and my family not being the sort who would have allowed it, anyway. Certainly no one in any generation wanted to actually live in a small one-bathroom three-bedroom 60-year-old two-story with a single carport and gravel drive. And formica countertops, well-used (the old girl could cook). Even allowing for the sentimental value and the recently reshingled roof. I am aware that my family might have been the last one in America to have experienced upward mobility between generations, but that’s the point, isn’t it? A family who had been counting on receiving “wealth” after probate would have been sorely disappointed. Heirs who made sure the property stayed "free and clear" by dutifully helping to support the elderly relative did not "inherit wealth," they got "paid back."

Reverse mortgages have to be heavily regulated. There really can be no serious argument against that. But the preoccupations of this blog are many. There is how debt-booms substitute for disposable income (the MEW problem). How housing “assets” do get marked to market (the RE bust problem). How we got such an excess inventory of housing units (the resource allocation problem). Given all that, it’s a good time to think about where this reverse mortgage thing is going before it gets there. This time around. So here are your facts:

1. People who keep getting older.
2. Houses that keep getting older, one-third of which are currently owned free and clear.
3. Medicare, prescription drugs, cat food, and everything else old folks don’t stop consuming.
4. 401(k)s with stocks and bonds in them. “Pensions” of course no longer appear on the list of “facts.”
5. A whole bunch of subprime and Alt-A and home improvement mortgage market participants who are or are about to be out of work, but not yet ready to retire, even if you are.
6. “The next big thing.”

If the “fixing up Social Security” and “death tax” fiascos have proven anything, it is that 1) it is harder to mess with old people than is often thought by those who haven’t been around that block yet and 2) there are a lot of people who stand to profit off of messing with old people and 3) don’t be stupid. Of course we’re going to borrow our way out of the problem. The question is how we’re going to do that. If you really think the tedious details of mortgage market regulation have nothing to do with the big economic picture, you’re a couple of recession bars short of a good CR chart.

If that didn’t give you people, young and old, something to argue about in the comments, I really will quit blogging.

Coda, for this Memorial Day: Tanta’s grandma’s house was built, in part, by the love of Tanta’s grandma’s life, a man who volunteered for service in WWII. He had to; he was too old for the draft. He lost most of his hearing on his tour of duty, but came back, with the recipe for SOS that Tanta still uses to this day. “Euelna” was a neighbor of grandma’s, a founding member of the local chapter of the Air Force Mothers Club. The dead people she talked to included her son, who returned from Vietnam in the wrong part of the transport plane. There were giants in the earth, in those days.

And there are giants still. I want them to have a home to come back to. I want them to come back. Now.