The first article in this series (see
First Article) indicated that major
changes were needed in the HECM program to a) reduce its
appeal to those with short time horizons looking for the
largest possible immediate “cash-out”, who impose the
largest costs on FHA; and b) to increase its reach to
seniors who need steady financial help to stay in their
homes during their retirement years. The one concrete
proposal directed to this objective, stated in a letter FHA
Commissioner Galante wrote to US Senator Bob Corker, is to
eliminate the fixed-rate standard HECM. This is the option
most used by seniors looking for the maximum cash they can
draw.
However, eliminating the fixed-rate standard HECM would not
eliminate the ability of seniors to use all of their HECM
borrowing power to draw cash. They could continue to do this
with the fixed-rate saver, which is identical except that
the maximum cash withdrawal on the saver is somewhat smaller
while the upfront mortgage insurance premium is largely
eliminated.
Viewed strictly as a way to reduce FHA deficits, elimination
of the fixed-rate standard while leaving the fixed-rate
saver, makes no sense. If the first is a loser for FHA, so
is the second. While the saver loans are smaller and
therefore expected losses are smaller, the insurance
premiums on the saver are correspondingly smaller. The only
financial benefit to FHA would occur from seniors who,
because the fixed-rate standard is no longer available,
elect to drop out altogether.
I would not expect many dropouts because the options
remaining are far more attractive than anything else
available to financially strapped seniors. Borrowers looking
for the maximum cash draw can switch not only into the
fixed-rate saver, but also into the adjustable rate
standard, which would allow them to draw more than on the
fixed-rate saver. I doubt that the risk of rising interest
rates would offset the attraction of larger cash draws.
If every borrower looking for the maximum cash draw who is
shut out of the standard fixed-rate HECM swings to either
the saver fixed-rate HECM, or to the standard
adjustable-rate HECM, the expected impact on FHA’s net
income would be zero. Indeed, it could be even worse if --as
seems very likely -- cash-out adjustable rate HECMs pose a
greater risk of loss to FHA than cash-out fixed-rate HECMs.
HUD/FHA are certainly aware of this. It is clear from the
tone of the Galante letter that the agency is looking into
other changes in the HECM program that may be needed to
protect FHA’s insurance reserve. Since we don’t know what
these other changes are, I will take the opportunity to
indicate what I believe they ought to be.
The way to strengthen FHA’s finances is to eliminate adverse
selection. HECM borrowers are not a cross-section of senior
homeowners, rather a disproportionate number are bad risks
who won’t properly maintain their properties and will
default on their property taxes.
Eliminating adverse selection means discouraging those who
are the greatest risks, and encouraging those who are the
smallest risks. The risk imposed on FHA by HECM borrowers is
highly correlated with the time horizon of the borrower. The
greatest risk is posed by those with short horizons who are
looking to draw the largest amount of cash allowed. The best
way to get rid of them is to limit cash withdrawals in the
early years – under all HECM programs.
One possibility would be to limit cash withdrawals to 20% of
what would now be the maximum cash withdrawal, in each of
the first 3 years. This might be subject to specified
exceptions based on the uses of the funds drawn. One such
exception could be seniors who use a HECM to purchase a
house, based on the premise that home buyers constitute a
relatively low risk group. Another possible exception would
be the use of a HECM to pay off the balance on a standard
mortgage.
FHA has the data to determine whether or not these and
perhaps other groups have sufficiently low default rates on
property taxes and insurance that they deserve to be exempt
from limits on the size of cash draws.
The restriction of cash withdrawals would be much more
palatable if it were combined with a provision to allow
combinations of fixed-rate and adjustable rate programs. It
makes good sense to allow seniors to select a fixed rate on
the cash they draw, and an adjustable rate on what they will
draw in the future.
Reducing adverse selection is actually the easy part of the
challenge facing HUD/FHA. The greater challenge is
increasing favorable selection by encouraging seniors with
long time horizons to participate in the HECM program. It is
important not only for making the program self-supporting,
but also as a way of redeeming the purpose of the program,
which is to help senior homeowners finance their retirement.
This is the subject of next week’s article.