Will HUD Rejuvenate the HECM Program?
This is a revised version of an article posted
earlier this month. That article over-stated the importance
of HUD’s requirement that the HECM be a stand-alone product,
as opposed to being part of an integrated retirement plan.
The intent of FHA Mortgagee Letter 2008-24, which bars HECM
lenders from “involvement with any other financial or
insurance product,” is to prevent collusion between lenders
and insurers at the borrower’s expense, which it does.
However, it does not bar a reverse mortgage borrower from
using the proceeds to purchase an annuity.
On the other hand, the HUD rule that limits the
size of the initial cash draw has the effect of reducing the
size of the annuity that is purchasable with the HECM, and
with it the amount of spendable funds that the borrower can
draw over her life. This is explained further below.
Synergy Between HECMs and Annuities
The mortality-sharing feature of annuities allows
retirees taking a HECM to draw larger amounts over their
lifetimes if they combine it properly with an annuity. This
would be particularly valuable for house-rich/cash/poor
retirees who have negligible financial assets.
Chart 1 applies to a retiree of 63 who owns a
$700,000 house but no financial assets. He draws a HECM
credit line and uses a portion of it to purchase an annuity
on which payments will begin after 10 years and grow at 2% a
year. The balance of the line is used for monthly draws
during the first 10 years, also growing at 2% a year, [Note:
The math underlying the seamless transition from HECM draws
to annuity payments was developed by my colleague Allan
Redstone.]
The horizontal line in Chart 1 is the highest HECM
tenure payment quoted by any of the lenders who report their
prices to my web site. Tenure payments are for a fixed
amount and cease if the borrower moves out of the house.
With a stand-alone HECM, this is the best the retiree could
do. The HECM/annuity combination can escalate, it is 2% a
year in the example, and it runs for life.
The higher of the two upward-sloping lines is based
on the best annuity price quoted by a network of carriers
who offer deferred annuities, to which I have access. The
lower line is based on the lowest price of the carriers in
the network, though there could be others with even lower
prices.
Stand-Alone HECMs Have Excessive Loss Rates
Current HECM losses are much higher than they would
be if HECMs were integrated into retirement plans.
The program has been subjected to a great deal of
bad publicity, for reasons I can’t explain, but the effect
has been to subject it to adverse selection. The HECM client
pool has been heavily weighted by borrowers with low credit
scores, many in desperate financial condition, who turn to a
HECM as their last resort. Many such borrowers fail to pay
their property taxes and maintain their properties in good
condition.
HECMs that are integrated with asset management and
annuities into comprehensive retirement plans are likely to
draw borrowers with better payment habits. Further, a
borrower who obtains a rising payment for life is better
positioned to meet home ownership charges than those who
exhaust their HECM borrowing capacity in the first few
years.
The
Maximum Initial Cash Draw Amount Is Counter-Productive
The intent is to discourage borrowers from drawing
as much as possible, without regard to future needs. But
forcing a compulsive spender with a life expectancy of 20-40
years to delay drawing funds for a year is unlikely to
prevent her from defaulting on her property taxes 10 years
later. In contrast, the same requirement on a borrower who
is purchasing an annuity has a major impact because it will
reduce spendable funds for the rest of her life.
This is illustrated in Chart 2, which covers the
same retiree as Chart 1. The higher line is based on an
annuity deferred 5 years, which is the optimal period for
this borrower. But the price of this annuity exceeds the HUD
limit. The lower line, based on a deferment period of 9
years, is the best available that meets the HUD limit.
Concluding Comment
HUD could fix the problem by removing the maximum
first year draw in cases when the borrower states that they
intend to purchase a lifetime annuity with the proceeds.
Disclosure
The writer has been developing a retirement
planning program, called the Retirement Funds Integratortm,
a segment of which is directed to the house rich/cash poor
retirees discussed above. We call it the “Enhanced HECM”tm,
and it will become operational shortly. It marries HECMs
with deferred annuities in the way described earlier, and it
provides competitively determined annuity and HECM prices.
However, in conformity with the stand-alone rule, the
program shields the lender from any involvement with the
annuity.
