OntheWilderSide

I spent a dozen years in private practice as an attorney.  During that time, I was engaged in residential real estate.  It is a pleasant practice, helping people buy the home they want.  I especially enjoyed working with first-time  home-buyers.  It was gratifying to guide people through the financial and legal paths to their goal.  I don’t claim to have any exceptional financial savvy.  I merely had the benefit of seeing the same transaction of home purchasing in innumerable different circumstances.

Helplessly Hoping

I would say around 2007, I became concerned about patterns I saw developing in the housing market.  I tried to warn my clients, but it is human nature to expect good times to last forever and bad ones to pass quickly. Unfortunately, neither is axiomatic.   In fairness,  I do not know if I came across as having any more of an authority than the pollyanna media of the time.  I had, and still have, no impressive financial credentials to burnish my observations.

I watched as home prices rose meteorically.  Builders’ profits increased 10-fold.

In fact, home prices were changing so fast that finance insurance rules were changed to account for the equity windfalls.  A slightly arcane example about this rule change will illustrate my point.  When a home had been purchased with less than 20% down, the homeowner was required  to purchase what is called Purchase Mortgage Insurance (PMI).  The PMI required monthly payments in addition to the mortgage payments until the homeowner paid down the principal of the  mortgage so that the equity of the house exceeded 20%.  PMI provides assurance to the lender that they could get their full loan back when the amount they loaned is too close to the value of the home. On a 3% down 30 year loan, it could take a decade to pay down the principal of a homeowner’s loan by 17% to reach 20% equity, and be free of additional PMI payments .   The slow pay-down of principal (17% principal pay down over the first 1/3 of the loan period) is caused by the design of mortgage amortization schedules where  early payments are mostly interest and very little principal.

The flaw that had existed in this PMI system is that the homeowner was allowed to request an appraisal at any time to determine if their equity exceeded 20%.  With home prices rising quickly, the equity increased to 20% by appreciation rather than principal payment.  So the mortgage insurers changed the rules so that the value of the home at closing was locked in as the method for determining the amount of equity.  This meant a homeowner could only reach 20%   paying down the principal of the loan.  This change in rules shows that someone in the insurance companies had the foresight to see the possibility of the coming downturn, and hedge against it.  Amazing that the banks and their regulators did not see the same signs.

Though I had not practiced law in the 1980s, I saw the remnants of that real estate crash because in the 1990s I had a hand in tying up the details of residential and commercial property that had either been sold at a loss or had been lost to the bank.  This was before modifications and short sales became an everyday occurrence.  With the knowledge of the prior fall, and the pain it caused, I imagined that the more recent real estate market could be subject to the same gravitational forces.

My concern was reinforced by the first hand knowledge of the weak foundation this real estate boom was being built upon.  Exotic loan products — who should have been so rare they existed in a zoo — instead became household pets.  106% loans with the first 2 years of interest only payments (and then an adjustable rate for the next 28) became the norm.

Or even worse, pick-a-payment negative amortization loans that allowed the homeowner to stay current while increasing the principal owed to the bank. Such products were designed for people with high earnings that were structured in an unconventional manner. The classic example was a saleswoman who made a low base salary throughout the year but earned a sales bonus at the end of the year that more than doubled her salary. It was expected that she could use the bonus to dig deep into principal owed.  These loans were never meant for the weekly paycheck earner who could just afford the interest-only payment.  If the average home-buyer asked about what they would do in 2 years when the payments shot up, they would be told by mortgage brokers that the house would appreciate so much that they could just refinance out of the loan.

In hindsight, the purpose of our economy has changed from wealth creation to wealth extraction.  Homes were never supposed to be investment vehicles.  Homes are supposed to be an asset we can use while increasing our equity, a long-term savings account.  We have colonized ourselves.   Our banks have extracted the value from our homes, and transferred the wealth to Wall Street.

Deja Vu

And I fear that the colonization continues.  The elderly often have sizable equity in their homes after paying down their forward mortgage for decades.   Enter the reverse mortgage, which are available for homeowners over age 62.  With a forward mortgage, the homeowner writes a check every month to pay off the amount borrowed.  With a reverse mortgage, the amount borrowed is paid back by the bank claiming an additional part of the equity monthly. The reverse mortgage must be paid back when the mortgaging homeowner no longer resides at the residence.   The need for the bank to be able to tap into the equity means that the home cannot be encumbered by a mortgage, or any other lien, to obtain a reverse mortgage.    It also means that homeowners with insufficient equity are unable to take out a reverse mortgage.

Now I will be the first to admit that today’s reverse mortgage is not your father’s reverse mortgage.  No one will be thrown out of their house because their reverse mortgage has risen above their home value.  In order to cover this risk, the government has become the sole institution to guarantee the reverse mortgages given through private banks.  All the private guarantors have left the reverse mortgage market.  This government guarantee program is known as Home Equity Conversion Mortgage (HECM).  The need for our tax dollars to be the sole protection for reverse mortgage lenders makes me question this mortgage programs’ viability.  (It reminds me of how we have hidden the crushing costs that make nuclear energy untenable by having the government as sole guarantor and insurer.)

Looking at  whether reverse mortgages are the best option for seniors one is still left with the question of whether wouldn’t it be better to downsize a home to have the full benefit of their equity rather than liquidating hard-earned equity into interest on a bank loan.

[youtube=http://www.youtube.com/watch?v=bkg8IH7e_6U]

There are still many other issues left with the HECM program.  Reverse mortgages do not account for the taxes, insurance and maintenance costs of keeping a home.    Technical issues arise if the homeowner has to leave the home for outside care, or if the spouse remaining behind in the home is not on the reverse mortgage.  These issues are supposed to be assuaged by the HECM program requiring a US H0using and Urban Development (HUD)-approved “counselor” to meet with the homeowner before a loan is written.  (I would like to adopt the idea of requiring counseling prior to taking out a mortgage for all government-backed forward mortgages.  Statistics show that homeowners with first-time homeowner counseling are less likely to default on their mortgages.)  Unfortunately in the case of reverse mortgages, I have to put the term “counselor” in quotes.  All the “counselor” is allowed to do is  provide educational material, which can be tailored to the particular circumstances. And the “counselor” does have to test for understanding of the general concepts of the materials. Yet the “counselor” has forbidden from actually counseling.   If a HECM counselor expresses an opinion or shares their experiences, their certification will be revoked and their agency will be in trouble with HUD.

As the profit-taking of the forward mortgage industry has been greatly reduced by the economic collapse they caused, there is increased pressure by the banks to make the reverse mortgage market work like — well — the disastrous pre-collapse sub-prime market.   One of the strengths of the government-backed reverse mortgage market was that it was literally one-size fits all.  No matter what bank you went to, you got the same exact mortgage.

Now there is the type of loan differentiate that existed during the sub-prime escalation.  The reason for the differentiation is clear.  Reverse mortgages originally had high upfront costs which properly discouraged many homeowners from taking them out.  The banks have not reduced those costs.  They have just hidden those costs in new loans by reducing the overall funds available to the homeowners.

With the increase in volume of reverse mortgages, the banks do not want to hold the mortgages.  They are pushing to adopt the worst attribute of the sub-prime casino — securitization.  This means that there no longer is any connection between the homeowner and their bank.  The loan is sliced and diced into an investment vehicle with piles of other reverse mortgages and is sold on Wall Street.  Not only doesn’t a homeowner with a securitized loan have a person to talk to, they don’t even know what faceless corporate entity holds their loan.   Securitization also greatly increases the risk on the bank side by de-linking the people who make the loans from the people who ultimately hold the loans.   Securitization is the cancer that killed the modern-day George Bailey.

I am not claiming that reverse mortgages are being written on the same order that sub-prime mortgages were written, but the general increase in number of reverse mortgages (and their sub-prime worthy differentiation and securitization) are cause for concern.  According to HUD, the high point of reverse mortgages was 2008.  Though the volume has decreased with the economic crisis, the 73,000  loans written in 2011 is still 10 times the 7,000 written in 2001.

To put it in perspective though, the amount of reverse mortgages given is still only 9% of the average number of the 800,000 sub-prime mortgages given annually during their heyday, a relatively small amount.

Still as Santayana warned, we must learn from our past or be doomed to repeat it.  It is not enough to take the current mortgage crisis as warning to tighten restrictions on forward mortgages to prevent suicidal loan underwriting. We must apply those lessons to other financial products, such as reverse mortgages, before they can become toxic.  I would recommend:

• Allowing HECM housing counselors to bring their experience to bear on counseling seniors just as HUD-approved counselors do in other subject areas such as foreclosure, first-time homebuyer, and landlord-tenant.
• (In a related suggestion) Making first-time home-buyer counseling mandatory in government-backed forward mortgages as it is for reverse mortgages
• Ban securitization of residential mortgages (reverse and forward)
• Require banks to hold (not sell-off) a sizable portion of the reverse mortgages they make. There is a similar proposal currently being floated for forward mortgages
• Require a loan budget be made for reverse mortgages to determine affordability including taxes, insurance and average maintenance costs as is done in forward mortgage underwriting.

Nothing herein is a reflection on the views of any organization that I may be associated with.  Nor is anything herein meant to substitute for individual financial or legal advice. 

Filed under: activism, economy, News, politics, US Politics Tagged: | economics, equity, finances, HECM, HECM counseling, HECM counselors, Home Equity Conversion Mortgage, housing, Loan, mortgage crisis, mortgages, Reverse mortgage, Reverse Mortgage counseling, sub-prime, wall street