When you hear (or read) the word “foreclosure”, what kind of images does that conjure up in your mind? Probably some pretty negative stuff, right? You’re probably thinking something along the lines of families experiencing hard times, falling behind on mortgage payments, and being forced out of their home as it’s being sold on the courthouse steps.
Am I pretty close?
Now what if I said that, according to a US News article, the California Reinvestment Coalition (CRC) reported recently that foreclosures on HECM reverse mortgages increased by a whopping 646% percent in 2016? Yikes! An over sixfold increase in reverse mortgage foreclosures in just one year? Stats like this would probably create a pretty bad impression of the HECM reverse mortgage in the mind of any normal person.
At first glance, yes, that’s a scary statistic. However, there’s more to the story than the statistic would suggest. The reverse mortgage is a very different animal than a traditional “forward” mortgage. Terms from the forward mortgage world don’t always have the same connotation in the reverse mortgage world. Thankfully, the US News article digs a little more to uncover what’s really going on.
Not What it Seems
Stripped of the emotional connotations, the term “foreclosure” at its most basic level means the sale of a property by a lender to recover a mortgage balance. That’s true of forward and reverse mortgages. The big difference is this: with reverse mortgages, foreclosure doesn’t necessarily imply that a borrower fell on hard times and is in danger of losing their home. Check out the following from US News:
HUD contends that the vast number of foreclosures occurs as part of the normal closing out of HECMs after the last surviving borrower dies. When that happens, the loan is due; heirs have the option to pay off the note if they want to keep the house. If not, they simply turn it over to the lender, who in turn initiates a foreclosure proceeding. That usually leads to sale of the home, often at auction.
HECM loan origination peaked in 2008, so any recent increase in foreclosures could simply mean that some of those loans likely are now coming due. “Borrowers are passing away,” said Peter Bell, president of the National Reverse Mortgage Lenders Association.
HUD says that occurred with 99 percent of HECM foreclosures from April 2009 thru December 2016. But that figure is at odds with analysis of loan industry data by Reverse Mortgage Insight, a firm that studies industry trends; it shows that among completed foreclosures from 2009 through 2017, 62 percent were due to death of the borrower; 22 percent occurred through a tax and insurance default, and 15 percent resulted because the borrower no longer occupied the home.
Foreclosure is a normal part of settling up the loan balance after a reverse mortgage borrower passes away. If the heirs don’t wish to keep the property or sell it on their own, the lender steps in and sells it to recover the balance through a foreclosure action. If the home isn’t worth enough to settle the entire balance, FHA makes up for the shortage through their insurance fund. Foreclosure is just a very negative-sounding way of saying the lender is getting paid back after a reverse mortgage borrower passes away.
If we’re trying to quantify distress within the HECM reverse mortgage program, foreclosures aren’t what’s important, defaults are. Fortunately, the US News article addresses that as well:
CRC points to an increasing number of defaults by borrowers. HECM loans do not require repayments, but borrowers can default if they fail to make property tax and insurance payments, and to make repairs to their homes. CRC analysis of HUD data found that the number of defaults expected to lead to involuntary loan termination surged in fiscal 2016 to 89,064, from 45,381 the previous year. That increase likely stems from moves by HUD to require lenders to take action against borrowers who fail to meet loan terms.
The most basic obligations under the HECM reverse mortgage program are this: live in the home and pay the required property charges, which are usually just property taxes and homeowner’s insurance for most people. As long as at least one borrower is meeting these obligations, no payment or payoff is required. However, if the borrower fails to meet these obligations, the HECM becomes due and payable.
An increase in defaults is definitely something to be concerned about, but HUD took steps in 2014 to reduce defaults by implementing more stringent qualifying guidelines. Borrowers now have to demonstrate a financial willingness and financial ability to keep up with property taxes and homeowner’s insurance obligations. If a borrower fails to demonstrate either of these, a lender may be required to carve out part of the reverse mortgage proceeds into a life expectancy set aside, or LESA, which will pay property taxes and insurance on behalf of the borrower. If the credit and/or income issues are severe enough, the borrower may not qualify at all.
There’s More to the Story
It’s unfortunate, but many people never read past the headlines and develop a misleading view of the HECM reverse mortgage. Foreclosure is a normal part of settling up the loan balance when a borrower passes away. Foreclosure technically means the same thing in the forward and reverse mortgage worlds, but it’s the result of very different circumstances. In the forward mortgage world, foreclosure is an indicator of financial distress on the part of homeowners. In the reverse mortgage world, foreclosure is typically just the settling of a loan balance as a result of the passing of a borrower.
If we’re looking to identify signs of financial distress in the HECM reverse mortgage world, the key indicator is defaults, not foreclosures.