REVERSE MORTGAGES. What is a reverse mortgage?

REVERSE MORTGAGES

THOMAS N. HERZOG

FEDERAL HOUSING ADMINISTRATION

WASHINGTON, DC

What is a reverse mortgage?

• Under a reverse mortgage the bank sends checks to

the homeowner.

• A reverse mortgage allows elderly homeowners to

turn their real estate equity, often their only asset, into

cash.

• The reverse mortgage is repaid when the borrower

dies or moves out of the house.

WHY GET A HECM?

• PENSION PLANNING/STRATEGY NO GOOD

• ****************************************

• MEDICAL/HOSPITALIZATION EXPENSES

• EVERYDAY EXPENSES (FOOD/MEDICINE)

• HOME REPAIRS/IMPROVEMENTS

• LONG-TERM CARE INSURANCE

• PAY BILLS/CREDIT CARDS

WHO IS DOING

REVERSE MORTGAGES?

• FEDERAL HOUSING ADMINISTRATION (FHA)

– HOME EQUITY CONVERSION MORTGAGE (HECM)

• FEDERAL NATIONAL MORTGAGE ASSN. (FNMA)

– HOMEKEEPER MORTGAGE

• FINANCIAL FREEDOM SENIOR FUNDING CORP.

Reverse Mortgage Risks

for Lenders

• Collateral Risk is the risk that the loan balance will exceed the property value at payoff.

• Interest Rate Risk – with fixed rate mortgages this is the risk that interest rates will rise. If rates decline, this is the risk that the borrower will pay off the loan via a refinance. • Term Risk is the risk that lenders will have to extend the

maturity data of the reverse mortgage, thereby increasing the time lenders are subject to collateral risk and interest-rate risk.

Reverse Mortgage Risks

for Borrowers

• Tenure risk is the risk that the borrower(s) will have

to move because their mortgage has become due.

• Interest-Rate Risk pertains (1) if the contract interest

rate is adjustable or (2) if the contract includes a risk

premium on a fixed rate loan.

• Equity Risk is the risk that the property value of the

home will not increase enough.

HECM Payment Options

• Tenure

• Term

• Line-of-credit

• Combination of (1) line-of-credit and (2) either

tenure or term feature

Payments are based on

•

Age of the youngest borrower

•

The interest rate

•

Lender’s share of house appreciation, if any, up

to a maximum of 25%.

•

The maximum claim amount

which is the lesser of

(1) appraised value of property and

(2) maximum FHA-insurable mortgage on a one-unit residence in the geographic area.

HECM Premium Structure

• An upfront charge equal to 2% of the

maximum

claim amount

plus

• A periodic charge of ½ % per year of the

outstanding balance of the loan

• ***************************************

• For refinancings, the upfront charge is 2% of the

increase in the maximum claim amount.

Insurance Options of Lender:

Assignment or Shared Premium

• Under the

assignment option

, FHA collects all of

the premiums and lenders can assign the loan to

FHA when the balance reaches the maximum claim

amount.

• Under the

shared premium option

, lenders retain a

portion of the periodic premium and are liable for

losses that exceed the maximum claim amount.

How much can be borrowed?

• Based on

principal limit

which is the maximum

amount that can be borrowed at closing and is

calculated from a “payments” model.

• This model has as its basic constraint that

(1) Present value of expected premium income

is set equal to

(2) Present value of losses resulting from future loan

balances exceeding their collateral values.

FEATURES OF HECM MODEL

(May & Szymanoski [1989])

• Annual house price appreciation is assumed to have

a normal distribution with mean of 4% and s.d.of

10%.

• Mortality rates are assumed to follow 1979-1981US

female table increased by 30% to account for

Estimated Principal Limits

10% interest rate (including servicing fee)

$167,549 $129,013 $99,341 $58,900 85 $142,231 $109,519 $84,330 $50,000 80 $118,337 $91,120 $70,163 $41,600 75 $97,286 $74,911 $57,682 $34,200 70 $79,650 $61,331 $47,225 $28,000 65 $70,262 $54,102 $41,659 $24,700 62 120 90 60 0

Months After Origination of Loan Age of

Borrower

Estimated Maximum Mortgage Payments

Selected Term Mortgages versus Tenure Mortgages

$100,000 appraised value, no shared appreciation, 10% interest rate (including servicing fee)

607 741 884 1180 85 460 622 742 991 80 357 510 608 812 75 278 411 490 654 70 218 328 391 522 65 $187 $284 $338 $452 62 120 90 60 Tenure Mortgage Term in Months

Age of Borrower

HECM Features

• HECM program (1) reduces tenure risk to homeowners because they can not be forced to move and (2) allows homeowners to alter payment schedules to fit changing circumstances.

• HECM program provides insurance to lenders against both term risk and collateral risk.

HECM Refinancings

In 2004, HUD reduced the premium for HECMs that

refinanced.

This increased the number of refinancings as follows

– Over the period FY1990 thru FY2004, only 2,256 (2%) of the 115,472 HECMs insured thru 9/30/04 refinanced. – During FY2005 and FY2006, 6,338 (3.7%) of the

Securitizing Reverse Mortgages

Lehman Brothers

• 1st RM securitization SASCO 1999-RM1 deal by Lehman Bros Aug 1999 (rated by Moody's) $317m notes with $185m loan principal • Lehman 4-5 RM securitizations from 1999 to

2006: seasoned RM loans

• Lehman reverse mortgage securitization 2006-RM1 named MBS deal of the year - $598m notes with $522m loan principal

• Private transactions

MECA Securitization of HECMs

• 1st HECM securitization MECA 2006-SFG1 by Mortgage Equity Conversion Asset Corp Aug 2006 (rated by Fitch) $221M notes with $135m loan principal

• Sold to single investor, 100% AAA notes because HUD-insured (low risk)

• 2nd HECM securitization MECA 2006-SFG2 by Mortgage Equity Conversion Asset Corp Sep 2006 (rated by Fitch) $215M notes with $128m loan principal

• 3rd HECM securitization MECA 2006-SFG3 by Mortgage Equity Conversion Asset Corp Nov 2006 (rated by Fitch) $456M notes with $256m loan principal

Planned GNMA Securitizations

of HECMs

• 1st securitizations announced Oct 2006,

issue planned for Summer 2007

• Home Equity Conversion Mortgage

Mortgage-Backed Security (HECM MBS)

• First non-private transaction

Number of HECMs Originated

(SelectedYears)

269,475 Total thru 1/31/2007

76,276 2006

37,789 2004

13,049 2002

6,637 2000

4,166 1995

157 1990

Number of HECMs Originated

Who is getting HECMs?

Single females, single males, couples?

36.1% 15.1% 48.5% 2004 38.6% 16.5% 44.2% 2006 34.7% 14.0% 51.3% 2002 30.2% 13.0% 56.8% 2000 30.0% 13.5% 56.5% 1995 26.1% 16.6% 57.3% 1990 Couples* Single Male Single Female

Gender of Borrower Fiscal Year

of Origination

How old are the people who are getting

HECMs?

Average Borrower Age Fiscal Year of Origination

HECM Property Values

$235,600 $289,700

2006

$182,200 $219,400

2004

$151,300 $178,000

2002

$124,600 $141,700

2000

$105,400 $124,800

1995

$84,200 $108,700

1990

Average Maximum Claim

Average Property Value

Fiscal Year of Origination

How Long Do HECMs Last?

4.6 6.5

6

84-86 74-76

64-66

Age at Loan Origination (in years)

Median Term of a HECM Single Female Borrowers

HECM MODELS

• SZYMANOSKI AND MAY [1989]

• DIVENTI AND HERZOG [TSA -- 1991]

• ABT Associates []

DIVENTI & HERZOG

STOCHASTIC SIMULATION

MODEL

• KEY FEATURE IS USE OF TWO-STAGE

MODEL TO SIMULATE HOUSE PRICE

APPRECIATION RATES

– FIRST STAGE (MULTIVARIATE NORMAL) --SIMULATES ANNUAL MEAN PRICE

APPRECIATION RATE

– SECOND STAGE (UNIVARIATE NORMAL) --SIMULATES PRICE APPRECIATION OF

INDIVIDUAL HOUSES WHERE MEAN IS RESULT OF FIRST STAGE OF MODEL

Abt Interest Rate

Transition Matrix

Change in Interest Rate

Current Level 7% 9% 25% 18% 22% 14% 5% >8% 0% 5% 29% 27% 34% 5% 0%

6.5 to 8%

0% 2% 31% 38% 29% 1% 0% 5.25 to 6.5% 0% 1% 27% 48% 20% 3% 0% 3.5 to 5.25% 0% 1% 23% 58% 18% 1% 0% <3.5% 1.25 to 2% .5 to 1.25% 0 to .5% 0 -0 to -1.25% -.5 to -1.25% -1.25 to -4%

Probability of Change in Interest Rate Given Current Level

Abt House Appreciation Rate

Transition Matrix

0% 8% 33% 25% 17% 17% 0% 1.5 to 2%

0% 6% 28% 22% 22% 22% 0% 1 to 1.5%

5% 16% 26% 11% 32% 11% 0% .5 to 1%

6% 50% 19% 6% 13% 6% 0% <.5% 1.5 to 2.5% .5 to 1.5% 0 to .5% 0% -.5 to 0% -1.5 to -.5% -2.5 to 1.5%

Shock (in addition to correlation with interest rate change) Current