Convert the Home Equity Conversion Mortgage Program From a Guarantee Program to a Direct Loan Program

Under current law, the Federal Housing Administration (FHA) of the Department of Housing and Urban Development is permitted to guarantee private home equity conversion mortgages (HECMs) for elderly homeowners. Such loans, which are also called reverse mortgages, enable homeowners who are at least 62 years old to withdraw some of the equity in their home in the form of monthly payments, a lump sum, or a line of credit. As long as they reside in the property, borrowers are not required to repay their loan. But when the home is no longer the borrower’s primary residence, the outstanding balance (which includes payments made to the homeowner and any interest accrued on those payments) must be repaid. The borrower or the borrower’s estate may either retain the home by repaying the loan in full or sell the home and repay the loan with the proceeds from that sale. If the proceeds are not sufficient to repay the outstanding balance of the loan, FHA will fulfill the terms of its HECM guarantee by reimbursing the private lender. In addition to the cost of the risk associated with that guarantee, FHA bears the cost of servicing some loans. Although private lenders initially bear the servicing costs of the loans they originate under the program, when the outstanding balance of a loan reaches 98 percent of the guarantee amount, it is assigned to FHA, and the agency takes on those costs.

This option would replace the HECM guarantee program with a direct loan reverse mortgage program. Instead of guaranteeing loans that private lenders originate, FHA would make loan disbursements directly to the borrower. The cost of the risk borne by FHA under a direct loan program would be largely the same as that associated with its guarantee on reverse mortgages under current law. The agency’s servicing costs would increase because it would be responsible for the cost of servicing all loans from the time they were originated. However, FHA’s interest income would also increase because the agency would collect all repayments of principal and interest from the borrower or the borrower’s estate.

The savings that this option generates stem from the fact that, in the Congressional Budget Office’s estimation, private lenders are charging rates on reverse mortgages that are higher than is necessary to cover their financing costs. Some of that surplus is used to cover their marketing and other nonfinancing costs, but some of it may result from lenders’ ability to charge borrowers more than they would be able to in a more competitive market simply because the number of lenders originating reverse mortgages is limited. If the legislation that created the direct loan program required FHA to charge borrowers an interest rate that was comparable to those charged by private lenders on reverse mortgages, the option would generate savings for the federal government. Although FHA would incur the costs of financing and servicing loans that are currently borne by private lenders, by charging an interest rate comparable to the rates projected to be charged under the current program structure, the agency would be able to retain the surplus built into that rate.

CBO estimates that if FHA implemented the direct loan program in 2018, it would originate approximately 550,000 reverse mortgages by 2026. (The number of new loans originated each year is estimated to rise from 60,000 in 2018 to nearly 63,000 in 2026). On the basis of that estimate and in accordance with the budgetary procedures prescribed by the Federal Credit Reform Act of 1990 (FCRA), CBO projects that if FHA charged borrowers an interest rate comparable to those charged by private lenders, the option would result in discretionary savings with a net present value of $23 billion from 2018 to 2026. (A present value is a single number that expresses a flow of current and future payments in terms of an equivalent lump sum paid today; the present value of future cash flows depends on the rate of interest, or discount rate, that is used to translate them into current dollars.)

The option would, under the FCRA approach, increase mandatory spending. Replacing HECMs with direct loan reverse mortgages would eliminate savings for the federal government generated by the securitization of HECMs by the Government National Mortgage Association, or Ginnie Mae. By eliminating the Ginnie Mae securitization program, the option would increase mandatory spending over the period by $0.7 billion, estimated on a FCRA basis.

Under an alternative method, the fair-value approach, estimates are based on market values—market prices when they are available, or approximations of market prices when they are not—which better account for the risk that the government takes on. As a result, the discount rates used to calculate the present value of projected loan repayments under the option are higher for fair-value estimates than for FCRA estimates, and the savings from those projected repayments are correspondingly lower. On a fair-value basis, net discretionary savings are projected to amount to approximately $16 billion over the period. Mandatory savings associated with eliminating the Ginnie Mae securitization program would be very close to zero.

The primary advantage of converting FHA’s HECM guarantees to direct loans is that the government—instead of private lenders—would earn the interest margin on reverse mortgages without incurring significant additional risk because, in its role as guarantor, FHA already bears much of the risk associated with reverse mortgage loans. In addition, the complexity of reverse mortgages has limited both demand for them and the number of lenders that originate them, so having FHA serve as the single originator of reverse mortgages might provide consistency and transparency and make them more attractive to borrowers. Finally, FHA could potentially reduce the cost of reverse mortgages for borrowers by lowering the interest rate or fees charged on such loans, but doing so would eliminate some of the savings from this option.

An argument against this option is that it would increase federal debt (but not debt net of financial assets) because FHA would need to fund the principal balances of the reverse mortgages that are currently funded by private lenders. The option would also reduce the private sector’s involvement in the reverse mortgage market, which may limit innovations in product features and servicing techniques designed to tailor those loans for elderly homeowners.