Escalating homeowners insurance and property tax payments are putting senior homeowners with home equity conversion mortgages (HECMs) at risk, unbeknownst until last week to the U.S. Department of Housing and Urban Development (HUD), which is responsible for insuring these loans.
According to a newly released internal watchdog report, more than 1,200 borrowers with reverse mortgages through the HECM program face an accelerating likelihood of default and home dispossession due to the regulator’s failure to audit program requirements for a subset of particularly financially vulnerable borrowers.
As a result, the Federal Housing Administration (FHA) that insures HECM loans could face up to $258 million in payouts if those borrowers default.
“This occurred because HUD did not evaluate whether LESA [life expectancy set aside] calculations were effective or whether LESAs would be available for the borrowers’ estimated life expectancy,” according to recently released findings from an audit of the HECM program by HUD’s Office of Inspector General (OIG).
“While HUD periodically evaluated the success and effectiveness of the HECM program, it did not include a formal examination of its LESA program, nor did it have measurable goals for LESA performance,” the OIG found, which undertook the audit “because of recent federal reporting” on rising nationwide tax and insurance costs paid by LESA funds.
Reverse mortgages enable homeowners age 62 and older who own their home outright or have a low mortgage balance to convert their home equity into cash without a monthly debt obligation. Borrowers are responsible for paying homeowners insurance, property taxes and “personal living expenses while residing in the home,” but can continue residing in the home until death, default or a sale of the home, at which point the HECM balance is repaid.
Life expectancy set asides function like escrow accounts for HECM borrowers whose credit or insurance and tax payment histories fall below HUD underwriting standards. The LESA is funded with a portion of the HECM amount “set aside” so that lenders can make property tax and insurance payments on behalf of certain “financially vulnerable” borrowers.
At the same time HUD lacked visibility into LESA performance, the OIG says LESA funds were being depleted at an accelerated rate.
Lenders calculate LESA fund amounts using the borrower’s age, projected property charges and “a formula provided by HUD.” Though not guaranteed, LESA funds are intended to last the duration of a HECM borrower’s life expectancy, the OIG report noted.
However, the inspector general’s office said that “HUD did not evaluate whether its LESA formula was effective” when introduced in 2015. The report flagged that “there is no requirement that active LESAs be evaluated to ensure that they last for the borrower’s estimated life expectancy.”
“As a result, if borrowers cannot make these payments, their HECM loans will default, resulting in a projected loss of up to $258 million,” the audit found, representing the combined balances on the 1,237 outstanding FHA-insured HECM loans with depleted LESAs. Those 1,237 borrowers will now have to pay tax and insurance costs out of pocket, and “may have only 30 days of notice” before needing to settle those out-of-pocket costs.
For all manner of senior homeowners — including those with limited means or reliant on fixed incomes — HECM loans were intended to promote financial stability by improving cash flow without a monthly debt obligation. Now, rising insurance and tax bills threaten to displace that equation and borrowers sold on that promise.
Furthermore, the OIG report notes that the problem may worsen if left unaddressed, given the continuing rise of property tax and insurance costs. HUD held 41,002 HECMs with LESAs in its portfolio as of the publication of the OIG report.
“Rising property charges and a lack of evaluating LESA effectiveness could result in more HECM borrowers experiencing accelerated depletion of their LESA accounts,” the report concluded. “As economic factors continue to change, more HECM borrowers could experience difficulties keeping their reverse mortgages in good standing.”
