This article proposes changes in HUD policies that would support an enhanced HECM that is part of an integrated retirement plan. Such integration will generate the following benefits:
- Larger payments to borrowers that can increase annually and last until death.
- Built-in protection against over-charges by HECM lenders and annuity providers.
- Reduced losses to the mortgage insurance fund.
Larger Payments to Borrowers
The mortality-sharing feature of annuities allows retirees taking a HECM to draw larger amounts over their lifetimes if they combine it properly with an annuity. This would be particularly valuable for house-rich/cash-poor retirees who have negligible financial assets.
Chart 1 applies to a retiree of 65 who owns a $500,000 house but no financial assets. He draws a HECM credit line and uses a portion of it to purchase an annuity on which payments will begin after 10 years and grow at 2% a year. The balance of the line is used for monthly draws during the first 10 years, also growing at 2% a year, [Note: The math underlying the seamless transition from HECM draws to annuity payments was developed by my colleague Allan Redstone.]
The horizontal blue line in Chart 1 is the highest HECM tenure payment quoted by any of the lenders who report their prices to my web site. Tenure payments are for a fixed amount and cease if the borrower moves out of the house. With a stand-alone HECM, this is the best the retiree could do.
In contrast, the HECM/annuity combination can escalate, it is 2% a year in the example, and it runs for life. The lower line is based on the lowest price quoted by an annuity provider.
Removing HUD Obstacles to the HECM/Annuity Combination
Prejudicial Instructions to Counselors
All HECM borrowers are required to be counseled by a HUD-recognized counselor following HUD guidelines. While HUD does not tell a borrower what it can or cannot do with HECM proceeds, the HUD guidelines require counselors to warn applicants that an annuity may not be in their best interest. As a misleading illustration, counselors are told that they should explain that “in some cases fixed monthly annuity advances that continue for life may be smaller than fixed monthly loan advances from a reverse mortgage for as long as the client lives in his/her home.” (HECM Protocol, Chapter 5, Section B).
Dysfunctional Maximum Initial Cash Draw
Under a HUD rule, borrowers cannot draw more than 60% of their maximum cash draw within the first year. The intent is to put a brake on compulsive spenders, but limiting cash draws to a year is not much of a brake. In contrast, an annuity provides a brake that lasts for as long as the borrower lives.
The unintended effect of the maximum cash draw is to limit the size of the annuity payment for borrowers with limited or no financial assets. Such borrowers may be forced to select an annuity deferment period that is longer than the period that would maximize their spendable funds.
This is illustrated in Chart 2, which covers the same retiree as Chart 1. The higher line is based on an annuity deferred 5 years, which is the optimal period for this borrower. But the price of this annuity exceeds the HUD limit. The lower line, based on a deferment period of 9 years, is the best available that meets the HUD limit.
HUD could fix the problem by removing the maximum first year draw in cases when the borrower states that they intend to purchase a lifetime annuity with the proceeds. A side benefit would be a decline in losses to the HECM component of mortgage insurance reserve fund, as noted below.
Protecting Borrowers Against Overcharges
FHA Mortgagee Letter 2008-24 bars HECM lenders from “involvement with any other financial or insurance product.” The intent is to prevent collusion between lenders and insurers at the borrower’s expense. While this is a laudable objective, it leaves untouched the principal source of overcharges.
Both HECMs and annuities are complicated and most consumers encounter them only once in a lifetime. As a result, significant price differences exist in both markets on transactions that are otherwise identical, Preventing a high-price HECM lender from doing business with a high-price annuity provider accomplishes very little,
The Effective Way to Protect Consumers.
What is needed is an entity that (a) guides consumers to the combination of HECM and annuity options that best meets their needs – counselors don’t do this, and (b) selects the individual lender and insurer that provide the best terms offered by competitive networks of lenders and insurers. Counselors don’t do this either.
Stand-Alone HECMs Have Excessive Loss Rates
Current HECM losses are much higher than they would be if HECMs were integrated into retirement plans.
The program has been subjected to a great deal of bad publicity, one effect of which has been to subject it to adverse selection. The HECM client pool has been heavily weighted by borrowers with low credit scores, many in desperate financial condition, who turn to a HECM as their last resort. Many such borrowers fail to pay their property taxes and maintain their properties in good condition.
HECMs that are integrated with asset management and annuities into comprehensive retirement plans are likely to draw borrowers with better payment habits. Further, a borrower who obtains a rising payment for life is better positioned to meet home ownership charges than those who exhaust their HECM borrowing capacity in the first few years.
The writer and his colleagues have developed a retirement planning program, called the Retirement Funds Integratortm. It marries HECMs with deferred annuities in the way described earlier, and provides competitively determined annuity and HECM prices.