HECM Default Risk Analysis – Abstract

18 Aug

An Analysis of Default Risk in the Home Equity Conversion Mortgage (HECM) Program


Stephanie Moulton

Ohio State University (OSU) – John Glenn School of Public Affairs

Donald R. Haurin

Ohio State University (OSU) – Department of Economics

Wei Shi

Ohio State University (OSU) – Department of Economics

July 18, 2014

Abstract:

While reverse mortgages are intended as a tool to enable financial security for older homeowners, in 2012, nearly 10 percent of reverse mortgage borrowers in the federally insured Home Equity Conversion Mortgage (HECM) program were in default on their property taxes or homeowners insurance. A variety of policy responses were implemented in 2013, including establishing underwriting guidelines for the first time in the program’s history. However, there is a lack of data and analysis to inform such criteria. Our analysis follows 30,000 seniors counseled for reverse mortgages between 2006 and 2011. The data includes comprehensive financial and credit report attributes, not typically available in analyses of reverse mortgage borrowers. Using a truncated bivariate probit model, we estimate the likelihood of tax and insurance default. Financial characteristics that increase default risk include the percentage of funds withdrawn in the first month of the loan, a lower credit score, higher property tax to income ratio, low or no unused revolving credit, and history of being past due on mortgage payments or having a tax lien on the property. We simulate the effects of alternative underwriting criteria and policy changes on the probability of take-up and default. While a simple limit on the initial withdrawal percentage substantially reduces default, it also substantially reduces participation in the program. A greater reduction in the default rate with less effect on participation can be achieved by setting thresholds based on credit score or derogatory credit indicators. Further reductions in the default rate with a minimal effect on participation can be achieved by requiring that participants with low credit scores to set aside some of their HECM funds for future property tax and insurance payments, a form of escrowing.

 

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