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Fear of crossover hole
Risk (or the chance of loss) is common to any type of mortgage lending but reverse-mortgage lending carries an uncommon risk. Insiders call it crossover risk.
Imagine this: you lend $100,000 to a 76-year-old borrower, secured by a home valued at $200,000; because there are no monthly repayments of principal and interest until the borrower moves, sells, or dies, the loan balance (debt) rises while the home’s equity falls, the opposite of what happens with a traditional forward mortgage loan.
To recoup your investment in reverse mortgage loans, you are restricted by law to the home’s market value. Then your borrower dies at 86, and loan repayment must be made. Meanwhile, the loan balance has climbed to $180,000 over 10 years, but the home’s value has dropped to $160,000. After selling expenses, your net is $150,000, so you are $30,000 in the hole, or the amount by which the loan balance crossed over the home’s net value, thus the crossover risk.
Since your reverse mortgage was a HECM and HUD insures it up to $200,000 (home’s value at origination), you get a $30,000 check to cover your crossover hole.
Assuming other factors remain the same, your crossover loss could have risen to $45,000 if your borrower were 5 years younger and had lived to 86. Because it is designed like an insurance product, younger borrowers present risk of larger losses than older ones.
In an April 8, 2011 paper filed with the Federal District Court for the District of Columbia, HUD’s fear of non-borrowing spouses (especially younger ones) generating insurance losses surfaced as the reason it denied them protection from displacement in its regulations for 25 years:
The mortgager [mortgagor] could even marry a much younger person after taking out the mortgage, thus requiring the lender to wait decades more than anticipated for repayment while interest continues to accrue beyond the value of the house. The lender’s losses would then be passed on to HUD through an insurance claim. (pp.29-30)
Crossover losses are real for HUD, the program was new and untested when the now invalid regulations were written, so we must assume HUD acted with good intentions. But how did HUD’s good intentions lead to the non-borrowing spouse problem? In our next post, we look at the role of HECM non-recourse feature in both masking and exposing the problem.
Atare Agbamu is author of Think Reverse! With more than 200 articles on reverse mortgages in circulation since 2002, Agbamu wrote Forward on Reverse, the first regular monthly column on reverse mortgages in America’s financial media from 2002 to 2011. Through his advisory, ThinkReverse LLC, Agbamu advises financial professionals, institutions, and regulators across the country.