On Feb. 5, 1988, President Ronald Reagan signed reverse mortgage insurance legislation, and it became the task of the U.S. Department of Housing & Urban Development (HUD) to create a marketable product out of the law. There were no models. So, HUD put a product-design team together. Edward J. Szymanoski, an Associate Deputy Assistant Secretary for Economic Affairs at HUD’s Office of Policy Development and Research, was a vital member of that pioneering product-development team.
At HUD, Szymanoski, a Hartford, Conn. native with degrees in applied mathematics and economics, manages economic and policy support for HUD’s programs. Before that, he ran the annual actuarial review of HUD’s home mortgage insurance fund, led modeling teams assisting HUD’s financial and budget reporting, and served at Fannie Mae and Freddie Mac’s former regulator.
Szymanoski has authored many papers on housing and economic issues in academic journals. His 1990 paper on reverse mortgage risk, “The FHA Home Equity Conversion Mortgage Insurance Demonstration: A Model to Calculate Borrower Payments and Insurance Risk,” is considered the best on the subject.
Personally, I have been a beneficiary of Ed’s boundless intellectual generosity over the years. He is one of my teachers on reverse mortgages and on Home Equity Conversion Mortgages (HECM). The following are the reflections of Edward J. Szymanoski, a principal architect of HECM and a world-class resource on reverse mortgages.
You are one of HECM’s inventors. Your contraption has spawned a multi-billion-dollar (possibly a multi-trillion-dollar by 2030 by some estimates) credit industry in 20 years. What attracted you to the design project at inception?
First, let me say at the outset, that my responses to your questions reflect my personal opinions, and I am not in any way speaking for HUD. Secondly, I want to say that HECM is not my “contraption.” It was very much a team effort. I presume you will be speaking with some of my colleagues involved with the development of HECM 20 years ago as well, including Judy May, who very ably led the HUD team.
A demonstration program for home equity conversion was authorized by the Housing and Community Development Act of 1987 (Public Law 100-242). This concept was championed by several very dedicated advocates for older homeowners who helped get the provision included in the law (for example, Ken Scholen whom I hope you will also interview). The statute limited the HECM pilot to 2,500 total mortgages, although that limit was soon raised. The first HECM loan was made in October 1989.
Congress, in its wisdom, left it up to HUD to design the HECM pilot. The legislation set down guidelines for consumer protections and basic program requirements, but HUD took the lead in establishing the main features of the HECM program. HUD needed to build a simulation model for analyzing the actuarial risks that the FHA [Federal Housing Administration] would be exposed to under various economic and demographic assumptions involving future house prices, and borrower mortality and move-out rates.
The HECM design team used this model to simulate the net present values of insurance premiums and claim costs under multiple program design features. Innovations from our initial design recommendations, which FHA adopted, included the first-ever two-part premium structure for an FHA program (two percent upfront and 50 basis points annual), a two-dimensional “principal limit” factor table (by borrower age and interest rate) that is used as an effective limit on HECM LTVs [loan-to-values], and formulas for borrowers to set up their own customized payment plans—allowing maximum flexibility in choice among monthly payment streams, lines of credit or combination plans with both. These HECM design features that we developed are still in use today.
The HUD Appropriation Act of 1998 made HECM a permanent program of HUD, based upon the early successes of the pilot program. HUD’s work in HECM design underscores the fact that sometimes government can get it right.
HUD accomplished this by assembling a design team of its own staff, including myself, along with extensive consultation with external stakeholders. My contribution was to propose an actuarial pricing and simulation model, and to provide clarity to some of the financial structure of the product. This means the development of the principal limit table, itself, and in establishing formulas for computing borrower cash draws from the principal limit. I also assisted in software development and early program implementation as well as initial program evaluation reports to Congress.
What attracted me to the team was the opportunity to apply mathematical models to the problem of managing risk for a new reverse mortgage product. I have an educational background in mathematics and a love for solving mathematical problems of an applied nature.
How has the product and the industry changed, and where do you see HECM and the industry going in the years ahead?
During the past 20 years (most of which I have spent working at HUD, except for a two-year stint at the Office of Federal Housing Enterprise Oversight [OFHEO], now the Federal Housing Finance Agency [FHFA]), I have seen the HECM product change from a limited pilot program to a nationwide niche market product, and then to a near mainstream product. I say near mainstream product because there is yet more work to improve the efficiency of the secondary market for HECM to the point where it provides as much liquidity and efficiency of execution as does the secondary market for standard prime mortgages (current market problems notwithstanding).
For most of the 20-year period, HECM relied on the liquidity provided by one investor, Fannie Mae. Fannie Mae played a key and valuable role in the early success of HECM. However, if HECM is to become a truly mainstream financial product, a sustainable, competitive secondary market is essential. Ginnie Mae, which began guaranteeing HECM MBSs [mortgage-backed securities] in 2007, has already made great strides toward achieving this goal.
In my view as a researcher, there is also need for more formal research on the benefits of HECM to borrowers and to society as a whole. This type of research will better enable us to retool HECM for the coming wave of retirements of the large baby boom cohorts over the next two decades. For example, in what ways are older homeowners better off from having taken out a HECM? Is society as a whole better off with a mainstream HECM product? These and other research questions will ultimately need to be answered in order to guide HECM policy changes in the future.
What were the design assumptions you started with as a team, and have they been validated by market experience?
The major design assumptions involve:
1. The timing of loan terminations due to mortality, voluntary move-out or refinancing into a new HECM;
2. The mean and volatility of home price appreciation; and
3. The projections of loan balances into the future based on variable interest rates and borrower cash drawdown patterns.
The answer to your question as to whether these assumptions have been validated by experience is an ongoing one. We are learning more and more, with each passing year, about these assumptions, and in hindsight, I would say that the original assumptions missed by a little but not by a lot. In some ways, the most confounding problem is in predicting future house price trends, because the past doesn’t always predict the future.
I would note, however, that between the first quarter of 1991 and the first quarter of 2009—an 18-year period covering most of the 20 years during which HECM has been active—the U.S. house price index, as reported by the Federal Housing Finance Agency, has increased at an annual compound rate of 3.9 percent. Even accounting for the recent price drop due to the recession, the 18-year growth in U.S. house prices has averaged very near the four percent assumed in the original HECM model.
With regard to the timing of loan terminations, studies have shown that younger borrowers terminate their HECM loans considerably earlier and older borrowers terminate slightly later than originally assumed in 1989.
The 2000 HUD report to Congress on HECM, “No Place Like Home,” contained an analysis of the original termination assumption and concluded that although no single multiple of mortality rates can adequately capture the timing of HECM terminations for all borrower age groups, the original assumed multiple of 1.3 “comes remarkably close for the entire HECM book of business.”
Besides sovereign insurance, what are the sources of HECM’s strength, and what structural changes would you make today, with the benefit of hindsight?
Clearly, the full faith and credit of the U.S. government is key in a program with risks that are hard to measure “ex ante” (meaning before the fact of insuring the loan) as is the case with the HECM program. However, HECM contains additional strengths that have made it a success. First, for all of its alleged complexity, HECM is really based on a simple guiding principle. This principle is that all the many actuarial and economic assumptions that one must make to assess risk can be boiled down to a single number, the principal limit factor, for any unique combination of borrower age and expected interest rate environment. These assumptions include borrower mortality and voluntary move-out patterns, house price growth trends (both average growth rate and price volatility), interest rate changes over time, and borrower cash draw patterns.
The concept of principal limit based on this single factor times the maximum claim amount (property value capped by the HECM lending limit) is the foundation for all cash flow patterns that borrowers could want (from regular monthly “tenure” payments to lines of credit under which borrowers control the amounts and timing of cash draws). This simplicity in HECM construction has provided borrowers and the lending community with a great deal of confidence in the product, in my view.
Comparatively, where do you think HECM and the U.S. reverse mortgage industry rank with other programs in the world (please give copious examples from your international engagements)?
HUD hosts many visiting international delegations each year that come to learn about HECM. I and other HUD staff regularly brief these visitors, whose backgrounds range from academics and researchers, to government officials and banking and finance industry executives. In addition, several foreign governments have requested HUD participation at conferences in their countries for exchange of information on reverse mortgages. Since the early 1990s, I have briefed about 30 or more visiting delegations, and these visitors came from places like Japan, Korea, Singapore, India, Australia, France and Poland. In addition, I have made presentations on behalf of HUD on HECM in five countries: Hungary, Mexico, Germany, Latvia and Chile.
My sense is that:
1. Asian countries are especially interested in learning about the U.S. experience with HECM because many of these counties are faced with populations which are aging even faster than the U.S. population is aging.
2. In some sense, the HUD HECM product is the envy of the world—it is the “gold standard.” There are many barriers to be overcome in implementing a successful reverse mortgage program in most nations (including legal, institutional and cultural barriers), and most countries which have launched reverse mortgage programs have not yet achieved the level of success that the U.S. has enjoyed with regard to overcoming the barriers. Legal barriers can range from statutes which explicitly conflict with reverse mortgages, to those which simply pose ambiguity about potential conflict. Institutional barriers can range from the insufficiently developed systems of property valuation to unwillingness of local banking institutions to participate. An example of a cultural barrier can be a widespread desire among seniors in some nations to pass along their wealth to their heirs rather than consume it themselves.
3. Finally, many nations are debating the role of the government in establishing an effective reverse mortgage program. In the U.S., the federal guaranty backing HECM has been a huge plus in the development of the market—other countries are debating whether they should or could replicate that government involvement.
What could be done to design a competitive private-sector product?
I believe that private sector reverse mortgage products will come back once there is a re-emergent non-agency secondary mortgage market to provide liquidity. The private sector products will probably focus on the jumbo market as in the past (loans on homes valued above $625,500), but maybe also on lower loan-to-value products in the non-jumbo space. For example, a 75-year-old senior homeowner with a $400,000 house might only want to borrow $75,000. This homeowner could get more than that from a HECM, but may choose instead to go with a conventional reverse loan that might be better priced than HECM due to the relatively low risk of the lower LTV.
On Oct. 19, 1989, Marjorie Mason of Fairway, Kansas, signed her closing documents, becoming the first person to receive an HECM reverse mortgage in the U.S. Twenty years and more than 500,000 HECM loans valued at more than $55 billion later, a vibrant growth industry is in place.
History matters, even in business. So, in this series, we bring you the priceless reflections, perspective, and insights of the men and women who created the U.S. reverse mortgage industry and made the first 20 years of HECM possible. We believe we will need their wisdom, leadership, pioneering and entrepreneurial spirit to take the industry to the next stage in its evolution.
Please send me your feedback on the series at [email protected]
If you know a person who you feel is a leader/pioneer in the U.S. reverse mortgage industry, send me the following via e-mail: Their name, phone number and e-mail, and a few words on why you think they are considered a leader/pioneer in the industry.
Author and columnist, Atare E. Agbamu, CRMS is director of reverse mortgages at Minneapolis-based AdvisorNet Mortgage LLC. A member of the BusinessWeek Market Advisory Board, Agbamu is author of Think Reverse! and more than 100 articles on reverse mortgages. Through his advisory firm, ThinkReverse LLC, Agbamu advises financial professionals, institutions and regulators across the country. In a 2007 national report on reverse mortgages, the AARP cited Agbamu’s work. He can be reached by phone at (612) 436-3711 or (612) 203-9434.