As of February 1, reverse mortgages will be significantly more difficult to obtain for residents of cooperatives (i.e. condominiums).

That’s because HUD recently changed the rules governing the process for this class of borrowers, by making the approval process more rigorous. Specifically, condo dwellers applying for reverse mortgages will have to wait a minimum of 8 weeks so that HUD can confirm that the dwelling meets their lending standards. In a recent article on the rule changes, one expert confided that the true wait time is likely to be closer to 18 weeks. In addition, all projects that have already been approved will need to be re-approved by HUD.

Of course, there is always a back door, and in this case, that means seeking what’s known as “spot approval” directly from the lender. Under this system, lenders can certify that individual units meet HUD lending standards, but take responsibility if it is later determined that their assessment was invalid. In order to crack down on lenders that were abusing their power, however, the FHA will replace this with a new version, under which any lender that confers spot approval on a project must also bear responsibility for all future loans against units in that same mortgage. Given the level of potential liability that carries, it’s no wonder that so few lenders are still willing to proceed with such spot approval.

On the one hand, this system is necessary, since condos were among the biggest price losers in the housing bust. From the standpoint of HUD, then, insuring reverse mortgages on these properties against default (i.e. that the home price falls below the value of the mortgage) is incredibly risky. The only way to mitigate against this possibility (and stave off having to ask Congress for a bailout, incidentally) is to approve condo loans on a case-by-case basis. For those seniors that live in private communities that are legal incorporated as cooperatives but whose homes are separated from each other, they can apply for “site condo” designation, which is apparently easy to obtain but complicated to undo.

Given the FHA’s financial troubles, this development was somewhat foreseeable, and probably necessary. And while it represents a small obstacle, it’s certainly not a roadblock for those that live in condominiums and want to obtain reverse mortgages. You’ll just have to be patient.

It has been reported that Congress is considering dealing with the mess of Fannie Mae and Freddie Mac by simply abolishing them. No privatization. No permanent nationalization. Certainly no return to hybridization. Instead, a neat and tidy sweeping into the dust-bin. While other columnists are busying themselves focusing on the complete set of ramifications, here, we’re mainly interested in the potential impact on reverse mortgages.

For whatever reason, Fannie (rather than Freddie, in this case) came to dominate the market for reverse mortgages. At its peak in 2008, it accounted for 90% of the funding of all HECM loans (the FHA-mandated reverse mortgage standard) which it purchased in securitized blocks – the reverse mortgage equivalent of the mortgage-backed securities (MBS) that have gained much notoriety for their role in fomenting the credit crisis. This market share has since shrunk to 10%, however, with most of the slack picked up by its competitor, Ginnie Mae.

Given that the reverse mortgage industry has continued to function (quite smoothly, in fact) in the absence of Fannie Mae, then, it seems that its complete disappearance from the scene shouldn’t matter too much. On the surface, this is probably true, but only because reverse mortgage originations remain small, as a fraction of overall mortgage lending activity. Thus, the industry’s capital needs can easily be met by one of the various mortgage giants (Fannie, Freddie, Ginnie, etc.) and a handful of other institutional investors.

The danger is that the reverse mortgage market is basically a monopsony (only one buyer, the reverse of a monopoly); as long as that buyer remains willing, everything is fine. When that buyer gets full and/or changes its mind, well, other buyers must be found. In this case, it would be difficult to find a buyer with the same capacity as Ginnie Mae.

If the industry continues to grow as fast as many experts expect (and lenders hope), however, lenders will probably have to find other sources of capital. Institutional investors are returning to mortgage-backed securities, but in small numbers and very cautiously. If Ginnie Mae cuts back on its purchases and/or reverse mortgage lending activity outpaces Ginnie’s ability to buy securitized HECM mortgages, lenders could be forced to raise interest rates, lower borrowing limits, and impose any number of other limitations on new loans in order to make them attractive for private investors.

In addition, while Fannie Mae’s overall market share of reverse mortgage lending has shrunk, its share of variable-rate mortgage remains sizeable. Given that most reverse mortgage borrowers prefer the fixed-rate version, this isn’t currently a problem. If Fannie were to disappear, variable-rate reverse mortgage lending would probably trickle to a halt. That could make it difficult for borrowers to select the line-of-credit payment option, and would instead have to opt for monthly payments and/or lump sum payment.

This has been a much-mooted question ever since the National Consumer Law Center issued a report in 2009 that concluded that there was indeed an eerie connection between these two types of mortgages. It implied that the recent boom in reverse mortgages would surely end in bust and losses, just like the explosion in subprime loans. But how accurate is this assessment?

According to Jack Guttentag, the self-proclaimed Mortgage Professor, the comparison is hardly apt: “In fact, the two programs could hardly be more different, and there is no chance of a similar fiasco. Subprime loans imposed repayment obligations on borrowers, many of whom were woefully unprepared to assume them, and which tended to rise over time….But reverse-mortgage borrowers assume no repayment obligation at all…They cannot default on their mortgage because the obligation to make payments under an HECM is the lender’s, not the borrower’s.” He argues further that bank losses associated with reverse mortgages will be non-existent (compared to the extensive sub-prime losses), because the majority are insured by the FHA.

While these are certainly fair points, the counter-argument is that home price declines erode the system behind reverse mortgages just like with sub-prime mortgages. Of course, the FHA stipulates limits to the maximum loan size that reverse mortgages borrowers are eligible for – a major difference. In this sense, it would be as if subprime borrowers were required to make 40% down-payments, so as to minimize the possibility of default. Furthermore, the insurance premiums that the FHA collects are theoretically supposed to offset any losses incurred from declines in property values. In that sense, the possibility of any kid of crisis, akin to the blowup in subprime, seems unlikely, if not altogether impossible. There will be no widespread defaults, no foreclosures, though perhaps some losses which will be ultimately born by the government (taxpayers).

When this round of reverse mortgages begin to mature (i.e. when the borrowers die), however, a crisis of conscience could arise. This crisis will not be financial in nature, but psychological. While the Mortgage Professor correctly points to a survey that established a high degree of borrower satisfaction with reverse mortgages, this could ebb when reverse mortgages come due. In other words, all is well and good when the money is flowing into borrowers’ hands. When it comes to repaying the mortgage and/or turning over the property, though, many borrowers’ (and their heirs) will probably feel some sense of regret. That’s because the very nature of reverse mortgages is such that they are very expensive, both upfront and over the life of the loan.

When borrower realize that in hindsight, the money they were getting wasn’t free, it could provoke the same accusations currently being leveled against subprime lenders: aggressive marketing tactics, inadequate screening of borrowers, a lowering of lending standards, high fees, etc. A crisis? Perhaps not. A growing controversy? Maybe so.

I recently read a press release (masquerading as a “news article”) in which one reverse mortgage lender aimed to refute 10 carefully selected reverse mortgage myths. While the refutations are certainly accurate, many of them struck me as unfair, and were deliberately worded so as to be easy to refute. Thus, I’d like the opportunity to refute their refutations.

Myth: If I take out a reverse mortgage the lender will own my home.

While this is not legally the case (the title still belongs to the borrower, who retains his rights as the homeowner), it can quickly become so financially. Those that borrow the maximum they are entitled to will quickly discover that they own less than half of the value of the home, and that their equity will continue to fall (both in nominal and relative terms) over the life of the home, such that when the loan matures, the lender will be entitled to the majority of the proceeds. In addition, the lender can force the premature sale of the property if the borrower fails to maintain the property and/or pay property taxes.

Myth: My children will be responsible for the repayment of the loan.

If your children want to keep the property after the borrower (you) dies, they MUST repay the loan. Otherwise, the lender has no basis, legal or otherwise, for contacting the children of the borrower.

Myth: I cannot get a reverse mortgage if I have an existing mortgage.

Borrowers with high LTV primary mortgages (perhaps 75%) will find it very difficult if not impossible to obtain a reverse mortgage, especially as a result of the recent lowering of FHA lending maximums. For those whose primary mortgage are close to being repaid, this myth is indeed a myth, and they can in fact use some of the proceeds from the reverse mortgage to repay the primary mortgage.

Myth: Only low-income seniors get reverse mortgages.

If this myth was reworded to read that “Only low-income seniors SHOULD get reverse mortgages” it would no longer be a myth. While it is true that income is not a factor when applying for a reverse mortgage, those whose financial/income positions are strong would have no reason to consider a reverse mortgage. In the event that one’s income declines or ceases, then one would perhaps have a basis for considering a reverse mortgage.

Myth: If I outlive my life expectancy, the lender will evict me.

It’s true that the lender would have no legal basis for doing so, under the terms of the loan. It’s worth pointing out, however, that loans are structured according to actuarial assumptions, such as life expectancy. Thus, if you outlive your life expectancy, you can expect your (heirs’) equity in the home to be even less than otherwise. The only point I’m trying to make here is that there is no free lunch by living longer, since the loan will accumulate interest until it is repaid.

Myth:  Reverse mortgage lenders pressure seniors to buy additional financial products.

While I’d like to believe that the majority of reverse mortgage lenders don’t engage in so-called cross-selling, more than a handful of lenders apparently do, necessitating new legislation to ban the practice.

Myth:  There are no objective advisors available to seniors trying to decide if a reverse mortgage suits their needs.

Thanks to recent FHA legislation, this myth can be firmly declared a myth. Borrowers are now required to undergo counseling with an FHA-approved adviser prior to obtainingthe reverse mortgage.

Myth: There are restrictions on how reverse mortgage proceeds may be used.

It is unfortunate, in my opinion, that there aren’t restrictions. While borrowers (and especially lenders, for marketing purposes) are probably happy that they can use the proceeds of a reverse mortgage for “frivolous” expenditures, they will probably regret this leniency in hindsight, when genuine financial necessity arises and/or they have very little equity left in their homes.

Myth:  Reverse mortgage lenders take advantage of seniors.

As with the “myth” about cross-selling, I’d like to believe that the majority of reverse mortgage lenders do not try to exploit their customers and are simply fulfilling legitimate demand for the service that they are providing. The reality, however, is that reverse mortgages are inappropriately marketed (and often sold, it seems) to customers that simply do not need them. While such borrowers still have every right to obtain reverse mortgages – this being a free country – it is arguable that lenders exploit their ignorance.

Myth: I’ve heard I won’t qualify for a reverse mortgage because of my limited income.

This is basically a restatement of an earlier myth, and it seems it was added by the lender solely to underscore the eligibility of low-income borrowers. What was I just saying about exploitation?