On November 18, 2009, the FHA published MORTGAGEE LETTER 2009-49, the purpose of which was to clarify “FHA requirements for secured subordinate financing under the Home Equity Conversion Mortgage (HECM) Program.” Specifically, the letter imparted that “there shall be no outstanding or unpaid obligations, either unsecured or secured, incurred by the HECM mortgagor in connection with the HECM transaction…”

This immediately sparked a raging debate in the reverse mortgage industry, where second liens had always been thought of as legal (if not uncommon) when subordinated under reverse mortgages. This debate has played out on the comments section of “Reverse Mortgage Daily,” where readers seem to have concluded that under no circumstances (except if used to make repairs, as stipulated in the FHA letter) can a second lien exist under a reverse mortgage.

Here, I’d like to offer my two cents. Let’s start with the basics: a second lien is basically another mortgage, that has lower priority than the primary mortgagee when it comes to being repaid by the borrower. This is especially relevant in the case of default, whereby the proceeds from the sale of the property would first be used to repay the primary mortgage holder before the second lien mortgage lender would receive anything.

The FHA has made it clear (on previous occasions, in fact) that it is forbidden for a borrower to take out a second lien in connection with a reverse mortgage. In other words, if the proceeds from the HECM reverse mortgage are not enough to pay the closing costs and/or repay any existing mortgage debt, the borrower is forbidden to take out a new (second lien) mortgage.

What’s less than clear is whether existing second liens are allowable. In other words, if the reverse mortgage proceeds were sufficient enough to repay an existing primary mortgage but not quite enough to cover a secondary mortgage, would the borrower still be allowed to obtain the reverse mortgage while continuing to service the existing secondary mortgage?

This uncertainty seems to be focused on a recent story that described precisely this kind of situation. The subject of the piece used the reverse mortgage to completely repay the primary mortgage but only partially repay an existing secondary mortgage. The folks over at Reverse Mortgage Daily have declared that “the subordination in the story by Mr. Kelly would be a violation of the mortgagee letter.”Personally, I’m not inclined to agree. The FHA’s letter forbids subordinated financing in connection with the HECM transaction. It doesn’t go so far as to say that subordinated financing is forbidden outright. Still, the letter is ambiguous, and we hope that the FHA will issue further clarification, so we don’t need to speculate further.

On a side note, subordinated financing (whether new or existing) is rare when the primary mortgage is a reverse mortgage. Since reverse mortgages are negatively amortizing (i.e. the loan value increases over time), there is a risk that the value of the mortgaged home could actually exceed the value of the mortgage. While lenders are protected against this possibility through the mandatory FHA insurance, a lender holding a second lien would have no protection against default, and thus would probably reject such an arrangement. In the case at the center of the RMD controversy, the reverse mortgage enabled the borrower to pay down half of the balance of the second lien. It is probably only because of this that the subordinate lender consented to a new primary mortgage.