Despite Significant Improvement over the Years, There Remain Worrying Signs of Overappraisal of HECM Loans

HECM properties showed a 15% higher rate of appraised value appreciation at origination

By Yanling Mayer Housing Affordability, Real Estate

Since the Home Equity Conversion Mortgage (HECM) program was officially signed into law in 1988, it has been through many policy changes and product innovations to make reverse mortgages better and safer in meeting the needs of aging homeowners.

One of the recent HECM policy changes was driven by concerns over collateral risk and led the Federal Housing Administration (FHA) to require HECM lenders to conduct a second property appraisal if the initial appraisal was deemed likely to have over-estimated the value of the collateral.  This is the first time in the history of the HECM program that a policy change was directed at the collateral valuation risk. The agency disclosed that about 37% of the loans had a high valuation risk vis-à-vis automated valuation model (AVM) estimates.[1]

Managing collateral risk takes on unique challenges in the context of reverse mortgage lending. Unlike a traditional mortgage where monthly repayment of principal and interest reduces loan balances and collateral risk over time, HECM loans allow homeowners to borrow against the present property value with no monthly repayments. As a result, excessive present property valuations can result in larger-than-expected losses when the properties are later sold upon loan terminations.  In fact, a recent HUD study found that overvaluation may have contributed to excessive losses on defaulted HECM loans. [2]

Rather than using AVM estimates, this analysis uses an alternative method to assess the reasonableness of an appraisal valuation for a HECM loan. By observing the repeat-transaction returns on HECM properties at the time of origination, one can compare the returns on other single-family homes in the local area. The expectation is that the two returns should track closely to each other. If appraisals consistently over-estimate the properties, one can expect homes with HECM originations to show greater value appreciation than non-HECM homes in the local area.

This analysis uses HECM originations identified in the CoreLogic public records database since 2008.[3] The price appreciation between the original purchase price paid by the homeowners and the appraised value for the HECM loan was tallied, along with the average county-level price appreciation during the same time period based on the CoreLogic County-Level Home Price Index.

Figure 1 counts the number of properties in each monthly HECM origination cohort that show either above-market price appreciation or below-market price appreciation. Since 2013, the divide is approximately 50-50. But notably, prior to 2013, there were considerably more HECM properties that had experienced faster price appreciation than the comparable county index. At its peak in 2008-09, 70-75% of the HECM loans originated each month were appraised with above-county price appreciation since the month that the homeowners had purchased the property.

Figure 1: Portions of HECM Properties

Figure 2 shows the rate of price appreciation in excess of the corresponding market rate. Looking at the median value for each monthly HECM portfolio, there are no strong indications that the properties were excessively appraised at origination. However, the mean price appreciations in excess of the market paints a different picture. The mean differences at the origination cohort level are positive and significant and have consistently fluctuated at about 10-20%─meaning that HECM properties have on average experienced between 10% to 20% higher return than their local markets. Statistical tests show that a hypothesis of 15% excess return could not be rejected using a conventional 95% confidence level.

Figure  2: HECM Properties' Price Appreciation in Excess of the Market

The findings are comparable to those in the HUD study of foreclosed HECM properties which found an average of 16% overappraisal at origination.

While returns from repeat transactions are a valid and common approach to property valuation and benchmarking, it nonetheless has its own limitations.  For example, it does not take into consideration property conditions or improvements made by homeowners over time which could have contributed to the differences observed.

[1] HousingWire report: https://www.housingwire.com/articles/46988-fha-we-saw-appraisal-issues-on-37-of-hecm-loans/

[2] “Reverse Mortgage Collateral: Undermaintenance or Overappraisal,” Kevin A. Park, U.S. Department of Housing and Urban Development. The study is available at https://www.huduser.gov/portal/periodicals/cityscpe/vol19num1/ch1.pdf.

[3] Excluded from the analysis are properties appraised at above FHA’s national loan limits. They represent less than 5% of the HECM originations.

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