FHA reverse mortgages are in the red, and taxpayers could be on the hook for a bailout

The Federal Housing Administration released its annual financial report for fiscal year 2018 last week, and one part of the agency's portfolio is raising alarm bells.

Reverse mortgages make up roughly 6 percent of the loans insured by FHA, yet, according to the Wall Street Journal, they're projected to be responsible for all of the mortgage insurance fund's future losses.

What does this mean?

FHA's insurance fund for reverse mortgages is in the red more than 18 percent for 2018, and the program is being propped up by profits from other loan products. Forward mortgages (purchases and traditional refinances) are showing a positive net worth of $46.81 billion for the agency this year, up $8.4 billion from 2017.

Reverse mortgages — also known as Home Equity Conversion Mortgages, or HECM's — are wreaking havoc on the balance sheets with no end in sight. The average appraised value for a HECM this fiscal year was nearly $335,000.

The current HECM portfolio has a negative net worth of $13.63 billion, and FHA is expected to lose money on the product throughout future projections, while it holds more than 8 million reverse and traditional mortgages to the tune of $1.26 trillion.

HECM's are a loan vehicle for the purpose of allowing elderly homeowners with equity to stay in their homes. Lenders allow the borrower to retain ownership while providing a cash payment either in a lump sum, equity lines or through monthly allotments. When the youngest household spouse passes away or moves out, the property is sold either through foreclosure or a private sale.

The product can be used for either refinance or for new purchases.

When the youngest spouse either vacates the property for a year or passes away, the loan comes due. If the sale of the home does not cover the lender's expenses, the lender can then ask for a bailout for the difference from FHA.

Why is the loan product volatile?

FHA chief Brian Montgomery blames his agency's shortfall on inflated appraisals, but acknowledges that the appraisals for HECM loans are typically conducted years (sometimes decades) in advance — which is one reason the loan product is so incredibly volatile.

In an effort to mitigate the losses, FHA implemented a rule in October calling for a second appraisal to be conducted on a reverse mortgage loan if an initial appraised value exceeds FHA's tolerance threshold. Since Oct. 1, 22 percent of HECMs have required a second appraisal, according to Montgomery.

Regardless, taxpayers will be on the hook if reverse mortgages losses hit the FHA too hard. In 2013, the agency received a bailout of $1.7 billion dollars from the U.S. Treasury, which was the first it had received in 79 years. At the time, the U.S. Department of Housing and Urban Development blamed reverse mortgages for FHA's shortfalls.

If the losses from reverse mortgages continue to accumulate as anticipated, taxpayers could again be left with the check.