Part 4: State of the ‘reverse’ market
As noted in the previous articles in this series, the financial crisis has made the Home Equity Conversion Mortgage (HECM), insured by the Federal Housing Administration, the only reverse mortgage in the market. Yet the HECM has been strengthened by higher loan limits and new options, offering valuable opportunities to many, though not all, seniors.
Characteristics of Seniors Who Should Look Into HECMs: They must be 62 or older and occupy the home as their permanent residence.
They have significant equity in their homes, meaning that their mortgage is either paid off or is small relative to the value of their property, but their income and financial assets are not large enough to meet all their needs.
They either intend to stay in their current home indefinitely, or they want to move to a different home immediately, using a reverse mortgage in the process, and remain there indefinitely. (Note: HECMs that terminate within a few years are very costly).
They are not uncomfortable about leaving their heirs with less (or no) equity in their homes.
A Simple Shopping Rule: Shopping for a HECM can be very difficult, or very easy. If you shop in the conventional way of compiling all the price components for each lender, the process is tedious and prone to error. Interest rates, origination fees, servicing fees and third-party charges are all costs to the borrower that can vary from deal to deal.
But there is a shopping shortcut that is close to foolproof. You shop for the largest amount of cash you can draw at the outset, which is called the "Net Principal Limit," or NPL. The NPL is the bottom line because it is reduced by higher interest rates, origination fees, third-party charges, and servicing fees. I gave an example of an NPL in last week’s column.
Just make sure that when you shop NPLs among different lenders, you give them all the same property value, age and existing debt, because these also affect the NPL. If you tell lender A that you are 72, for example, and only remember that you have a spouse of 68 when you get to lender B, you will be comparing apples and oranges.
The fact that you shop for the largest NPL does not mean that you must draw that amount. On a fixed-rate mortgage (FRM), you must draw the full amount, but on an adjustable-rate mortgage (ARM) you can draw any part of it at the outset, including none, retaining the remainder as a credit line. Or you can use all or part of it to purchase a term or life annuity.
HECM Rates: A HECM has two interest rates. The expected rate is used to calculate the future growth of the borrower’s loan balance, which affects the NPL. The note rate is the actual rate the borrower pays. The two are the same on a FRM, but on an ARM, the note rate changes every month with changes in the rate index.
Locking: Locking the terms of a HECM is easier than locking the terms of a forward mortgage. The expected rate used in calculating the NPL is locked at application with a "float-down" for 120 days. If the rate declines before the loan is closed, the borrower gets the benefit of it. On an ARM, however, the note rate is reset every week and is not locked. This has caused a problem only once, in March, when Fannie Mae increased the ARM margin by a large amount, catching both borrowers and lenders by surprise.
Appraising the Property: When you apply for a HECM, the lender will order an appraisal. The NPL is not finalized until the appraisal is accepted. However, any difference between the final NPL and a preliminary NPL based on a different property value should be exactly proportionate to the difference in values. For example, if you estimate your house value at $400,000 and the appraisal comes in at $396,000, a decline of 1 percent, the NPL should be lower by 1 percent as well.
Selecting a Lender: I recommend going to www.reversemortgage.org, which lists reverse mortgage lenders by state and has links to all their Web sites. Narrow your choice to those who provide calculators that you can use anonymously to find their NPLs for both the adjustable-rate and fixed-rate HECMs.
As a test case, I recently did this for Pennsylvania where I live. Of the 22 lenders listed in the state, six had anonymous calculators. That’s enough. The six included three national lenders that would come up in all other states. Two other lenders in Pennsylvania had calculators on their sites but to use them you have to provide contact information. There is no need to expose yourself to solicitations.
What Not to Do: Under no circumstances allow yourself to be solicited by a loan provider, which requires that your name not appear on lists of reverse mortgage leads. Compiling leads and selling them to lenders is a thriving business. You avoid becoming a lead by not responding to teaser ads, such as "Great New Government Program, See How Much You Qualify to Receive."
It is very hard to get into trouble if you initiate the HECM. When someone else initiates it and you go along with the solicitation, the likelihood of a bad deal for you escalates dramatically. If the soliciting party ties the HECM to an annuity or house purchase, you are almost certainly going to be scammed.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
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