One of the more interesting subtopics at the last NRMLA Convention was how to reduce the entry costs of HECM reverse mortgages. This certainly takes on more importance in early 2009 than at any time since the 1990s — as HECMs are the sole products available to reverse mortgage originators.

Since the House Financial Services Committee announced its intent last year to reduce and cap HECM origination fees, reaction from originators has been swift and at times furious. Some attacked HUD, others leashed out at AARP, still others blamed Congress, and some even questioned NRMLA.

The immediate reaction from many originators was to ask if FHA was taking a similar hit on their upfront fees. When the answer was negative, the response from RM originators at times was delivered with great anger. So at the NRMLA Convention it was interesting to see some of the meekest originators stepping up to the microphone to ask HUD/FHA officials if there was a way to lower the 2% upfront MIP or defer some part of it by increasing the rate of the monthly MIP fee from an annual 0.5% rate to say 1%.

Many in the industry ask the question since the law generally mandates lenders (and thus the originators) to lower their fees, why was the FHA fee structure left in place so that it could increase to over $8,000 on a Maximum Claim Amount of over $400,000? Rumors abound that the HECM pool is greatly overfunded and could be severely cut back with little risk to the program. Others fear that the fund is being used to support the forward FHA insurance program. Some are concerned that politicians covet the excess and want it for their own pet projects.

Seniors and their advisors are put off by the high upfront costs of HECMs. Originators find that some seniors would rather do without necessities than to incur such large upfront costs.

As of yet there has been no recent, fundamentally sound actuarial study to determine if the pool is, in fact, overfunded. Looking at where most of the homes are located that are insured by FHA HECM coverage and at the reduced values of those homes, a theoretical argument could be made that as long as any significant portion of the existing pool of HECMs is still outstanding, there should be concern that the pool may be underfunded. After all, didn’t the proprietary product market devolve in part because of this concern?

As an example, one borrower in San Bernardino, California got a reverse mortgage in 2005 when the value of the home was $300,000. He had no existing debt in 2005, has taken no proceeds, and has left his line of credit alone. Today his creditline is over $230,000 but the value of his house is less than $150,000 before selling costs. Imagine if he invested his entire creditline in treasuries today, stayed in the house for six months, handed the house keys to the bank, and purchased a new, better, and more expensive home with his newfound money using a “HECM for purchase” to pay part of the purchase price.

What about the widow who had a $400,000 home in a California resort area when she took out her loan in 2005, used some proceeds to pay off her existing mortgage and paid down personal debts. Today she finds her home worth less than $200,000 but her HECM balance is over $275,000. These are only two of the “toxic” loans that if “accelerated,” could begin depleting the alleged HECM surplus. Just remember HECM risk is not evenly distributed around the country. A disproportionate percentage of the HECM loans are on homes in markets where the home values have declined precipitously and may yet go still lower.

Supposedly by 2000 only a little over 40,000 HECMs had been originated. Since that time over 10 times that many have come within the “HECM pool”. Some say the average life of a HECM loan is 7 years and others, over 11. With the vast majority of these loans originated in the last 36 months and many of them in the condition described in the prior paragraph, a thorough study should be made of the “surplus” in the HECM pool. Those announcing their findings should be able to say “our report is based on a 99% level of confidence in our findings.”

Now let’s move to a totally different subject — funding the pool. Many want to reduce the upfront MIP by increasing the MIP annual rate to say 1%. The problem is that rate is used in computing the principal limit; thus if the MIP annual rate increases, the principal limit in most cases will drop.

Instead of being restricted by how the program is currently being funded, let’s “step outside of the box.” Why not have a flat upfront MIP fee of say $3,000 for every single HECM, continue the current annual 0.5% rate monthly MIP on the outstanding loan balance as is, and charge 3% for the use of the funds as the funds are taken by the borrower? This 3% should not apply to accruing interest or monthly service charges. The reason for the 3% rate is: 1) the base (the available principal limit, i.e., the principal limit minus the servicing fee set aside) is much lower in most cases than the Maximum Claim Amount, and 2) the cost to the borrower to insure the loan reflects more of the risk inherent in higher loan balances. However, this methodology is not based solely on a risk base concept which FHA deems unsuitable.

At the moment no one can say if 3%, 1.5%, or some other percentage is needed until a fundamentally sound actuarial study is complete! The 3% is just an example. It is not intended as an exact or even reasonably correct rate to charge on loan proceeds. What is being suggested is a different way to fund the MIP by reducing the upfront fee and not raising the monthly MIP annual rate.

Some mechanism will need to go into place so that if the borrower pays down the loan and later obtains more proceeds, the 3% fee will not be applied to any proceeds until the total amount repaid has been distributed back to the borrower. By restructuring the upfront MIP, the industry might even see a rise in the acquisition of HECMs by those who currently owe no debt on their own home. Obviously until money is taken, these loans are all but risk free. The additional fees that these otherwise reluctant borrowers might bring into the HECM insurance pool could substantially offset the reduced upfront MIP.

What is clear is that this is only one idea out of many. Those of us who originate should come to the NRMLA “table” with many more ideas that can be used in helping HUD determine how it can fundamentally reduce the upfront MIP fee for most borrowers while not reducing the principal limit by increasing the annual 0.5% rate monthly MIP charge against the outstanding loan balance and at the same time help more seniors obtain the funds they need.

Just an idea….

James E. Veale, CPA, MBT
SVP of Tax and Government Affairs & Director of Originator Recruiting for Security One Lending

Technorati Tags: Reverse Mortgage,News,HECM,FHA,HUD,Insurance