Are Reverse Mortgage Credit Lines Really Shrinking?

August 3rd, 2009 | by Jim Veale Published in Commentary, FHA, News, Reverse Mortgage | 31 Comments

This article has been written in response to the Reverse Mortgage Daily (RMD) article titled Negative Loan Growth Hits Reverse Mortgage Credit Lines, that covered a news story on Mr. Donald Conn. If you have not read his story, it is worth the read. However, the story does not indicate what kind of reverse mortgage Mr. Conn has, HECM or Homekeeper.

A General Overview

The purpose of this article is to debunk the industry myth that the Home Equity Conversion Mortgage (HECM) credit line always increases by the “growth rate.” Unless otherwise indicated, the “growth rate” in this article is defined as:

one-twelfth of the sum of
- the note rate (i.e., the interest rate used in computing accrued monthly interest for the prior month) plus
- the Federal Housing Administration (FHA) mortgage insurance premium (MIP) rate of 0.5% also charged on the balance due.

Part of the reason why the myth is so prevalent and difficult to eliminate is most loan officers were taught and are still being instructed that the line of credit grows by the growth rate. Authors and even some NRMLA basic course instructors ignore the correct formula in favor of this simple multiplication approach. Unfortunately the amortization schedule only reinforces this myth.

While the computation is simple, the convoluted explanation to the math formula contained in HUD Handbook 4235.1 (sometimes called “the HECM Handbook”) and the related appendices make it seem far more difficult than it really is. Examples would have been helpful.

For the last few months, it has been hoped that the U.S. Department of Housing and Urban Development (HUD) and the National Reverse Mortgage Lenders Association (NRMLA) would reach agreement on how to simplify the problem so that this article would be unnecessary. However, agreement and the resulting HUD Mortgage Letter (ML) may yet be months away.

Limitations on and Assumptions in the Example Below

ML 1997-15 modified the computation in the HECM Handbook for those HECMs “executed” after April 30, 1997. This article only addresses those HECMs executed after that date.

For ease of computation and clarity, the example reflects no activity in the line of credit for the month under consideration other than the change required by the monthly increase to the principal limit as provided in ML 1997-15. For simplicity, the only four components presented are: the principal limit (PL), the unamortized servicing fee set aside (USFSA), the line of credit (LOC) and the balance due (BD). No other potential components of the line of credit equation, such as the taxes and insurance set aside or tenure payments, are included in the example.

So How Is the LOC Computed?

As to this example, the LOC = CPL – BD – USFSA, where CPL is the current principal limit which is the principal limit for the prior month times (one + the monthly growth rate). For example if the prior month’s PL was $120,000 and the growth rate for the month is 0.5%, then the CPL is $120,000 X 1.005 or $120,600.

As a more formal example, assume the following as of the start of the prior month:

PL (Principal Limit) — $119,537.34,
BD (Balance Due) — $82,400.37, and
USFSA (Unamortized Servicing Fee Set Aside) — $2,941.99 (being amortized over the remaining 143 months); thus the
LOC (Line of Credit) — $34,194.98.

The expected interest rate on this HECM was 6.25% and the note rate for the month is 5.00%. The growth rate for the month is 0.458333% or ((5.00% + 0.5%)/12).

As to start of the current month the following results:

CPL — $120,085.22.
1. Growth in the CPL — $547.88 (or $119,537.34 times 0.458333%)
BD — $82,808.03 composed of the following:
1. the beginning balance of $82,400.37 plus
2. the interest of $343.33 plus
3. the MIP of $34.33 plus
4. the monthly servicing fee of $30.00,
USFSA — $2,928.54; thus
LOC — $34,348.65 (which is the difference between $120,085.22 and the sum of $82,808.03 and $2,928.54)

So what is the controversy? The actual growth in the credit line in this example is only $153.67 while multiplying the growth rate by the prior month’s line of credit results in an expected growth of $156.73 for a -$3.06 difference. Because of this discrepancy some have accused lenders of charging borrowers a hidden service fee without disclosure, amounting to many millions of dollars each year.

So what creates the difference? In this example, it is entirely wrapped up in the amortization of the USFSA. Since the increase to the principal limit is based on the note interest rate and the amortization of the USFSA, the expected interest rate, a difference occurs. In this example if there were no USFSA, there should be no difference other than rounding. If the note rate were the same as the expected rate for a HECM, no difference should arise. However, this same difference phenomenon also occurs with tenure and term payouts combined with a LOC (along with other set asides that amortize based on the expected interest rate).

Where the USFSA is the only item being amortized by the expected interest rate, the difference in the actual and calculated growth can be calculated by 1) subtracting the expected note rate from the note rate, 2) dividing that difference by 12, and then 3) multiplying that quotient by the USFSA. From the example above, the difference is -1.25% (5.00%-6.25%) which when divided by 12 is ‑0.1042%. Multiplying -0.1042% times the USFSA ($2,928.54) for the prior month results in ‑$3.06 which is the exact difference between and the actual and calculated LOC.

If this concept is difficult to explain to the most experienced originator, it is even harder to explain to borrowers. However, the key issue is that the difference does not impact the balance due, just proceeds available from the LOC in this example (or the Net Principal Limit generally). However, for those who have assumed that their loan balance will exceed the value of the home at the time the HECM comes due, this is like taking sales proceeds.

While the difference can be negative as in the example above, it can also be positive when the note rate is greater than the expected rate. This can also occur where set asides are fixed and cannot be adjusted for increases to the principal limit. If positive adjustments occur will we hear cries that the lenders are offering too many proceeds to borrowers?

Conclusion

This purpose of this article was to describe, illustrate, and explain the computation of the monthly change to the HECM line of credit. To gain a better understanding, it is highly recommended readers refer to the HECM Handbook (4235.1), its appendices, and ML 97-15.

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

Email This Post

Print This Post

Related Posts

Anonymous

Sorry I don’t have any of that information anymore, it’s all from memory.
Anonymous

Can you please provide a reference? Maybe there is a specific webpage? Do you know how that adjustment is computed? Any information would be useful.
Anonymous

I only know of it through the way Fannie Mae interpreted the HUD guidelines for the calculations.
Anonymous

Mr. DeRenzo,rnrnI read your latest comment a couple of times. In rereading it, there is one question you need to ask yourself: u201cWhat level of professionalism and knowledge do my clients deserve from me?u201d If it is to know what is on the face of the forms, so be it. If it is to know the product and where the forms are misleading, then that will take some additional labor and effort on your part. But to call other liars because of your choice in style in originating hardly seems appropriate.rnrnThe HECM program began with the current line of credit formula with the one change in 1997 as described in the article. To be clear the HECM financial forms are filled with ambiguities, assumptions, short cuts, estimates, and presumptions. Should we be hiding behind these forms? They were not designed with that in mind.rnrnSince we find ourselves providing fixed rate HECMs more and more, there are fewer and fewer times I find myself needing to give a detailed explanation of the growth in the line of credit. However, the emphasis when explaining the growth rate on the loan comparison sheet and the growth (if any) displayed on the amortization schedule is one thing; they are approximations. First, the initial growth rate is only representative since it will not be determined until the loan is funded and will change monthly thereafter. Second, once the growth rate is determined, simple multiplication approximates actual growth but actual growth will be a few dollars more or less based on a somewhat more convoluted formula. rnrnThere has never been one time, anyone ever asked for a more detailed explanation as to a HECM. A retired engineer and his wife, a 64 year old controller of a major metal fabricator wanted a very detailed schedule on how their expected draws would impact the growth in the line of credit on their proprietary reverse mortgage. That presentation and explanation was much simpler than a HECM would have been. rnrnI tell clients to call me with questions on their servicing statements. Only one has ever taken me up on that offer. Not once has anyone ever questioned the calculation of the change to the line of credit. It has always seemed better to explain at origination in general terms what the actual line of credit is about than to wait and take the abuse that your customers seem to be giving you later on.rnrnAs to the nonrecourse issue, I explain it now as HUD has refined that term in Mortgagee Letter 2008-38. I chose to handle my prior clients differently. I did it through an article I write monthly for a monthly senior publication that has a circulation of over 250,000. Knowing that so few of my clients were even interested in the subject, I handled it in this fashion and as I remember to discuss it as I contact many of them. Since I refer to the publication in explaining the issue, I have received little direct criticism. rn
Anonymous

Mr. Veale,rnrnMy comment regarding Non-recourse was meant as a joke. I really didn’t mean for it be the topic, sorry to side track your point of view. rnrnNon-recourse was merely similar in that, it is another issue that makes our industry “back peddle” and look bad.rnrnMy point is simple “enough with acting like this isn’t a big deal”. We can blog until we are blue in the face but it doesn’t change the definition of GROW.rnrnThis issue (and non-recourse) should be faced “head on” and with a “tone” similar to mine instead of this dismissive attitude that justifies why grow doesn’t really mean grow.rnrnDon’t worry Peter, I’m not contemplating jumping “off the ledge” if that was the image you were picturing. Besides, my soap box is not very tall so injury would likely be limited to my ego.rnrnIf it were any of YOUR credit lines, out there, wouldn’t you be as upset as I? I challenge each of you to step into your Client’s shoes and post how you felt when you found that your credit line shrunk and when you asked the LO he/she said “bla bla bla”.rnrnMr. Veal, Do you present Reverse Mortgage Comparisons that reflect the phrase “Credit Line Growth Rate”?rnrnNo, I’m not trying to make this personal, I am trying to wake up dismissive and complacent attitudes out there. I think we have the same goal, right?
Anonymous

Your_Legacy,rnrnPlease elaborate on and expand your last sentence. It would be helpful to see how “the calculated service fee set aside adjustment” is calculated. I have never seen that concept in print or a clear illustration on how it is calculated. I do not remember HUD every presenting that concept in the HECM Handbook, its appendices, or any mortgagee letter. Can it be calculated without knowing the unamortized servicing fee set aside for the prior month?
Anonymous

Mr. DeRenzo,rnrnNo, I am not seeking to redefine “Non-Recourse”. HUD states it is simply publicizing the fact that it has always taken non-recourse to mean that owners and heirs will have to pay the balance due back in full if they want to keep the home when the HECM matures and becomes due and payable in full. rnrnIf you are referring to the tax rules on gains from foreclosure (or short sale) on a non-recourse mortgage, the prior tax article simply applies known tax rules to the known non-recourse nature of HECMs. In absolutely no HUD approved documents is there any statement that proceeds are never taxable. That is someone’s mistaken concept. However, proceeds do not always result in taxable gain even in foreclosure; in fact they rarely result in increased income tax liability but certainly that is a possibility. But taxability does not change the non-recourse nature of a HECM. rnrnCongress can change the rules on all matters related to the non-recourse nature of HECMs including the taxation of HECM proceeds when they are cancelled in foreclosure or short sale. It is generally better to know what the real situation is than to be blind-sided by it. The best place to seek the changes you believe through NRMLA.rnrnAs to the growth rate, NRMLA is working to get that changed through HUD. There seems to be some delays getting the underlying Mortgagee Letter released. Perhaps those who are more familiar with that situation can address it. rnrnAlthough not in the industry at the inception of HECMs, the HECM Handbook was and what is presented above is in that handbook. Again if HUD documents are not consulted, whose fault is that?rnrnThere is indeed a growth rate discussed in the article but it and the word u201cgrowthu201d apply to the principal limit not the line of credit.rnrnFinally, who is it you are referring to when you use the term, “the liars”? There are several servicing executives who agree with your sentiments but not your tone.rnrnThe purpose of the articles was not to make out any individuals as liars but simply to debunk certain myths that are promoted within the industry.rn
Anonymous

Travis-rnrnPlease step back from the ledge….rnrnEffectively, the credit line does grow, it is just not a simple, straight calculation based on the prior months credit line PLUS activity as most of us were taught. It’s based on the prior months principal limit MINUS set aside and current loan balance. We’re all not liars, we just have an opportunity now to present it clearer and correctly.
Anonymous

Every single Reverse Mortgage Comparison I have ever seen shows a “Credit Line Growth Rate”.rnrnApparently you seek to redefine the word GROWTH. (Along with Non-Recourse)rnrnYou are making liars out of all of us by defending this ridiculousness.rnrnIf there is no “Growth” rate and the formula is different than how everything else in the world GROWS then SHAME ON OUR INDUSTRY and shame on you for defending it rather than exposing the liars!!!!
Anonymous

I noticed this years ago at Seattle Mortgage. Looking from a servicing standpoint, it was easier to see and describe as the difference between the straight growth calculation on the Line of Credit as opposed to the growth calculation of the Net Prinicipal Limit, which should equal the LOC loan unless there is a monthly payment. The difference from that perspective is seen by the difference between the monthly service fee and the calculated service fee set aside adjustment, factoring its effect on the growth of the principal limit as well.
Anonymous

Not long ago there was a big debate on RMD on the LOC and the formula shown above. I remember someone named Scared_Of_Politicans (or something like) who was arguing that an unnamed HUD official was saying the LOC could never grow to be bigger than the original Principal Limit. It seemed to be based on a skewed reading of a sentence in the HECM Handbook that looked like it had been taken out of context. I know John Smaldone was involved in that thread. rnrnScared_Of_Politicans was doing research on the subject and promised to discuss the subject with NRMLA. Does anyone know what came of all that? It seemed a little too secretive with little substance despite the very legitimate concern over some kind of a perceived misuse or potential abuse of the LOC.
Anonymous

How wonderfully refreshing to see someone take the time to gather the FACTS and actually analyze them BEFORE publishing an article. If everyone did so, articles like this one wouldn’t be necessary. Kudos!
Anonymous

Mr. Veale,rnAppreciate your efforts and clarity on computing LOC growth rate.
Anonymous

Jim,rnrnThank you for uncovering this most common of misconceptions perpetrated in our industry. The better educated we are, the better our clients needs are served in a professional manner.
Anonymous

Jim is correct, and very clear in his example.rnTake the time to “Do The Math”, explain it and understand it.rn
http://www.facebook.com/people/Bob-Purcell/586834082 Bob Purcell

Jim is correct, and very clear in his example.
Take the time to “Do The Math”, explain it and understand it.
junglegene

Mr. Veale,
Appreciate your efforts and clarity on computing LOC growth rate.
Tobkin

How wonderfully refreshing to see someone take the time to gather the FACTS and actually analyze them BEFORE publishing an article. If everyone did so, articles like this one wouldn't be necessary. Kudos!
The_Critic

Not long ago there was a big debate on RMD on the LOC and the formula shown above. I remember someone named Scared_Of_Politicans (or something like) who was arguing that an unnamed HUD official was saying the LOC could never grow to be bigger than the original Principal Limit. It seemed to be based on a skewed reading of a sentence in the HECM Handbook that looked like it had been taken out of context. I know John Smaldone was involved in that thread.

Scared_Of_Politicans was doing research on the subject and promised to discuss the subject with NRMLA. Does anyone know what came of all that? It seemed a little too secretive with little substance despite the very legitimate concern over some kind of a perceived misuse or potential abuse of the LOC.
Your_Legacy

I noticed this years ago at Seattle Mortgage. Looking from a servicing standpoint, it was easier to see and describe as the difference between the straight growth calculation on the Line of Credit as opposed to the growth calculation of the Net Prinicipal Limit, which should equal the LOC loan unless there is a monthly payment. The difference from that perspective is seen by the difference between the monthly service fee and the calculated service fee set aside adjustment, factoring its effect on the growth of the principal limit as well.
TravisDeRenzo

Every single Reverse Mortgage Comparison I have ever seen shows a “Credit Line Growth Rate”.

Apparently you seek to redefine the word GROWTH. (Along with Non-Recourse)

You are making liars out of all of us by defending this ridiculousness.

If there is no “Growth” rate and the formula is different than how everything else in the world GROWS then SHAME ON OUR INDUSTRY and shame on you for defending it rather than exposing the liars!!!!
peterhamilton

Travis-

Please step back from the ledge….

Effectively, the credit line does grow, it is just not a simple, straight calculation based on the prior months credit line PLUS activity as most of us were taught. It's based on the prior months principal limit MINUS set aside and current loan balance. We're all not liars, we just have an opportunity now to present it clearer and correctly.
James_E_Veale_CPA_MBT

Mr. DeRenzo,

No, I am not seeking to redefine “Non-Recourse”. HUD states it is simply publicizing the fact that it has always taken non-recourse to mean that owners and heirs will have to pay the balance due back in full if they want to keep the home when the HECM matures and becomes due and payable in full.

If you are referring to the tax rules on gains from foreclosure (or short sale) on a non-recourse mortgage, the prior tax article simply applies known tax rules to the known non-recourse nature of HECMs. In absolutely no HUD approved documents is there any statement that proceeds are never taxable. That is someone's mistaken concept. However, proceeds do not always result in taxable gain even in foreclosure; in fact they rarely result in increased income tax liability but certainly that is a possibility. But taxability does not change the non-recourse nature of a HECM.

Congress can change the rules on all matters related to the non-recourse nature of HECMs including the taxation of HECM proceeds when they are cancelled in foreclosure or short sale. It is generally better to know what the real situation is than to be blind-sided by it. The best place to seek the changes you believe through NRMLA.

As to the growth rate, NRMLA is working to get that changed through HUD. There seems to be some delays getting the underlying Mortgagee Letter released. Perhaps those who are more familiar with that situation can address it.

Although not in the industry at the inception of HECMs, the HECM Handbook was and what is presented above is in that handbook. Again if HUD documents are not consulted, whose fault is that?

There is indeed a growth rate discussed in the article but it and the word “growth” apply to the principal limit not the line of credit.

Finally, who is it you are referring to when you use the term, “the liars”? There are several servicing executives who agree with your sentiments but not your tone.

The purpose of the articles was not to make out any individuals as liars but simply to debunk certain myths that are promoted within the industry.
James_E_Veale_CPA_MBT

Your_Legacy,

Please elaborate on and expand your last sentence. It would be helpful to see how “the calculated service fee set aside adjustment” is calculated. I have never seen that concept in print or a clear illustration on how it is calculated. I do not remember HUD every presenting that concept in the HECM Handbook, its appendices, or any mortgagee letter. Can it be calculated without knowing the unamortized servicing fee set aside for the prior month?
TravisDeRenzo

Mr. Veale,

My comment regarding Non-recourse was meant as a joke. I really didn't mean for it be the topic, sorry to side track your point of view.

Non-recourse was merely similar in that, it is another issue that makes our industry “back peddle” and look bad.

My point is simple “enough with acting like this isn't a big deal”. We can blog until we are blue in the face but it doesn't change the definition of GROW.

This issue (and non-recourse) should be faced “head on” and with a “tone” similar to mine instead of this dismissive attitude that justifies why grow doesn't really mean grow.

Don't worry Peter, I'm not contemplating jumping “off the ledge” if that was the image you were picturing. Besides, my soap box is not very tall so injury would likely be limited to my ego.

If it were any of YOUR credit lines, out there, wouldn't you be as upset as I? I challenge each of you to step into your Client's shoes and post how you felt when you found that your credit line shrunk and when you asked the LO he/she said “bla bla bla”.

Mr. Veal, Do you present Reverse Mortgage Comparisons that reflect the phrase “Credit Line Growth Rate”?

No, I'm not trying to make this personal, I am trying to wake up dismissive and complacent attitudes out there. I think we have the same goal, right?
James_E_Veale_CPA_MBT

Mr. DeRenzo,

I read your latest comment a couple of times. In rereading it, there is one question you need to ask yourself: “What level of professionalism and knowledge do my clients deserve from me?” If it is to know what is on the face of the forms, so be it. If it is to know the product and where the forms are misleading, then that will take some additional labor and effort on your part. But to call other liars because of your choice in style in originating hardly seems appropriate.

The HECM program began with the current line of credit formula with the one change in 1997 as described in the article. To be clear the HECM financial forms are filled with ambiguities, assumptions, short cuts, estimates, and presumptions. Should we be hiding behind these forms? They were not designed with that in mind.

Since we find ourselves providing fixed rate HECMs more and more, there are fewer and fewer times I find myself needing to give a detailed explanation of the growth in the line of credit. However, the emphasis when explaining the growth rate on the loan comparison sheet and the growth (if any) displayed on the amortization schedule is one thing; they are approximations. First, the initial growth rate is only representative since it will not be determined until the loan is funded and will change monthly thereafter. Second, once the growth rate is determined, simple multiplication approximates actual growth but actual growth will be a few dollars more or less based on a somewhat more convoluted formula.

There has never been one time, anyone ever asked for a more detailed explanation as to a HECM. A retired engineer and his wife, a 64 year old controller of a major metal fabricator wanted a very detailed schedule on how their expected draws would impact the growth in the line of credit on their proprietary reverse mortgage. That presentation and explanation was much simpler than a HECM would have been.

I tell clients to call me with questions on their servicing statements. Only one has ever taken me up on that offer. Not once has anyone ever questioned the calculation of the change to the line of credit. It has always seemed better to explain at origination in general terms what the actual line of credit is about than to wait and take the abuse that your customers seem to be giving you later on.

As to the nonrecourse issue, I explain it now as HUD has refined that term in Mortgagee Letter 2008-38. I chose to handle my prior clients differently. I did it through an article I write monthly for a monthly senior publication that has a circulation of over 250,000. Knowing that so few of my clients were even interested in the subject, I handled it in this fashion and as I remember to discuss it as I contact many of them. Since I refer to the publication in explaining the issue, I have received little direct criticism.
Your_Legacy

I only know of it through the way Fannie Mae interpreted the HUD guidelines for the calculations.
James_E_Veale_CPA_MBT

Can you please provide a reference? Maybe there is a specific webpage? Do you know how that adjustment is computed? Any information would be useful.
Your_Legacy

Sorry I don't have any of that information anymore, it's all from memory.
Anonymous

Can you please provide a reference? Maybe there is a specific webpage? Do you know how that adjustment is computed? Any information would be useful.
LegacyJim

Sorry I don’t have any of that information anymore, it’s all from memory.

Are Reverse Mortgage Credit Lines Really Shrinking?

Wholesale Lender Sponsors

Sponsors

Exclusive Training Provider

Reverse Mortgage Jobs

Recent Articles

Popular Posts

Our Sites