WSJ: Rethinking Reverse Mortgages Once Again

July 18th, 2012 | by Elizabeth Ecker Published in News, Reverse Mortgage | 6 Comments

Reverse mortgages are increasingly being used as a retirement planning tool, but still have some pitfalls for unwary borrowers, writes the Wall Street Journal this week in the second installment of a two-part series on rethinking reverse mortgages.

After publishing the first part in the series, WSJ collected input from readers, including assertions that a reverse mortgage prolongs the inevitable, with downsizing being a more viable option.

The article also reviews concerns expressed in a recent Consumer Financial Protection Bureau report, including a focus on the proportion of fixed rate reverse mortgages relative to the overall number.

“The CFPB report pegged much of the blame on an increase in retirees taking lump-sum payouts. In the 12 months ended September 2011, almost three-quarters—73%—of borrowers took all or almost all of their funds upfront, a rise of 30 percentage points since 2008.

Ironically, a contributor to this trend appears to be one of the newer, low-cost government-backed reverse-mortgage options. While most HECM reverse-mortgage options carry adjustable rates and offer a line of credit or annuity-like payouts over time, the sole fixed-rate HECM choice is available only with a lump-sum payout.

“Consumers like the idea of fixed rates,” says Megan Thibos, author of the CFPB report. “They focus more on that than on the rest of the loan, and that is something we worry about.”

Read the original Wall Street Journal article.

Written by Elizabeth Ecker

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James_E_Veale_CPA_MBT

Fixed rate HECMs have been problematic from their introduction five fiscal years ago in the same way adjustable HECMs are when all available proceeds have been drawn down (other than tenure payouts). The difference between the two situation is that with fixed rate HECMs, proceeds must be drawn down while with an adjustable rate HECM that option is not mandatory unless all of the proceeds must be used to pay off liens at funding or later due to failure to pay property charges.

Fixed rate HECMs are the dinosaur of our industry as monthly adjustable HECMs are for the interest rate cap risk tolerant. It is time for a change.

It is time for the industry to adopt hybrid HECMs and keep the adjustable rate HECMs as is. Fixed rate HECMs should go the way of all questionable financial products.

For those who do not know what a hybrid HECM is, it has many variations; however, the one being generally discussed in our industry is fixed rate up to the amount of proceeds taken at funding. The loan is divided into two parts, the fixed rate portion would be no different than it is today. The remainder of the hybrid HECM would be treated as if a separate adjustable rate HECM with tenure payouts, term payouts, and the line of credit.

For example if a borrower has a net principal limit of $400,000 of which $280,000 is used to pay off the existing mortgage and HECM loan costs, $120,000 would be available as if a different HECM. The “first” HECM would be a typical fixed rate HECM. The “second” would be an adjustable rate HECM with a line of credit and the typical payout methods available including tenure payouts. If the borrower wanted, they could elect a lump sum payout at funding so that the entire HECM will be held as a fixed rate HECM. Being hybrid would allow borrowers choose if they wanted the entire HECM to be fixed rate. Once funded, no changes to the basic structure would be permitted.

To make this switch, the secondary market will need time to accept and understand the product so any change will take some time as long as the investment community is willing to price the product in relation to the the portion of the product which is fixed rate and adjustable at the same pricing it does today. So for example, if 80% of the principal limit was fixed then that portion would be priced in the same way that fixed HECMs are priced now and the remainder would be priced as an adjustable rate HECM. When this was shopped in 2007 for a proprietary product it was rejected; however, this product is much different than since it would be a HECM.
ReverseGal2

Thank you James Veale! Great explanation. The Hybrid Fixed/Arm would be an excellent way to add credibility to our industry. As it stands now, our product choices push folks into taking all of their money which is often not in their best interest.
Another product or secondary market item that could be addressed in the shorter term, is the cap on the ARM. Is a 10 lifetime cap justified when it is standard to have a 5 lifetime cap plus annual caps on forward mortgages? I know it does not change the borrowers monthly payments like a rate change does on forwards, but it scares many folks into taking the fixed and all of their money. A more reasonable lifetime cap would help. When a potential borrower already believes that a fixed rate is the most secure type of loan, discussing an ARM/LOC loan with a potential rate of over 12% doesn’t sound good. It is easy for someone that only wants to sell fixed rates to look like the good guy to the customer.
Lancejackson

I hope the loan officers out there are doing a good job of educating borrowers on the pros and cons of fixed rate HECMs under their current form. They have a place for borrowers that need all or most of the cash immediately, otherwise they are sometimes not the best choice. Showing that to prospects is a great way to earn their trust and business.
Guest

Would this new loan be considered open or closed for Reg Z purposes?
James_E_Veale_CPA_MBT

Great question. I wish I had an answer.

On Tuesday in the CFPB Study webinar, Mr. Peter Bell indicated that HUD is willing to work with the industry on the product and right now the ball is back in the lenders’ court.
As to how the mortgage must be structured, those issues are best left to legal counsel. Some have stated it will have to be divided into two separate mortgages.

Right now, legal issues seem less critical than finding acceptance in the secondary market.
James_E_Veale_CPA_MBT

ReverseGal2,

There is one existing product which because of its pricing in the secondary market has not been offered through lenders for some time. It has a 2% annual cap, adjusts once a year, and has a lifetime cap of 5%. The margin was 1.6% higher than the comparable monthly adjusting HECMs.

Towards the end of the period in which this product was being offered, I ran a 750 word article about it and found interest. The people who called, I would have offered an annually adjusting Saver if they had existed back then. The callers needed less $100,000 and had homes valued above $450,000.

Our monthly adjusting rate product adjusts to market conditions which makes it more desirable than the annually adjusting rate HECM since there is no way to tell how the overall earnings will be in comparison to the monthly adjusting. Investors do not like this kind of uncertainly even though historically, the annually adjusting usually accrued more interest than the monthly adjusting.

Sorry, there is not better news.