The Return of Jumbo Reverse Mortgages: A Closer Look

NewImage.jpgGeneration Mortgage’s decision to release the first jumbo reverse mortgage product in years is a big step for the industry and a closer look at the product guidelines provides some insight into where proprietary products are heading.

Signaling the future of reverse mortgages will include some sort of a credit underwrite, the Plus products requires a minimum FICO score of 700, a first for the industry.

“Eventually we will see credit underwriting in all reverse mortgage products,” said Jeff Lewis, Chairman of Generation Mortgage in an email to RMD.  “It is better for the guarantor/investor when the borrower has the means to stay current on their other obligations and maintain the home properly.”  Since the PLUS product is private, Generation was able to make a change it cannot impose on the government’s product unilaterally he said.

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Targeted at borrowers whose home values higher than $1 million, the program is offered at two different rates, 7.875% and 8.875%.  The higher rate provides the borrower more money upfront.  “The proceeds difference is about 10% on average between the two coupons,” said Lewis.  Compensation for each rate is the same, so there is no benefit for the lender to steer a consumer into the higher rate unless they’re looking for additional proceeds.

The product also provides borrowers and their estates with an extra benefit through its Gen Plus Estate Guard.  “The benefit is that despite the non-recourse nature of the loan, borrowers and heirs are potentially exposed to significant tax liability if the future home value is not sufficient to cover the accrued loan balance,” said the company in materials provided to correspondents.  “By having the ability to monitor the home value versus the loan balance, they can potentially help keep the loan from becoming grossly upside down.”

Essentially, the feature allows borrowers to order a new appraisal after the loan has been originated and if it indicates the value of the Property is less than 80% of the outstanding balance of the note, the mortgage amount due will cease to accrue interest.

However, Generation has the right to order a subsequent appraisals at its discretion and if the appraisal finds the value of the property is more than 90% of the outstanding balance of the note at the time of the subsequent appraisal, interest will start to accrue again.

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  • Mr. Pinter,

    I agree with you wholeheartedly that with sufficient caveats, one can make a case for HECM proceeds being tax free. For example, currently it is quite appropriate and accurate to say: u201cIf a HECM is repaid in full, HECM proceeds are tax free.u201d

    (Be prepared, however,there is a theory in income taxation which treats proceeds from a nonrecourse debt as cancelled when paid to the borrower if on the date of payment, the balance due (after payment) exceeds the value of the home at the time of payment. The amount considered cancelled is the lesser of 1) the amount paid to the borrower or 2) the balance due in excess of the value of the property securing the debt. For example assume the payment is $1,000. Immediately before payment the balance due was $89,300 and the value of the home on that day was $90,000. The amount considered cancelled is $300. The reason is after the payment is made, the balance due is $90,300 which is $300 greater than the value of the home. The lesser of — 1) the payment ($1,000) or 2) the balance due (after payment) in excess of the value of the home at the time of payment ($300) — is the latter which is $300. rnrnAlthough the theory has been applied to certain loans where the proceeds have exceeded the value of the property at the time of funding, it is currently the exception, not the rule. The rational is based on the principle that the lender has no grounds to reasonably believe that such excess will in fact ever be repaid, i.e., the security is insufficient at the time of payout to repay all of the balance of the loan then due. Because 1) most lenders do not know the value of the underlying property at the time of payout unless it is on or near funding and 2) the sheer difficultly in enforcing such a concept, the theory has never been incorporated or formally adopted into the federal Internal Revenue Code.)

    If you feel there is a “silver bullet” definition of “tax free” that will stand up to all tests of that term being challenged as false and misleading in all forums when it comes to a correct description of HECM proceeds, it would be a huge benefit to the entire industry if you would share it with us all. I have no such definition to offer the industry. I personally would appreciate having that definition and any underlying documents justifying that position.

    From an economic, financial, and tax viewpoint, I believe calling HECM proceeds tax-free without sufficient caveats is not only false and misleading but also entirely indefensible when properly attacked. I now realize the conclusion to my first example in the comment above from yesterday is only partially correct. Since there is a required and agreed upon order to the application of repayment on a HECM with accrued but unpaid servicing fees being paid first, followed by accrued but unpaid interest, then unpaid principal, it seems that at least $50,000 (and in all likelihood much more) of the amount forgiven would be treated as cancelled or forgiven debt.

    I am not so naive that I believe my conclusions are always correct. Please take a stab at it and let us know why you believe my conclusions are erroneous. I have fairly thick skin. Whatever your definition, please give us your sources and/or rational.

    I just took advantage of the Generation Mortgage statement about their Estate Guard to let my conclusions about HECM proceeds be known.

  • Mr. Veale,rnI don’t want to waste your time, but I think the answer to my last question was simply “yes”. I never wanted to get into a long discussion with you about muni bonds or semantics about the words “tax-free”. I think we disagree about how the term “tax-free” can be adequately qualified to make it acceptable to advertise in connection to a HECM and I’m pretty sure that neither of will chage our minds. I appreciate your expertise and the time you have given to my questions.

  • Mr. Pinter,rnrnMy problem with all of your questions and responses is you miss the most basic issue. The basic issue is what is the definition of u201ctax-free?u201d What my comments and replies demonstrate is that HECM proceeds can become taxable, increase a tax gain, and result in higher income tax liabilities.rnrnYour questions and responses assume what tax-free means. But the definition of that term is up to the governmental bodies (including the courts) overseeing our activities. I honestly do not know what that term means to the Federal Trade Commission, the HUD OIG, a civil court, or any other place of determination. It could mean different things to the same agency because it is being defined by different individuals within that agency. The term may have one definition as to one agency but an entirely different definition to another. rnrnSince u201ctax-freeu201d does not refer to a specific tax, the taxing agencies involved include federal, state, and in some case, cities. One cannot simply look to the federal Internal Revenue Code for a direct answer because even in there u201ctax-freeu201d is a term of art and has different meanings based on the context of its use. Besides that, you might believe we are seeing change in HECM land but our change is static when compared to the rate and volume of changes in federal, state, and city tax rules. So what the definition of u201ctax-freeu201d is today could be different tomorrow. rnrnYou seem to be seeking for a science when in fact what we are looking at is a term of art. It is not the menagerie and complexities of income tax computations which are at issue; those merely help prove or disprove if the results meet a particular definition. What matters is what does the governing body which is looking into the matter mean when it says u201ctax-freeu201d and that can vary greatly.rnrnFor example, does u201ctax-freeu201d mean free of tax? If that is the definition then the calculation must be done on a case-by-case basis. It could involve as much as 2 decades of federal, state, and city income tax returns (or more). Determining if the transaction was tax-free could take years and years after the reverse mortgage terminates due to utilization of loss carryforwards including capital losses which generally continue for individuals for the lifetime of the taxpayer.rnrnIf u201ctax-freeu201d means exempt from taxation, i.e., tax-exempt, that is a simple answer; it is not. If u201ctax-freeu201d means nontaxable, again the proceeds could be taxable, so again, HECM proceeds are not tax-free under this definition. If it means that the particular borrower will pay no taxes, that is a question of fact. But if it means HECM proceeds can never result in the increase of any tax, then that is false. rnrnSince I am not all knowing and have no idea who may question the use of the term u201ctax-free,u201d it is best if that term is avoided when describing the tax characteristic of HECM proceeds. It is to this end I am addressing my concerns.rnrnHowever, you may feel you have the absolute definition of “tax-free” which everyone will agree to and thus can use the term without fear of retribution or being found to lure seniors into a transaction that is not or may not ultimately be tax-free.rnrnI must get on to other things. I can only provide so much. You must make your own decision.rn

  • Mr. Veale; I apologize for not understanding but I just want to be clear: Are you saying that your issue with the term “tax-free” is only because of the possibiity of the client owing more than the value of the home at termination?

  • Mr. Pinter,

    What I did NOT say was: “we should not advertise HECM’s as tax-free because in a situation where the borrower owes more than the value of the value of the home at terminitation and gets that interest forgiven, there could be a tax liability.” It is not JUST the forgiveness of interest that is at issue, it is also the forgiveness of principal proceeds paid out to the senior.

    For example, if a senior received proceeds of $200,000 at HECM funding based on a home value of $300,000 in 2006 and at termination in 2010 (due to death) the net proceeds from the sale of the home are only $150,000, not only will all of the accrued interest be forgiven but so will $50,000 in proceeds previously received plus all upfront costs, accrued MIP, and monthly servicing fees.

    But rather than continuing in this narrow reply area, please see the rest of my comment below.

  • Mr. Pinter,rnrnI do not say this lightly; your comparison is at best flawed. You present a common but mistaken notion about municipal bonds (u201cmunisu201d). Unfortunately I have heard several securities and insurance licensees who sell munis — and thus SHOULD know better — make the same erroneous argument. rnrnTo state that muni interest paid by the issuer to the muni holder is excludible as tax-exempt is absolutely accurate. That is the only tax information which most muni prospectuses present or marketing references. Internal Revenue Code Section 103 (as well as the U.S. Constitution) specifically exempts all such income from taxation. rnrnWhat you are talking about is the taxation on the payoff of muni principal. I have never read any muni prospectus discussing the taxation of the payoff of muni principal or declaring it to be tax-free. Further I know of no marketing declarations of that nature. rnrnWhile interest from munis can result in increased income tax liabilities due to 1) increased taxable Social Security income and 2) (if a special class of muni, private activity bonds) increased alternative minimum tax (u201cAMTu201d) taxable income, a detailed discussion of taxation resulting from munis is complex and beyond the scope of this reply. (Please see the article at http://www.investinginbonds.com/learnmore.asp?catid=8&subcatid=60 along with IRS Publications 17 and 915 for further information).rnrnNormally as to munis issued after 1984, the sole gain that can arise at maturity is that related to u201cmarket discount,u201d all of which is ordinary income. However, total gain from the disposition of a muni before maturity is measured by subtracting the adjusted income tax basis of the muni from its net selling price. In this context the net selling price is gross proceeds minus interest and accrued interest ( reflected in those proceeds) as well as commissions and other selling costs. rnrnCash paid out to borrowers on a nonrecourse mortgage is not unique to HECMs nor were reverse mortgages the first mortgages to permit borrowers to receive cash in a mortgage refinance. Please point out a single lender which advertises cash paid out at closing on a nonrecourse forward mortgage as tax-free or any HELOC lender which declares distributions on their nonrecourse HELOCs are tax-free; I am not aware of any. rnrnAt the last NRMLA national convention in San Diego, the session dealing with marketing concerns warned against using this term, “tax-free”. While I disagree with some of the rational in that portion of the meeting, I wholeheartedly endorse the conclusion. However, that is not to say I am rendering legal advice on marketing.rnrnGoing back to your statement, it is the payoff of muni principal that can result in capital gain and/or ordinary income. Again I know of no marketing literature that discusses the taxation of the payoff of muni principal. It is as wrong to declare that the payoff of muni principal is tax-free as it is to declare that the receipt of HECM principal is tax-free. Although to the extent proceeds eventually end up being taxable, they will generally be what tax advisors term u201ctax deferred.u201d rn

  • Mr. Veale,rnrnWhile I am sure that you have forgotten more about tax law than I will ever know, I disagree with your opinion.rnIf I understand your post correctly (and I had to read it several times) you are saying that “we should not advertise HECM’s as tax-free because in a situation where the borrower owes more than the value of the value of the home at terminitation and gets that interest forgiven, there could be a tax liability”rnBy this reasoning, Municipal Bonds also should not be advertised as tax free because the buyer can sell them at a profit and incur a capital gain.rnHowever, munis are all advertised a tax-free because their income is tax free (for this discussion, let’s just stick to federal income tax and not get into what municipality the buyer lives in) just as HECM proceeds are tax free because they are loan proceeds.rnThe fact that there is a possiblilty of tax liability, in my opionion, should not preclude saying that “HECM proceeds (or cash-flow) are tax-free”

  • This product definetly fits a small niche. Bank of America’s product has a lower LTV but currently at almost half the interest rate and no 700 credit score requirements.rnrnThese products with lower costs (no MIP) are great for someone who does not need or want the full amount they have to take with a HECM. I personally have come across many borrowers who only want a smaller amount for home improvements etc. and can not qualify for a Home Equity Loan.

  • Mr. Pinter,

    I believe the last sentence of the second paragraph of my comment makes that plain. But let’s view it from a more technical point of view.

    Cancellation (or forgiveness) of any portion of nonrecourse debt as part of the disposition of the underlying security will result in additional proceeds for purposes of determining gain or loss on the transaction for federal income tax purposes. If the additional proceeds result in additional gain, some or all of that additional gain MAY be eligible for exclusion under various provisions of the Internal Revenue Code including the exclusion for gain on the sale of a principal residence. To the extent any taxable gain remains, it may increase the gross federal income tax liability. To the extent that the net income tax liability before refundable income tax credits increases (i.e., gross income tax liability less nonrefundable income tax credits), a HECM was not “tax-free.” Since the possiblity exists that a HECM will not be “tax-free,” how can we advertise it is?

    Some may want to bring up the deduction of interest but since that matter is far too technical for a reply, to the extent that interest is deductible in the year of HECM termination, it will reduce the gross income tax liability; however, it is still possible that increased net income tax liability could result so that we come back to the same question. Should we advertise that a HECM is tax-free?

    Additional state income tax liabilities could result especially if the state income tax structure or treatment of the various tax items differ substantially from the federal. So again should we advertise that a HECM is tax-free?

    There is much more to say but not in a reply. Also this subject was covered in a RMD article last year.

  • Guest,

    A HECM is nonrecourse because the note itself makes the loan nonrecourse. For example, the first sentence of Subsection (C), titled u201cLimitation of Liabilityu201d of Section 4, titled u201cManner of Paymentu201d of the Bank of America HECM note states: u201cBorrower shall have no personal liability for payment of the debt.u201d That sentence alone makes the note nonrecourse. Every HECM note has a statement like it. However, HECM notes have other statements further refining the nonrecourse nature of the note.

    A HECM is a qualifying reverse mortgage insured by FHA. To be a HECM, the mortgage must first be a qualifying reverse mortgage; 15 U.S.C. 1602(bb), quoted in my comment, makes it clear that all reverse mortgage transactions are nonrecourse. So what would happen if the HECM loan were closed but then FHA rejected the loan as uninsurable? It seems you would deem the note recourse but why? It is still a reverse mortgage.

    If the note is nonrecourse, then why does the consumer need FHA insurance? One very significant answer lies in the fact that the insurance reduces risk to the lender allowing for both lower interest rates and higher principal limit factors. If you believe you are still correct, please cite the legal premise for your statements.

    I have absolutely no idea what “the silent deed and trust” are. HUD records a second note and a second trust deed here in California, making them both public documents. When something is public, it is not u201csilent.u201d So to what documents are you referring and what do the documents you cite have to do with a HECM being nonrecourse?

    As to your point about FHA taking over u201cwhen the first position institution failsu201d, you seem to have missed the following statement from the beginning of the final paragraph of my comment above: u201cWhile there are other benefits, the main consumer benefitu2026.u201d I consider the right and responsibility of FHA to take over the responsibilities for the loan to the consumer in the event the lender is not able to fulfill its obligations, as one of the u201cother benefits.u201d You may disagree with the categorization but there is no question it is a consumer benefit; no one in the article or this thread have stated otherwise. But what does any of this have to do with the nonrecourse nature of a HECM?

  • Has anybody seen what LTV’s the new product will go to? Is this another Bank of America product at 20-30 LTV that no one wants or is this a real 50-60 LTV product that makes sense?

  • I don’t agree with your arguement about it being farther from the truth and it being a myth. I personally would have picked the word further but that’s not the point. The FHA insurance is a reserve to cover cross overs- where the mortgage is more than the value of the home at time of loan settlement. That is what makes it non-recourse. A second benefit is the silent second deed and trust that go into action if and when the first position institution fails or is terminated by HUD.

  • In providing the following caveat, Generation Mortgage dispels one of the myths our industry promotes when it comes to reverse mortgages: u201cu2026despite the non-recourse nature of the loan, borrowers and heirs are potentially exposed to significant tax liability if the future home value is not sufficient to cover the accrued loan balanceu2026.u201d rnrnThis is true of HECMs as well. For years members of our industry have falsely promoted reverse mortgage proceeds as u201ctax-free;u201d they are not. Because of several income tax provisions, the nonrecourse nature of a HECM will rarely result in an increase in income tax liabilities for borrowers (and only borrowers). Except for perhaps for the heirs of the last borrower who still resides in the home as the principal residence of that borrower and passes away in 2010, u201cheirs are potentially exposed to significant tax liability if the future home value is not sufficient to cover the accrued loan balanceu2026.u201d Of course, exposure to potential income tax liability may be direct as well as indirect through increased income tax liability in the estate or trust of the decedent.rnrnAnother myth members of our industry promote is that FHA insurance makes a HECM nonrecourse. Nothing could be farther from the truth. A HECM is a reverse mortgage and 15 U.S.C. 1602(bb) states: u201cThe term u2018reverse mortgage transactionu2019 means a nonrecourse transactionu2026.u201d In at least two places in the HUD HECM Handbook, HUD declares that HECMs are nonrecourse. The HECM note document itself makes it clear the note not MIP is what makes HECMs nonrecourse.rnrnWhile there are other benefits, the main consumer benefit that FHA insurance provides is lower interest rates and higher ratios of principal limit to maximum claim amounts than would otherwise be available for values of homes up to $625,500 (and higher) due to less risk to lenders/investors for HECMs which is provided through FHA insurance. This is one of the factors that caused Congress to permit MIP to be treated as additional interest (at least from 2007 through 2010) rather than nondeductible insurance as it once was.rn

  • Congratulations to Mr. Lewis and Generation Mortgage in putting this product together. While not many seniors may have 700 FICO scores in retirement, this is a useful and unbiased measure of the ability of the borrower to pay household obligations. The Estate Guard is a great feature as well.

  • Congratulations to Mr. Lewis and Generation Mortgage in putting this product together. While not many seniors may have 700 FICO scores in retirement, this is a useful and unbiased measure of the ability of the borrower to pay household obligations. The Estate Guard is a great feature as well.

  • In providing the following caveat, Generation Mortgage dispels one of the myths our industry promotes when it comes to reverse mortgages: “…despite the non-recourse nature of the loan, borrowers and heirs are potentially exposed to significant tax liability if the future home value is not sufficient to cover the accrued loan balance….”

    This is true of HECMs as well. For years members of our industry have falsely promoted reverse mortgage proceeds as “tax-free;” they are not. Because of several income tax provisions, the nonrecourse nature of a HECM will rarely result in an increase in income tax liabilities for borrowers (and only borrowers). Except for perhaps for the heirs of the last borrower who still resides in the home as the principal residence of that borrower and passes away in 2010, “heirs are potentially exposed to significant tax liability if the future home value is not sufficient to cover the accrued loan balance….” Of course, exposure to potential income tax liability may be direct as well as indirect through increased income tax liability in the estate or trust of the decedent.

    Another myth members of our industry promote is that FHA insurance makes a HECM nonrecourse. Nothing could be farther from the truth. A HECM is a reverse mortgage and 15 U.S.C. 1602(bb) states: “The term ‘reverse mortgage transaction’ means a nonrecourse transaction….” In at least two places in the HUD HECM Handbook, HUD declares that HECMs are nonrecourse. The HECM note document itself makes it clear the note not MIP is what makes HECMs nonrecourse.

    While there are other benefits, the main consumer benefit that FHA insurance provides is lower interest rates and higher ratios of principal limit to maximum claim amounts than would otherwise be available for values of homes up to $625,500 (and higher) due to less risk to lenders/investors for HECMs which is provided through FHA insurance. This is one of the factors that caused Congress to permit MIP to be treated as additional interest (at least from 2007 through 2010) rather than nondeductible insurance as it once was.

      • Mr. Pinter,

        I believe the last sentence of the second paragraph of my comment makes that plain. But let's view from a more technical point of view.

        Cancellation (or forgiveness) of any portion of nonrecourse debt as part of the disposition of the underlying security will result in additional proceeds for purposes of determining gain or loss on the transaction for federal income tax purposes. If the additional proceeds result in additional gain, some or all of that additional gain MAY be eligible for exclusion under various provisions of the Internal Revenue Code including the exclusion for gain on the sale of a principal residence. To the extent any taxable gain remains, it may increase the gross federal income tax liability. To the extent that the net income tax liability before refundable income tax credits increases (i.e., gross income tax liability less nonrefundable income tax credits), a HECM was not “tax-free.” Since the possiblity exists that a HECM will not be “tax-free,” how can we advertise it is?

        Some may want to bring up the deduction of interest but since that matter is far too technical for a reply, to the extent that interest is deductible in the year of HECM termination, it will reduce the gross income tax liability; however, it is still possible that increased net income tax liability could result so that we come back to the same question. Should we advertise that a HECM is tax-free?

        Additional state income tax liabilities could also result especially if the state income tax structure differs substantially from the federal. So again should we adversite that a HECM is tax-free?

        There is much more to say but not in a reply. Also this subject was covered in a RMD article last year.

      • Mr. Veale,

        While I am sure that you have forgotten more about tax law than I will ever know, I disagree with your opinion.
        If I understand your post correctly (and I had to read it several times) you are saying that “we should not advertise HECM's as tax-free because in a situation where the borrower owes more than the value of the value of the home at terminitation and gets that interest forgiven, there could be a tax liability”
        By this reasoning, Municipal Bonds also should not be advertised as tax free because the buyer can sell them at a profit and incur a capital gain.
        However, munis are all advertised a tax-free because their income is tax free (for this discussion, let's just stick to federal income tax and not get into what municipality the buyer lives in) just as HECM proceeds are tax free because they are loan proceeds.
        The fact that there is a possiblilty of tax liability, in my opionion, should not preclude saying that “HECM proceeds (or cash-flow) are tax-free”

      • Mr. Pinter,

        What I did NOT say was: “we should not advertise HECM's as tax-free because in a situation where the borrower owes more than the value of the value of the home at terminitation and gets that interest forgiven, there could be a tax liability.” It is not JUST the forgiveness of interest that is at issue, it is also the forgiveness of principal proceeds paid out to the senior.

        For example, if a senior received proceeds of $200,000 at HECM funding based on a home value of $300,000 in 2006 and at termination in 2010 (due to death) the net proceeds from the sale of the home is only $150,000, not only will all of the accrued interest be forgiven but so will $50,000 in proceeds previously received plus all upfront costs, accrued MIP, and monthly servicing fees.

        But rather than continuing in this narrow reply area, please see the rest of my comment below.

      • Mr. Veale; I apologize for not understanding but I just want to be clear: Are you saying that your issue with the term “tax-free” is only because of the possibiity of the client owing more than the value of the home at termination?

  • I don't agree with your arguement about it being farther from the truth and it being a myth. I personally would have picked the word further but that's not the point. The FHA insurance is a reserve to cover cross overs- where the mortgage is more than the value of the home at time of loan settlement. That is what makes it non-recourse. A second benefit is the silent second deed and trust that go into action if and when the first position institution fails or is terminated by HUD.

    • Guest,

      A HECM is nonrecourse because the note itself makes the loan nonrecourse. For example, the first sentence of Subsection (C), titled “Limitation of Liability” of Section 4, titled “Manner of Payment” of the Bank of America HECM note states: “Borrower shall have no personal liability for payment of the debt.” That sentence alone makes the note nonrecourse. Every HECM note has a statement like it. However, HECM notes have other statements further refining the nonrecourse nature of the note.

      A HECM is a qualifying reverse mortgage insured by FHA. To be a HECM, the mortgage must first be a qualifying reverse mortgage; 15 U.S.C. 1602(bb), quoted in my comment, makes it clear that all reverse mortgage transactions are nonrecourse. So what would happen if the HECM loan were closed but then FHA rejected the loan as uninsurable? It seems you would deem the note recourse but why? It is still a reverse mortgage.

      If the note is nonrecourse, then why does the consumer need FHA insurance? One very significant answer lies in the fact that the insurance reduces risk to the lender allowing for both lower interest rates and higher principal limit factors. If you believe you are still correct, please cite the legal premise for your statements.

      I have absolutely no idea what “the silent deed and trust” are. HUD records a second note and a second trust deed here in California, making them both public documents. When something is public, it is not “silent.” So to what documents are you referring and what do the documents you cite (if they exist) have to do with a HECM being nonrecourse?

      As to your point about FHA taking over “when the first position institution fails”, you seem to have missed the following statement from the beginning of the final paragraph of my comment above: “While there are other benefits, the main consumer benefit….” I consider the right and responsibility of FHA to take over the responsibilities for the loan to the consumer in the event the lender is not able, as one of the “other benefits.” You may disagree with the categorization but there is no question it is a consumer benefit; no one in the article or this thread have stated otherwise. But what does any of this have to do with the nonrecourse nature of a HECM?

  • Has anybody seen what LTV's the new product will go to? Is this another Bank of America product at 20-30 LTV that no one wants or is this a real 50-60 LTV product that makes sense?

  • Mr. Pinter,

    I believe the last sentence of the second paragraph of my comment makes that plain. But let's view from a more technical point of view.

    Cancellation (or forgiveness) of any portion of nonrecourse debt as part of the disposition of the underlying security will result in additional proceeds for purposes of determining gain or loss on the transaction for federal income tax purposes. If the additional proceeds result in additional gain, some or all of that additional gain MAY be eligible for exclusion under various provisions of the Internal Revenue Code including the exclusion for gain on the sale of a principal residence. To the extent any taxable gain remains, it may increase the gross federal income tax liability. To the extent that the net income tax liability before refundable income tax credits increases (i.e., gross income tax liability less nonrefundable income tax credits), a HECM was not “tax-free.” Since the possiblity exists that a HECM will not be “tax-free,” how can we advertise it is?

    Some may want to bring up the deduction of interest but since that matter is far too technical for a reply, to the extent that interest is deductible in the year of HECM termination, it will reduce the gross income tax liability; however, it is still possible that increased net income tax liability could result so that we come back to the same question. Should we advertise that a HECM is tax-free?

    Additional state income tax liabilities could also result especially if the state income tax structure differs substantially from the federal. So again should we adversite that a HECM is tax-free?

    There is much more to say but not in a reply. Also this subject was covered in a RMD article last year.

  • This product definetly fits a small niche. Bank of America's product has a lower LTV but currently at almost half the interest rate and no 700 credit score requirements.

    These products with lower costs (no MIP) are great for someone who does not need or want the full amount they have to take with a HECM. I personally have come across many borrowers who only want a smaller amount for home improvements etc. and can not qualify for a Home Equity Loan.

  • Mr. Pinter,

    I do not say this lightly; your comparison is at best flawed. You present a common but mistaken notion about municipal bonds (“munis”). Unfortunately I have heard several securities and insurance licensees who sell munis — and thus SHOULD know better — make the same erroneous argument.

    To state that muni interest paid by the issuer to the muni holder is excludible as tax-exempt is absolutely accurate. That is the only tax information which most muni prospectuses present or marketing references. Internal Revenue Code Section 103 (as well as the U.S. Constitution) specifically exempts all such income from taxation.

    What you are talking about is the taxation on the payoff of muni principal. I have never read any muni prospectus discussing the taxation of the payoff of muni principal or declaring it to be tax-free. Further I know of no marketing declarations of that nature.

    While interest from munis can result in increased income tax liabilities due to 1) increased taxable Social Security income and 2) (if a special class of muni, private activity bonds) increased alternative minimum tax (“AMT”) taxable income, a detailed discussion of taxation resulting from munis is complex and beyond the scope of this reply. (Please see the article at http://www.investinginbonds.com/learnmore.asp?c… along with IRS Publications 17 and 915 for further information).

    Normally as to munis issued after 1984, the sole gain that can arise at maturity is that related to “market discount,” all of which is ordinary income. However, total gain from the disposition of a muni before maturity is measured by subtracting the adjusted income tax basis of the muni from its net selling price. In this context the net selling price is gross proceeds minus interest and accrued interest ( reflected in those proceeds) as well as commissions and other selling costs.

    Cash paid out to borrowers on a nonrecourse mortgage is not unique to HECMs nor were reverse mortgages the first mortgages to permit borrowers to receive cash in a mortgage refinance. Please point out a single lender which advertises cash paid out at closing on a nonrecourse forward mortgage as tax-free or any HELOC lender which declares distributions on their nonrecourse HELOCs are tax-free; I am not aware of any.

    At the last NRMLA national convention in San Diego, the session dealing with marketing concerns warned against using this term, “tax-free”. While I disagree with some of the rational in that portion of the meeting, I wholeheartedly endorse the conclusion. However, that is not to say I am rendering legal advice on marketing.

    Going back to your statement, it is the payoff of muni principal that can result in capital gain and/or ordinary income. Again I know of no marketing literature that discusses the taxation of the payoff of muni principal. It is as wrong to declare that the payoff of muni principal is tax-free as it is to declare that the receipt of HECM principal is tax-free. Although to the extent proceeds eventually end up being taxable, they will generally be what tax advisors term “tax deferred.”

  • Mr. Pinter,

    My problem with all of your questions and responses is you miss the most basic issue. The basic issue is what is the definition of “tax-free?” What my comments and replies demonstrate is that HECM proceeds can become taxable, increase a tax gain, and result in higher income tax liabilities.

    Your questions and responses assume what tax-free means. But the definition of that term is up to the governmental bodies (including the courts) overseeing our activities. I honestly do not know what that term means to the Federal Trade Commission, the HUD OIG, a civil court, or any other place of determination. It could mean different things to the same agency because it is being defined by different individuals within that agency. The term may have one definition as to one agency but an entirely different definition to another.

    Since “tax-free” does not refer to a specific tax, the taxing agencies involved include federal, state, and in some case, cities. One cannot simply look to the federal Internal Revenue Code for a direct answer because even in there “tax-free” is a term of art and has different meanings based on the context of its use. Besides that, you might believe we are seeing change in HECM land but our change is static when compared to the rate and volume of changes in federal, state, and city tax rules. So what the definition of “tax-free” is today could be different tomorrow.

    You seem to be seeking for a science when in fact what we are looking at is a term of art. It is not the menagerie and complexities of income tax computations which are at issue; those merely help prove or disprove if the results meet a particular definition. What matters is what does the governing body which is looking into the matter mean when it says “tax-free” and that can vary greatly.

    For example, does “tax-free” mean free of tax? If that is the definition then the calculation must be done on a case-by-case basis. It could involve as much as 2 decades of federal, state, and city income tax returns (or more). Determining if the transaction was tax-free could take years and years after the reverse mortgage terminates due to utilization of loss carryforwards including capital losses which generally continue for individuals for the lifetime of the taxpayer.

    If “tax-free” means exempt from taxation, i.e., tax-exempt, that is a simple answer; it is not. If “tax-free” means nontaxable, again the proceeds could be taxable, so again, HECM proceeds are not tax-free under this definition. If it means that the particular borrower will pay no taxes, that is a question of fact. But if it means HECM proceeds can never result in the increase of any tax, then that is false.

    Since I am not all knowing and have no idea who may question the use of the term “tax-free,” it is best if that term is avoided when describing the tax characteristic of HECM proceeds. It is to this end I am addressing my concerns.

    However, you may feel you have the absolute definition of “tax-free” which everyone will agree to and thus can use the term without fear of retribution or being found to lure seniors into a transaction that is not or may not ultimately be tax-free.

    I must get on to other things. I can only provide so much. You must make your own decision.

  • Mr. Veale,
    I don't want to waste your time, but I think the answer to my last question was simply “yes”. I never wanted to get into a long discussion with you about muni bonds or semantics about the words “tax-free”. I think we disagree about how the term “tax-free” can be adequately qualified to make it acceptable to advertise in connection to a HECM and I'm pretty sure that neither of will chage our minds. I appreciate your expertise and the time you have given to my questions.

    • Mr. Pinter,

      I agree with you wholeheartedly that with sufficient caveats, one can make a case for HECM proceeds being tax free. For example, currently it is quite appropriate and accurate to say: “If a HECM is repaid in full, HECM proceeds are tax free.”

      (Be prepared, however, there is a theory in taxation which has yet to be fully adopted by Congress, the IRS, or the courts, which says that if at the time when a lender pays proceeds to the borrower on a nonrecourse debt, such proceeds should be considered cancelled debt to the extent that the balance due AFTER payout exceeds the value of the underlying property at the time of payout, but limited to the actual amount of the payout. Although that has been applied to certain loans where the proceeds have exceeded the value of the property at the time of funding, it is currently the exception, not the rule. The rational is based on the principle that the lender has no basis to reasonably believe that those proceeds will in fact ever be repaid, i.e., the security is insufficient at the time of payout to repay all of it. Because 1) most lenders do not know the value of the underlying property at the time of payout unless it is on or near funding and 2) the sheer difficultly in enforcing such a concept, the theory has never been incorporated or formally adopted into the federal Internal Revenue Code.)

      If you feel there is a “silver bullet” definition of “tax free” that will stand up to all tests of that term being challenged as false and misleading in all forums when it comes to a correct description of HECM proceeds, it would be a huge benefit to the entire industry if you would share it with us all. I have no such definition to offer the industry. I personally would appreciate having that definition and any underlying documents justifying that position.

      From an economic, financial, and tax viewpoint, I believe calling HECM proceeds tax-free without sufficient caveats is not only false and misleading but also entirely indefensible when properly attacked. I now realize the conclusion to my example is only partially correct. Since there is a required and agreed upon order of the application of repayment on a HECM with accrued but unpaid servicing fees being paid first, followed by accrued but unpaid interest, then unpaid principal, it seems that at least $50,000 (and in all likelihood much more) of the amount forgiven would be treated as cancelled or forgiven debt.

      I am not so naive that I believe my conclusions are always correct. Please take a stab at it and let us know why you believe my conclusions are erroneous. I have fairly thick skin. Whatever your definition, please give us your sources and/or rational.

      I just took advantage of the Generation Mortgage statement about their Estate Guard to let my conclusions about HECM proceeds be known.

  • Mr. Veale,rnI don’t want to waste your time, but I think the answer to my last question was simply “yes”. I never wanted to get into a long discussion with you about muni bonds or semantics about the words “tax-free”. I think we disagree about how the term “tax-free” can be adequately qualified to make it acceptable to advertise in connection to a HECM and I’m pretty sure that neither of will chage our minds. I appreciate your expertise and the time you have given to my questions.

  • Mr. Pinter,

    I agree with you wholeheartedly that with sufficient caveats, one can make a case for HECM proceeds being tax free. For example, currently it is quite appropriate and accurate to say: u201cIf a HECM is repaid in full, HECM proceeds are tax free.u201d

    (Be prepared, however,there is a theory in income taxation which treats proceeds from a nonrecourse debt as cancelled when paid to the borrower if on the date of payment, the balance due (after payment) exceeds the value of the home at the time of payment. The amount considered cancelled is the lesser of 1) the amount paid to the borrower or 2) the balance due in excess of the value of the property securing the debt. For example assume the payment is $1,000. Immediately before payment the balance due was $89,300 and the value of the home on that day was $90,000. The amount considered cancelled is $300. The reason is after the payment is made, the balance due is $90,300 which is $300 greater than the value of the home. The lesser of — 1) the payment ($1,000) or 2) the balance due (after payment) in excess of the value of the home at the time of payment ($300) — is the latter which is $300. rnrnAlthough the theory has been applied to certain loans where the proceeds have exceeded the value of the property at the time of funding, it is currently the exception, not the rule. The rational is based on the principle that the lender has no grounds to reasonably believe that such excess will in fact ever be repaid, i.e., the security is insufficient at the time of payout to repay all of the balance of the loan then due. Because 1) most lenders do not know the value of the underlying property at the time of payout unless it is on or near funding and 2) the sheer difficultly in enforcing such a concept, the theory has never been incorporated or formally adopted into the federal Internal Revenue Code.)

    If you feel there is a “silver bullet” definition of “tax free” that will stand up to all tests of that term being challenged as false and misleading in all forums when it comes to a correct description of HECM proceeds, it would be a huge benefit to the entire industry if you would share it with us all. I have no such definition to offer the industry. I personally would appreciate having that definition and any underlying documents justifying that position.

    From an economic, financial, and tax viewpoint, I believe calling HECM proceeds tax-free without sufficient caveats is not only false and misleading but also entirely indefensible when properly attacked. I now realize the conclusion to my first example in the comment above from yesterday is only partially correct. Since there is a required and agreed upon order to the application of repayment on a HECM with accrued but unpaid servicing fees being paid first, followed by accrued but unpaid interest, then unpaid principal, it seems that at least $50,000 (and in all likelihood much more) of the amount forgiven would be treated as cancelled or forgiven debt.

    I am not so naive that I believe my conclusions are always correct. Please take a stab at it and let us know why you believe my conclusions are erroneous. I have fairly thick skin. Whatever your definition, please give us your sources and/or rational.

    I just took advantage of the Generation Mortgage statement about their Estate Guard to let my conclusions about HECM proceeds be known.

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