Fears of Reverse Mortgage Prepayment Rally Overblown says Barclays

The reverse mortgage industry is no stranger to changes, but when the Department of Housing and Urban Development unexpectedly lowered the floor rate for the HECM Standard, Wall Street got nervous.

After the announcement, trading for Ginnie Mae’s HMBS program − which is the dominant vehicle for liquidity −  halted for days over worries about how the new floor would impact prepayment speeds.  While there was plenty of talk about a “refi-rally” that was about to begin, analysts from Barclays say it’s unlikely.

“We believe the concerns may be overblown, given the past performance of HECM loans, refinancing costs and negative amortization of the loans,” said analysts in a report.

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There is no doubt that by lowering the principal limit floor from 5.5% to 5.0%, there is some incentive to refinance, but not enough to drive any rally.

For loans originated prior to October 2009, refinancing at the new factor levels is unlikely according to Barclays.  This group of loans closed prior to the 10% reduction and if homes were re-appraised today, odds are good that values would be lower than before.  “This will overcome any benefit that one might seek to get from the marginal increase in principal limit factors,” analysts said.

Borrowers who closed during 2010 pose the most risk to refinancing, since they will likely receive a higher principal limit factor today.  However, historical data shows borrowers rarely refinanced due to potential benefits in the form of higher balances.  “We believe older borrowers do not react much to small potential increases in balances,” analysts said.  “They may not be aware of the benefit or they may be unwilling to take the extra effort.”

Whether originators will drive the rally without considering the significant costs to borrowers for a minimal increase in proceeds is also unlikely.  Even if lenders overlook the fees “HUD’s strict enforcement of anti-churning laws leaves little room to game the system by cutting the fees too far,” said Barclays.

“Though we do not think there is strong case for higher prepayments given the historical evidence, it is clear that the borrowers at the lower end of the HECM age scale will see some economic incentives,” analysts said. “If any borrowers are to prepay, it will most likely be a brief and quick affair, with remaining borrowers continuing to exhibit prepay behavior as seen in the past.”

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