WSJ: Reverse Mortgages Get a Makeover

NewImage.jpgThe Wall Street Journal reported over the weekend that reverse mortgages are getting a makeover, in the form of the HECM Saver.

Released in October, the new product is appealing to a new type of borrower according to the WSJ.  For example, a retired management consultant decided to go with a HECM Saver rather than a traditional home equity line of credit.

The Saver’s 4.01% “effective” rate—consisting of a 2.76% variable interest rate, plus a 1.25% annual fee—”compares favorably” with the 4.78% variable rate the client would pay for a home-equity line of credit, he says.

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Although closing costs on the Saver are higher, the client plans to hold the reverse mortgage long enough to come out ahead thanks to the lower interest payments, Mr. Gregory says. The client also didn’t want to worry about his wife being saddled with monthly loan payments if something were to happen to him.

However, the article notes that it’s not all positive with the HECM Saver.  The amount of money provided is less than the standard and the HECM Saver rate is higher from many lenders due to investor uncertainty over the loans.

While “it may be appropriate to pay a higher interest rate to get a lower upfront fee,” Barbara Stucki, vice president for home-equity initiatives at the nonprofit National Council on Aging says, such a move could backfire if a borrower plans to keep the loan for a long time.

The Reverse Mortgage Gets a Makeover

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  • This article shows how poorly media, borrowers, and originators understand basic financial concepts. While all seem to have some idea what a HECM is, few apply financial principles to the products well.

    For example the reporter analyzes the upfront costs by looking at the percentage of upfront costs to the value of the home. That literally makes no sense unless one is using that percentage to compare the costs of selling the home which was not part of the presentation. HECMs are loans. The percentage should be based on the upfront costs (excluding any set aside) to the net principal limit, i.e., the principal limit minus upfront costs and servicing fee set aside.

    If one home is appraised at a million and another, $750,000, the upfront cost of proceeds should be the same to borrowers of identical age looking at the same products offered by the same lender on the same day in same metropolitan area. If one uses the value of the home, the one with the $1,000,000 home would show a percentage 75% of the other home owner. That is a ridiculous measure. If one caps the value at the lending limit, what sense does that make?

    Then you have the situation where one borrower is 82 years old and another is 62. Both have a home of equal value and are looking at the same loan from the same lender on the same day in the same metropolitan area. Both intend on keeping the HECM for five years because both are intending on moving then. Using the value of the home as the denominator makes the percentage upfront cost of the HECMs the same for both but that presents an entirely false illusion unless both will use exactly the same amount of proceeds throughout the five year period which is again a ridiculous assumption. Since the 82 year old will have more proceeds available, the percentage cost of those available proceeds should be less than the percentage upfront cost of the proceeds available to the 62 year old.

    Now we come to an interesting statement by the originator: “He thinks his investments are likely to appreciate by more than the housing market….” What does the housing market have to do with anything? In either scenario, the home owner will be keeping the home. The comparison should be the expected after tax growth of the investments less the after tax cost of the HECM to the expected net after tax growth of the investments based on the conversion of the some of the investments to cash (as needed) over the expected life of the HECM. The quoted statement shows that the senior seems to believe he is losing some growth in the value of the home during the time the HECM is in place. It seems the originator has the same understanding or why illustrate the use of a Saver with the statement of a borrower which shows the borrower does not understand how a HECM works?

    I will end with this last statement: “So far, lenders say, Saver loans appear to be attracting a more-affluent borrower who likes the idea of a smaller reverse mortgage and lower fees. At MetLife Bank, for example, customers with a Saver have an average home value of about $350,000, versus $250,000 for those with regular reverse mortgages.” Since when is affluence based on gross home values?

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