Retirement Experts Discuss New Case for ‘Low Cost’ Reverse Mortgages

In some cases, the perceived high costs of reverse mortgages deter otherwise eligible borrowers from tapping into their home equity for retirement purposes. But financial experts suggest that if these products came equipped with substantially lower setup fees, a new case could be made for reverse mortgages in retirement planning.

Reverse mortgages are often overlooked by retirees who could potentially benefit from these products. Even among those who have reviewed reverse mortgages as a potential funding source, the vast majority of retirement age adults largely misunderstand reverse mortgages, as evidenced by a survey from The American College of Financial Services earlier this year.

“Reverse mortgages do have a negative image with the public,” said Wade Pfau, director of retirement research at McLean Asset Management in McLean, Va., during a webinar this week hosted by Retirement Experts Network.

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Much of the negative public image, Pfau said, relates to reverse mortgages of pre-2013, before many of the significant changes to the Home Equity Conversion Mortgage (HECM) program were enacted.

“Some things have changed,” he said. “The government has changed rules around protecting consumers, making sure consumers have adequate resources so they don’t spend down home equity and can’t meet their obligations.”

In the past, reverse mortgages also had high costs, Pfau said, noting circumstances where it cost more than $10,000 just to set up the loan. But today, some companies now offer HECMs for a low, one-time setup fee of $125. One such company is Reverse Mortgage Funding LLC, which sponsored the Retirement Experts Network webinar.

The webinar, co-hosted by Tom Dickson, who leads RMF’s Financial Advisor Channel, served to educate financial services professionals on refreshed ways of thinking about reverse mortgages, particularly within the context of retirement income planning. This involved a basic overview of the HECM program, including the recent program changes post-2013, as well as a variety of simulations depicting how a reverse mortgage can fit into a financial planning client’s retirement plan.

One scenario assumes a 62-year-old client with a home worth $625,500 in Pennsylvania. By taking a HECM line of credit, this client has $327,500 available to them at the time of the credit line’s inception. If the credit line is left to grow, after 10 years, the available proceeds available to the client will have grown to $613,365. By year 20, the credit line will have grown to $1,149,193.*

With this pricing option, the borrower receives a lender credit covering nearly all closing costs. The upfront cost of $125 is for a non-refundable independent counseling fee, on average, which the borrower pays directly to the counseling agency.

“This [reverse mortgage credit line] can basically provide another deferred income vehicle,” Dickson said during the webinar.

Opening a HECM line of credit can basically serve as a “put option” on the value of the home that can protect borrowers in the event that their home price falls in value, Pfau said.

“If interest rates don’t increase in the future, eventually the line of credit will grow to be more than the home value,” Pfau said. “If you start to introduce risk for home price fluctuations and the potential for rates to increase in the future, by age 82—for someone who opens a line of credit at 62—there’s a 50% chance that the line of credit can grow to be more than the value of the home.”

Unlike most retirement strategies and investments, where low interest rates could hurt, today’s current low rates are particularly beneficial for HECMs and the retirees who use them.

“Reverse mortgages are one of the interesting tools that work better in a low interest rate environment,” Pfau said. “Normally, low rates are bad for retirees—it makes retirement more expensive. Opening the reverse mortgage is one of the few strategies out there, relatively speaking, that benefits from a low interest rate environment.”

*This scenario assumes (1) 62-year-old borrower; (2) PA home valued at $625,500; (3) LOC will grow at 1.25% above the adjustable-rate mortgage, which uses the 1-year LIBOR plus a margin of 3.375%. Initial APR is 4.741% as of 6/21/16, which can change annually. Also assumed: 2% annual interest cap, and 5% lifetime interest cap over the initial interest rate. Maximum interest rate is 9.559%; (4) the growth rate remains at 5.85%; (5) no draws by the borrower.

Written by Jason Oliva

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  • The growth rate cannot be a constant while the LIBOR index fluctuates. The growth rate is one-twelfth of the sum of the ongoing MIP rate of 1.25% plus the current month’s interest rate on the note. Since the example is an annual adjustable rate HECM, interest will never change more frequently than once a year.

    The math is simple. If the line of credit starts at $327,500 and is $613,365 after ten years, the growth rate is 0.52426% which means that beside the MIP ongoing being 1.25%, the effective average interest rate on the note was 5.0412%. If the line of credit on that same HECM is $1,149,193 after twenty years, then the effective average interest on the note rose to 5.0431% a minor but measurably higher average interest rate. It is unclear why the example assumes an incorrect growth rate of 5.85%.

    It seems we are to assume that the unpaid upfront costs were $262 since the current highest PLF for a 62 year old is just 52.4%.

    Examples should be reasonably complete as to assumptions and there should be some assurance that the math is correct.

  • In this example it appears that the borrower did not have a mortgage that was paid off by the Reverse Mortgage, how does RMF cover the closing costs when there would be no lender credit to use?

    • It sounds like a risky gamble by RMF to me. They have to pay the originator and have fixed costs associated with taking the loan through the process. That’s not a small sum of money.

      I guess they are assuming (hoping) these clients aren’t going to leave the LOC unused for years. Seems like a long term play to me, and how many of these loans can you afford to originate now? You’d need to have a solid percentage of high draw loans to counter these.

      As a broker I’m competing more frequently with lenders that are waiving their origination fees on no (or low) draw loans. It would be nice to see a wholesaler open that up to brokers.

      • When you say you wish lenders would offer this to brokers are you saying you want them to pay us a flat fee to do a loan?
        I see doing loans for basically free as a very bad business model and shows how desperate times have become. Look at the loses Walters Investment Management has taken and I am sure they are not the only ones. Maybe RMF is trying to load up on customers to look good for possible investors or buyers?

      • Yes, as a broker operating in a highly competitive space, I don’t like my product offering to be limited compared to my competition. I don’t know if it’s feasible to pay a flat fee on one loan and not another, as that’s above my pay grade. My guess is there would be some challenges there.

        I agree with the latter part of your comment. This cannot be a good idea as these are very expensive businesses to run. If draws aren’t made for 20 years or made and repaid quickly, where’s the revenue coming from?

      • Matt and Eric,

        What seems to be going on is that the lenders are making the entire premium on tails with none of the related origination costs. So lenders can afford to take some risks. If those risks do not pay off, they can always “reverse” their loss leader strategy at will.

        If brokers want to swallow the costs, I do not see why lenders would stop it but of course how long could any broker afford that since they will not be making any money on tails.

        Matt, if you are suggesting that lenders swallow the costs, lenders would be paying more for the same risky reward as it would be with one of its retail originators.

  • High cost???? We usually give the loan costs back. Origination is one of three costs, which is the same for all bank loans. Third party is also the same as all loans which is not in control of the lender. The only difference is the Initial Mortgage Insurance Premium which is 2% of balance at the start ( includes administration to set up) and 1.25% each year on the balance. Without the insurance, this would not be possible (no payment, keep your home). The FHA is the ONLY government program not paid by taxpayers, that’s why the government stays out of this, a major benefit worth the cost by far.
    With a client that has little or no mortgage, the growth on the money in the LOC is most always enough to give them ALL THREE loan costs back in ONE YEAR that they can spend on other things. This loan is virtually FREE from costs with the growth factor applied, which NO other loan offers. Them are some good apples to me.

    • mephisherman,

      First the initial MIP is not 2%. Today it is either 0.5% or 2.5%, depending on whether the disbursements available from the loan the first year is or is not greater than 60%. It seems you missed the program changes FHA made on September 30, 2013, so please READ the official HUD notification, Mortgagee Letter 2013-27, which you can find at:

      http://portal.hud.gov/hudportal/documents/huddoc?id=ML13-27.pdf

      Let us be clear, only adjustable rate HECMs even have a line of credit. Its growth is not income to the borrower but rather additional proceeds made available to the borrower which if used increase the balance due. If the borrower had the right to offset the growth in the line of credit against the balance due, then we might be talking about something like “this loan” being “virtually FREE from costs with the growth factor applied,” BUT unfortunately we are not.

      Here is but another myth: “The FHA is the ONLY government program not paid by taxpayers, that’s why the government stays out of this….” (Me)Fisherman, notice I cut the sentence short because there is no point in spewing out this fishy mess more than once.

      If you knew much about the HECM program you would know that in fiscal year 2013, HUD bailed out the HECM program by taking $1.686 billion out of the US Treasury and placing it into the HECM portion of the MMI Fund.

      You might try to stop misinforming and read the post at:

      http://reversemortgagedaily.com/2013/09/30/house-committee-1-7-billion-fha-bailout-is-unacceptable/

  • This “no fee credit line model” would put all brokers and correspondent lenders out of business. It makes sense for RMF to push this from their retail perspective, but I wonder how much of their business comes from TPO, broker, correspondent channels?

    Bottom line(I think) is this model will further shrink(and maybe sink) the industry. The only folks willing or able to originate will work for the servicers…

    Finally, the majority of financial advisors and attorneys that I work with recognize that the reverse mortgage has such value that the fees are more than justified. In fact I’ve never had an EDUCATED financial advisor complain about the fees(or at least to my face)!!!

    • Jason,

      The following conclusion makes no sense: “The only folks willing or able to originate will work for the servicers…” (sic)

      Servicers do not make income on tails; issuers do. In many cases issuers also have servicing and lending (as FHA approved lenders) operations. It seems as if in the scenario you allude to, HECM only TPOs will evaporate.

      Please explain what you mean by the quoted sentence.

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