Rate Volatility Cranks Up the Pressure on Reverse Mortgage Lending

Rising short-term interest rates have a minimal impact on reverse mortgage borrowing compared to conventional mortgage lending, but recent volatility in longer-term expected rates is a cause for concern among both reverse mortgage lenders and borrowers alike.

The expected rate on a Home Equity Conversion Mortgage is not the rate at which the loan accrues interest. Rather, these rates are tied to calculating the Principal Limit and as such, they are used to determine the amount of loan proceeds available to borrowers.

As these rates increase, the less money HECM borrowers are be eligible to receive. So while rising expected rates stand to adversely impact reverse mortgage borrowers, the implications for lenders will result in slimmer profits and roadblocks to future loan production.

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Expected rates for adjustable-rate HECMs are based on the London Interbank Offered Rate (LIBOR) Index. When calculating the expected interest rate on LIBOR-indexed HECMs, lenders use the 10-Year LIBOR swap rate.

The 10-year swap rate used for calculating the LIBOR HECM principal limit was 2.18% as of Tuesday, November 29, 2016, up 0.06% from the previous week. This means that LIBOR HECMs with a margin of 2.88% or less can pay the maximum principal limit, according to weekly rate data compiled by Ibis Software Corporation, which regularly tracks rate activity associated with HECMs.

Though the expected rate is still below the Department of Housing and Urban Development’s “floor” of approximately 5%, rates have been ticking upward since the beginning of the month. Just a few weeks ago, the rate dipped as low as 1.68% as of November 8.

The complexities of a fluctuating expected rate bring a multitude of challenges to reverse mortgage originators and their customers, said Cliff Auerswald, president at All Reverse Mortgage.

“When the expected rate moves above the floor, originators will need to offer lower margins to maximize a customer’s principal lending limit,” Auerswald said.

Because lower margins yield less profit to the lender, Auerswald says originators will also be challenged to become more conservative in their pricing models. As a result, this could lead to a reduction of incentives such as closing cost credits, which will raise costs to the customer and subsequently lower their net principal limit.

“A rise in closing costs and lower proceeds will have a significant impact on those qualifying with high mandatory obligations as those who need every bit of their principal limit to retire existing mortgage obligations may find themselves at a shortfall,” Auerswald said.

Unlike the forward market, reverse mortgages lenders are not allowed to pre-lock loan interest rates. Typically, lenders must wait for the appraisal to be conducted on the applicant’s property and the loan has to be approved in underwriting before they can lock-in rates.

This presents yet another obstacle for reverse mortgage lenders, many of whom are facing appraisal delays as long as 4-8 weeks, and even beyond, in certain markets. By the time the appraisal is completed, it is likely that the interest rate quoted to a loan applicant will not be the same as it was earlier in the application process.

Other reverse mortgage product offerings, such as the HECM for Purchase, will also be challenged by expected rate volatility, particularly for those waiting on new construction since an originator is prohibited from taking an application before the Certificate of Occupancy is issued, and therefore, also unable to lock the principal lending limit for 120 days.

“There are a lot of moving parts to the expected rate and application process, but the best advice for any originator would be to educate your customers before application on these market conditions, which better sets expectations in a changing interest rate environment,” Auerswald said.

Written by Jason Oliva

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  • I think the more interesting article would be “Pricing Volatility Cranks Up the Pressure on Reverse Mortgage Lending”. Anyone that’s been in this industry for the past three years has dealt with the expected rate swings. It wasn’t that long ago (Jan. ’14) that we had a 3% expected rate. If you’ve been in the industry for a good bit longer than that, you’ve dealt with the floor being exceeded on all margins. That will be tougher to deal with the next time due to how low PLFs are now compared to back then.

    The bigger issue in our industry, as least from a broker perspective, is what is happening to our pricing as we close out each calendar year. In 2015 our fixed rate pricing dropped about 250 basis points in the span of 60 days. This year, we are seeing the same thing happen with a 350 basis point reduction in the past 30 days. Granted some of that is related to the economy, but the rest is coming from lackluster investor demand. At least that’s how it has been explained to me. If this is going to be an annual issue, we need to address it.

    What bothers me is the inability to lock a loan at the time of application, or soon thereafter. Isn’t it time to take some guidance from the forward market and get this system in place? It appears it won’t happen unless enough of us put pressure on the wholesalers we do business with.

  • “By the time the appraisal is completed, it is likely that the interest rate quoted to a loan applicant will not be the same as it was earlier in the application process.”

    A change in interest rate at settlement from that which was quoted at the date of application has always been the case, if one is referring to the effective/note/actual/accrual rate. The expected rate, however, has always been locked for 120 days from the date of application thereby providing some degree of assurance that available loan proceeds at settlement will be as stated (subject of course to any change in appraised property value).

    The issue for originators is largely one of changes in the expected rate between the date a PROPOSAL is given to a prospect and that same prospect’s eventual application. Significant changes in available loan proceeds can occur due to change in the 10-year LIBOR swap during this interval, and prospects find this hard to understand and/or accept without proper preparation.

  • Early this morning HUD announced the endorsements for November 2016. An analyst noted that although the related applications with case numbers assigned were up, the pull through rates for October and November 2016 has mysteriously dropped when compared to the same months in 2015.

    Perhaps volatility in the expected interest rate has something to do with the drop in the pull through rate due to applicants seeing lower principal limits just before closing.

    As stated in the prior comments, the volatility in the expected interest rate has had a substantial impact on the principal limit when there were few weeks that the floor rate of 5.56% (back then) were not exceeded. In 2006 we saw the expected interest rate over 5.56% and the INITIAL note interest rate even higher than the expected interest rate. Back then there was no significant origination of fixed rate products.

    • Again, applicants should see no decrease in the PL from what was quoted at application, other than that caused by a lower appraisal, due to the 120 lock provided on the expected rate.

  • please correct me if I am incorrect… borrower will receive whatever the GREATER benefit calculation at time of closing, should rates change from time of application? clarify?

    • 2bmagoo4u,

      Sort of.

      You need to talk to your mentor about the differences between margin changes and index rate changes. Legal counsel for approved mortgagees during the last period of volatility found margin adjustments to be fundamentally different than index rate changes which had very different consequences.

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