Rate Hike to Have Mixed Effect on Reverse Mortgages

The Federal Reserve raised the federal funds rate for the third time in a little more than a year last week, an expected move that experts say will have a mixed effect on the reverse mortgage market in the coming months.

“The recent rate increases by the Fed are probably not much of a surprise to those in the lending industry, since the economy has been showing signs of improvement in recent months,” said Mike Gruley, executive vice president of reverse mortgage lending at 1st Nations Reverse Mortgage in Ann Arbor, Mich., in an e-mail to RMD.

Borrowers looking for a fixed rate, one-time draw will likely see the most immediate effects, as rising interest rates mean a lower principal limit, which could possibly turn off needs-based consumers who have to cover immediate expenses with the Home Equity Conversion Mortgage proceeds. Michael McCully, partner at New View Advisors, said declines in principal limits could lead to a dip in origination volume as interest rates rise. 

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These trends also put competitive pressure on originators as margins decline: Gruley notes that borrowers could previously get the maximum principal limit amount at a margin of 3.25%, but now that number is closer to 2.5%. This puts lenders in a bind, Gruley said, as offering the maximum principal limit increasingly hamstrings their ability to sweeten the deal with reduced origination fees and lender credits; but were they to set rates that exceeded the expected rate floor in order to achieve a higher margin, any credits or reduced fees they’d offer would be offset by the resulting lower principal limit.

“Eventually, in a higher interest rate market, originators will have to make a competitive decision to either quote rates and margins that provide borrowers with the maximum funds at closing, or maintain their revenue margins by exceeding the floor,” Gruley said.

Shelley Giordano, chair of the Funding Longevity Task Force at the American College of Financial Services, said rising interest rates are a prime example of why the industry needs to market reverse mortgages as retirement tools, and not just as one-time fixes for the desperate.

“The fact that the rates will go up and the principal limit will go down [illustrates] even more that people should have diversified their business, and be appealing to people who don’t necessarily so-called ‘need’ a reverse mortgage,” Giordano told RMD.

She noted that when she started in the reverse mortgage industry, interest rates were almost 9%.

“I would say that it’s not a mortal blow to have higher interest rates,” Giordano said. “We’ve had higher interest rates over the years.”

McCully noted that modestly rising interest rates could be a good thing for HMBS issuers, as it quickens the pace of negative amortization — the rate at which interest is added onto the loan balance. In turn, the loans would reach 98% of the home’s value and see reassignment to HUD faster, potentially reducing loss exposure to issuers. 

However, rising rates could also lead to lower valuations on adjustable-rate HMBS, which McCully said would likely put a damper on new HECM originations.

Written by Alex Spanko

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  • Let us look at the Shelley almost 9% rate and put into today’s situation.

    Back then the margin was just 1.5% and the ongoing MIP, just 0.5%. Margins today are twice (or more) what they were then and ongoing MIP is 150% higher.

    So an interest rate of almost 9% back then was a total cost accrual rate of almost 9.5% (including ongoing MIP). Today on a HECM with a case number assigned after 10/3/2010, that same 9.5% would closer to 11.75%.

    So are we going to be truthful about the likely APR or are we going to play it down the way that Shelley has? Today, APRs are about 2.25% or more than they were in the early days when Shelley came into the industry.

    Do I believe Shelley is promoting being devious? ABSOLUTELY NOT!! My respect for Shelley far too high for that. But like so many when it comes to ongoing MIP, it is all but forgotten EXCEPT when it comes to the growth rate for the line of credit. It IMPACTS the balance due and it is 150% higher today than back then.

    The index rate may not change, but a change in the margin on new HECMs has the same impact as it would in the index, except the margin will never drop once the HECM is originated due to the way that HECM notes are written. Could Margins change over time? Absolutely but lenders do not want that to happen.

  • Shelley has it right BUT is speaking without perspective. Let us try to put some perspective to her statement about how much harder she had it back in her day than now.

    First we have to look at all accrued costs today versus back then. Today ongoing MIP is 1.25% while back in her day it was just 0.5% for a difference of 0.75%, a significantly higher ongoing cost on HECMs originated today versus back then.

    Next let us look at margins. Back in the period Shelley speaks of, the margin was just 1.5% rather than the 3.25% Gruley discusses today. That is a different of 1.75%. Thus the first two costs have more than doubled.

    Now let us look at PLFs which provides with maximum proceeds available to a borrower. The factors have gone down at most ages and interest rates by about 10% between today and the era Shelley speaks of. Let us say that is equivalent to about a 0.5% interest rate.

    Finally let us look at the floor for PLFs today and back then. That is another 0.5% impact on the interest rates to get to the same PLFs today as they were in effect back then.

    Shelley is talking about a CMT index rate of 7.5%. The equivalent LIBOR index rate today is just 4%. That is due to a 0.75% higher ongoing MIP rate, a 1.75% difference in margins, 0.5% for PLF reductions since 10/1/2009, and 0.5% for the increase to the PLF expected interest rate floor. That is a total of 3.5%. Meaning an index rate of 7.5% is a 4% index rate today.

    So the impact of a 9% expected interest rate in Shelley’s day is about a 7.25% today. So at an approximate 5% expected interest rate today, it will take a rise of just about 2.25% today for us to feel the same level of that Shelley’s era experienced at about 9%. This time period is for a lot of reasons correctly more sensitive to increases in respective LIBOR indices than the era Shelley speaks of. Part is higher ongoing costs and part is a higher expected interest rate PLF floor and generally lower PLFs.

    My estimate is no doubt off depending on the age of the borrower and the expected interest on that age. Yet the principle is exactly right.

    What was tough back then was the very low lending limits. Thank goodness for both HERA (The Housing and Economic Recovery Act of 2008) and the ARRA (The American Recovery and Reinvestment Act of 2009) which raised the HECM lending limit.

  • The big question we should have is how low are approved mortgagees willing to let their margins go? EricSD stated in a comment to another RMD post that four lenders are offering adjustable rate HECMs with a 2% margin. If that becomes the consensus margin bottom, then looking at a 7.5% index rate (the assumed index rate Shelley was alluding to), how would the balance due, total ongoing MIP, and interest change on our amortization schedule.

    The total accrual rate of ongoing costs shows 9.5% for the earlier period and 10.25% for today. 9.5% is arrived at by adding the average effective note interest rate of 7.5% to the margin of 1.5% and the ongoing MIP rate that applied to HECMs with case numbers assigned before 10/3/2010 of 0.5%. The 10.25% rate is the same 7.5% interest rate added to a margin of 2% and the ongoing MIP rate of 1.25%. While that might not seem like a lot of difference, the results may be surprising.

    The two scenarios below assume a beginning UPB of $100,000. No further payouts to the borrower and no pay downs of the UPB before termination. Termination is shown for 10 years, 20 years and 30 years.

    The earlier HECM will have an unpaid balance of $257,606 after 10 years. After 20 years, it will be $663,606 and after 30 years, $1,705,486.

    Today’s HECM would have an unpaid balance of $291,600. After 20 years it will be $850,307 but after 30 years, $2,479,496.

    So what is the difference in the accrued ongoing MIP? After 10 years it is $13,984. After 20 years, it is $57,582 but after 30 years, $191,976. (The total ongoing MIP for today’s HECM scenario after 30 years is $276,686.)

    Finally let us look at the interest after 10 years; the difference between the earlier and today’s HECM scenario is $20,010. After 20 years it is $129,119 but after 30 years it dramatically rises to $578,034. (Total interest for today’s HECM scenario is $2,102,810.)

    One would expect that the differences between the two scenarios would be with the ongoing MIP than with interest, since the ongoing MIP is up 0.75%, while the interest is up just 0.50%. Yet by year 30, the difference in the accrued interest is 3 times the difference in the accrued MIP. Why? The nature of compounded interest is that many times a smaller change in a higher interest rate will have a far more substantial impact on the result than a larger change but on a lower interest rate.

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