HECM Credit Line Growth Could Slow Substantially Under New Rules

Since HUD’s reverse mortgage rule changes took effect October 2, Home Equity Conversion Mortgage experts and researchers have struggled to get a clear picture on what they might mean for the loan and its use as a retirement product.

But one trend is emerging: New principal limit factors and annual insurance premiums will result in slower growth for the line of credit (LOC) option, a popular tool in some borrowers’ retirement strategies.

Wade Pfau, professor of retirement income at the American College of Financial Services in Bryn Mawr, Pa., has been re-running his numbers to project what the changes might look like. He said the LOC option is still compelling, but not as compelling as before.

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His projections show that, under the new rules, a 62-year-old with a $250,000 home can take out a $102,500 line of credit, down from $131,000 before the changes. In 30 years, the LOC would grow to $383,895 under the new rules, as opposed to $608,043 under the old regulations.

Pfau based his projections on a 10-year LIBOR swap rate of 2.25%, a lender’s margin of 2.75%, and a one-month LIBOR rate of 1.25%.

“For clients who don’t have a mortgage, the line of credit is still an option, but with bigger costs and slower growth rate,” Pfau said. “Whether it will be a recommendation will depend on how much initial costs and lender’s margins will be.”

He added that margins will likely go down.

In addition, Pfau from fundinganllc.com said retirees still carrying a mortgage could express more interest in refinancing into a reverse mortgage.

Shelley Giordano, chair of the Funding Longevity Task Force, said that even at a slower growth rate, the reverse mortgage is still a powerful financial tool for ensuring necessary liquidity and cash flow in retirement — when it’s set up early.

“This is not just a loan, but something akin to an insurance policy,” she said. “It insures for long-term care. It’s dental insurance; it’s housing maintenance insurance; it’s portfolio insurance; it’s divorce insurance. It’s an unbelievably versatile product.”

Unlike other insurance products for specific calamities, which generally have high premiums and recurring costs, this loan has only a one-time expense, Giordano said.

Further, she said that loan officers should not be defensive about the insurance costs associated with the loan, but instead tout them as a benefit that allows for the non-recourse feature.

“It’s going to take more, deep conversations explaining the benefits of having an insured product,” Giordano said.

“I just think the industry made a huge mistake in trying to habituate the idea that a reverse mortgage is only good if it’s cheap. There is no financial instrument like a reverse mortgage,” she said.

Written by Maggie Callahan

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  • It seems Shelley is unfamiliar with how FHA insurance is charged. She is cited as saying: “Unlike other insurance products… which generally have high premiums and recurring costs, this loan has only a one-time expense….”

    Yes, there is a one time expense which is 2% of the Maximum Claim Amount (the lower of the appraised value of the home or the FHA HECM lending limit (which is currently $636,150) but there is also a monthly charge for FHA insurance which is based on an annual rate of 0.5%. Normally the total of the monthly charges is the second largest cost on most terminating HECM.

    Unfamiliarity with the product is a common problem with those who write or who advise in that they are too far removed from presenting the financial costs of a HECM to prospects.

    It is also unclear why Wade is using a 2.75% margin since many lenders are at 3% or above. I just heard about a recent national webinar where the lender used a 3.375% margin in its example to CFPs and other financial advisers. Is Wade right in saying that margins will drop below 2.75%? Why use a monthly LIBOR rather than an annual LIBOR since most borrowers generally select the annual LIBOR with its slightly higher index?

    All in all it seems those who are advising us are as lost (if not more lost) as most of us as to what future rates hold. It would seem people like Wade should be holding off on their new illustrations and examples until margins “normalize.”

    • Cynic –

      Shelley is far more than “familiar” with the costs of a HECM loan, both up-front and recurring. I am sure she simplified things to make a point.

      One who adopts the suggested insurance strategy will not finance their closing costs but pay them out-of-pocket, leaving the required minimum balance of $50-100 outstanding on the line. At .5%, the annual MIP charge on $100 is 50 cents (yes, I know it compounds monthly and so is likely closer to 60 cents) and at such a de minimus figure she is ignoring it with no ill effects.

      While I disagree with your assessment of Wade Pfau as being “lost”, I do agree that he and others would be wise to wait a few months for margins to normalize before undertaking a re-work of their various studies…or set them up with easily adjustable margin variables so that they can be updated as needed.

      • REVGUYJIM,

        I never accused Wade of “being lost.” My implication was about the majority of us (including Wade) being lost when it comes to accurately depicting the future of interest rates.

        I did say: “All in all it seems those who are advising us are as lost (if not more lost) as most of us as to what future rates hold.” You will find both yourself and me in the term “most of us.” If you want to defend yourself as not being lost, you are free to do so.

        If you feel Wade is right then defend his statement and do not go off on something that you accuse me of saying when I never said it.

        Second, you make up a nice story up for Shelley but the article above never cites your fictional tale. All we have to work with is what the story states; you can make up all the stories you want but that does change what the article says.

        Yes, even I know Shelley is more than familiar with both parts of MIP but you never read what I wrote. I said: “It seems Shelley….” The article is what makes it seem as if Shelley has forgotten about ongoing MIP. Please read what is written and do not put in or leave out words when you disagree with the tone of the comment.

        You state: “One who adopts the suggested insurance strategy will not finance their closing costs but pay them out-of-pocket….” Where does the article state anything about such a strategy and in fact rarely is that how HECMs are originated? Please provide the evidence where your allegation can be shown to be factual. Do even 5% of HECM borrowers start out with a $100 to $500 balance due at closing? Please let us not get carried away in Never Never Land.

        Never in the article does Shelley limit her discussion of the upfront MIP to just an unused line of credit insurance strategy. In fact she states: “It’s an unbelievably versatile product” after citing its use in such things as divorces and long-term care. None of the uses cited have a zero balance due STRATEGY throughout the life of the HECM. Pragmatically, most HECM balances due have NO reduction resulting from payments by borrowers at closing or after closing unless mandatory obligations exceed the net principal limit. So why you bring up this make believe story seems more deflective than relevant.

        However, if you are saying that ongoing MIP is not the second highest cost for most terminating HECMs, then you need to get better grounded in HECMs. That is an easy point to debate when looking at the type of terminations we see in monthly FHA reports.

      • REVGUYJIM,

        I never accused Wade alone of “being lost.” That is false. As to being lost I stated: “All in all it seems those who are advising us are as lost (if not more lost) as most of us as to what future rates hold.” In the term “most of us” you will certainly find me and perhaps even YOU. If you disagree please write to what I have said. Remember I caveated my statement with the words: “IT SEEMS.” It seems you do not quite understand what that term or the entire sentence is saying.

        If you feel Wade is right then defend his statement. He could be right but you do not even say that. You cannot even agree with Wade but attack me for questioning his use of a 2.75% margin and his noting that it could go lower.

        Second, you make up a nice story for Shelley but the article above never cites that story or any part of it. All we have to work with is what the article above states. Can you limit yourself to what is written rather than to what you make up or can you cite another contemporaneous written source that confirms what you present and can that document be verified as contemporaneous?

        If you can cite where my assessment of the cited statement of Shelley is in error, please do so. Instead you resort to your own story.

        I frankly do not believe that even 5% of all HECMs close with $100 to $500 in the balance due at closing. Even if it is 50% of all HECMs, how can you demonstrate other than with anecdotes WHY borrowers are doing that. You can’t. Again you make up gibberish to attack with.

        I do not view the insurance premiums borrowers pay as anything other than a policy for lenders so that they will offer HECMs with all of their risky features such as a growing line of credit and nonrecourse nature at a reasonably low interest rate and with ridiculously high principal limit factors. If you don’t believe what I say compare the features of an adjustable rate HECM and ULTIMATE costs to today’s proprietary jumbos which are only offered as fixed rate reverse mortgages.

        As to the talk about insurance using a HECM, the FHA insurance premiums do not create a policy for the borrower against losses from a divorce or long-term care. A payoff from an insurance policy to pay off a valid claim within the terms of the policy do not have to be repaid do they? Yet a HECM payout to pay the costs of a divorce or long-term care must be repaid even if nonrecourse comes into play since at a minimum in the use of the nonrecourse feature, the home is lost.

        Credibility for our originators is already at a true premium. It would seem all you want to do is attack someone for pointing out difficulties in a published story. I don’t mind if you poke holes in what I write but I do mind if you make up stories or make false statements about what I say to do that.

    • If (like a single premium insurance policy) you pay all the fees up front then where is the reaccuring expense? I understand the loan cost start once you use it but if it’s looked at insurance you use because you really need it, would it make more sense to not do it and then not have it when you really need it? The key to retirement planning is understanding your assets and finding the wisest ways to harvest them , period..

      • Tom,

        Your first question is a good one. Perhaps you should be asking REVGUYJIM since he is trying to justify what happens with a HECM to protect what it is that Shelley supposedly said that is cited above. What is interesting is that we have not heard from Shelley yet. Quite frankly, not even REVGUYJIM knows exactly what Shelley said except those directly involved in the interview. My criticism was of what the Shelley reflected in the article supposedly said.

        Now as to how HECMs actually work. Currently at closing HUD charges 2% of the Maximum Claim Amount which is the lower of the appraised value of the home or the FHA HECM which is currently $636,150.

        Monthly FHA charges the loan each month an amount equal to the average balance due during the month times 0.5% divided by 12. So even though it is an annual rate of 0.5%, it is charged monthly making it a compounded cost.

        It is ridiculous to think that “THE key to retirement planning” is assets alone. The key to retirement planning is cash flow. You could understand assets all you want but if the cash they can generate is insufficient to pay the bills, then all of the planning was in vain. You need to attend a beginning masters degree course in personal financial planning where you will generally obtain a far more holistic approach than just being focused assets.

        This is why I am not so hot on Retirement Income Planning certificate programs although I am certainly not against them. The programs have their place but are too narrowly focused unless the student is supplementing those courses with ones concentrating on other areas of financial planning or the student will only be dealing with such assets in their career.

        Perhaps I am so strong about other areas of financial planning because I and most of my close friends are but months away from
        turning 70.

  • The title of the article leaves some question as to the growth of the line of credit slowing done. First we know that all things being equal, the principal limit is lower because of lower lending limits for the same expected interest rates. We also know that the net principal limit will drop (or go up) even further because of the new 2% initial upfront rule for MIP, i.e., unless the lender or originator covers the increase if any. Under the old rule, the initial MIP was based on if the expected first year disbursements were expected to exceed 60% of the principal limit when the MIP would rise five times from 0.5% to 2.5%. Even though the principal limit factors between September 30, 2013 and October 1, 2017 were about the same as Savers, the minimum cost of the upfront MIP rose 50 to 250 times as much, i.e., from 0.01% to 0.5% or 2.5%.

    We also know that even if the average effective interest rate turns out to be the same as loans with case numbers assigned before the effective date of Mortgagee Letter 2017-12 but after April 27, 2015, the growth rate will be less because the ongoing MIP rate has dropped 60% from an annual rate of 1.25% to an annual rate of 0.5%.

    All this means that when all other things are equal, a HECM with a case number assigned between September 30, 2013 and October 1, 2017 will have a higher growth rate and a higher line of credit balance throughout the loan period than HECMs with case numbers assigned after October 1, 2017.

  • I felt Shelley Giordano made some very good points. It is true like The_Cynic has pointed out, you can’t compare the LOC to other insurance policies.

    As far as a one time cost, that is not the case, there is the 0.5% annual MIP cost, charged monthly. Who knows, we may also see servicing fees come back!

    I liked what Shelly said about loan officers not being defensive about the initial MIP costs associated with the loan! Instead, explain it as a benefit that allows for the non-recourse feature and the protection of their LOC, tenure income or monthly income for a time certain.

    Yes, I believe this will slow down the usage for the LOC but definitely not eliminate it. I feel we are going to be our own worse enemies in this latest change. Physiologically it is creating to many LO’s to over talk about the new ruling. In many situations, there is no need even to discuss the new ruling. Go on with business like normal, explain what the HECM is today as if no changes were ever made!

    Sure, if you run into someone that asks about the new ruling because they were aware of it, explain away but don’t let October 2nd be a deterrent for you to move forward! If you do, it will be your misfortune!

    John A. Smaldone
    http://www.hanover-financial.com

    • John,

      You know how silly your comment sounds in light of the industry’s declaration that it does not sell; it educates..

      An educator would start off with what the HECM is like today comparing to what was being offered last month. So are we educators or are we salespeople who use product education as part of our ethical sales pitch?

      What you have advocated is not educating; however, I fully agree with you. Yet why are we such hypocrites that we say we are not salespeople?

      I have no idea why Shelley is promoting the idea that a HECM is a single premium insurance product. First it is not an insurance product. Our salespeople have mortgage licenses, not insurance licenses.

      I have heard that the insurance is not that of the borrower but that of the lender. It is not FHA that offers tenure payouts but the lender. It is right to say that the lender would never offer the tenure payout unless they were insured from loss by FHA. The reason why the borrower reimburses the lender for its insurance, is because this is a direct cost of each loan that can be separately identified and thus passed through to the borrower.

    • John,

      I am not trying to be picky but rather I am trying to understand why you mean. For example, you say: “Yes, I believe this will slow down the usage for the LOC….” Why would the usage go down? The article addresses the fact that the line of credit will not grow on new HECMs as fast as they did if they had a case number after October 3, 2010 but before October 2, 2017. So why are you saying their usage will go down?

      What did you mean by “physiologically” in the following sentence: “Physiologically it is creating to many LO’s to over talk about the new ruling.” Google says “physiological” means the following: “relating to the branch of biology that deals with the normal functions of living organisms and their parts.” Google provides an example of the use of the word “physiological” in the following: “physiological research on the causes of violent behavior.”

  • The Principal Limit growth has indeed been slowed, albeit more so over time. Some considerations (1) few ever keep an open HECM LOC for 30 years, (2) A higher assumed % rate & margin should be factored into loans before 10/2/2017, and (3) the lower ongoing MIP and slightly lower margins after October 2nd should be considered.

    Based on these factors and assuming a 5.0% EIR before 10/2 and a EIR of 5.25% after 10/2 and including reduced MIP: one would see about -$6,856 (8 years), -$18,776 (15 years), -$33,774 (20 years), and -$92,222 (30 years).

    • SoundOfReason,

      Huh?

      The second point in your first paragraph makes no sense based on your example. What is the margin in each scenario? You show your EIR to be higher after 10/1 than before 10/2. Yet you say: “A higher assumed % rate & margin should be factored into loans before 10/2/2017.” So why is the EIR 5% before 10/2/2017, when it is 5.25% after 10/1/2017. Did you mean it to state just the opposite because your example is?

      You never state what “% rate” represents. Is it the index rate, the growth rate, or what? That could be adding to my confusion about your second point.

      Based on the data in your second paragraph, where do get your line of credit balances? You show no beginning line of credit and have insufficient information to calculate it. Beyond that what is your effective average interest rate for 8 years, 15 years, 20 years, and 30 years. Are you saying that the EIR is your effective average interest rate in each scenario? If so, you never state that.

      If you are using the same amount for the line of credit at closing for each scenario, you never state that. Remember at the same age and with the same expected interest rate, principal limits on HECMs with case number assignments after 10/1/2017, are lower due to lower PLFs and also the net principal limit is lower even further due to the increase upfront MIP after 10/1/2017 unless the lender or originator is paying that cost or first year disbursements will be greater than 60% of the principal limit in which case the net principal limit will go up by the difference.

      Keep trying. Eventually you will be able to provide a decent example.

      If your line of credit was $100,000 in each scenario and the related EIR in each scenario was also the average effective interest rate, then I get a line of credit at the end of 96 months of $164,658 in the first scenario but $158,233 in the second for a difference of $6,425, not $6,856.

      Your premise and conclusions have been well presented by others for over a month. You should follow their examples. Without more information it is hard to figure out where you went wrong (if in fact you did). One suggestion is to make sure you are compounding monthly.

  • Thank you to all for your comments as it is important that we do not characterize the HECM as actual insurance against shocks in retirement. Perhaps the nuance of the argument was not clear? Or perhaps not everyone has had the experience of a 96 year old mother who has paid LTC premiums for 25 years and was not allowed to go “on claim.” The point really is that insurance products can be expensive and must be paid yearly. In a recent meeting with planners, they stated that a couple buying LTC would pay premiums of $8-10 thousand dollars a year, whether or not they ever redeem those benefits. And these policies are limited in scope, certainly not capable of addressing the myriad of unforeseen shocks that longevity potentiates in retirement, including portfolio shock. So, of course the HECM is NOT insurance for calamities in retirement and yes, there is a cost to setting up a HECM. More importantly, once the HECM is used to address liquidity challenges in retirement, it becomes debt. Honestly, we all know that, right? But for retirees who wish to establish a buffer against a broad range of unexpected shocks , the HECM Line of Credit is uniquely versatile. And here is the best part: if a client’s retirement is smooth sailing, and the LOC is never accessed, the remaining equity is theirs to keep.

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