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.
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