Recent changes in the HECM reverse mortgage program
My inbox recently has been crowded with letters from seniors who are anxious about impending adverse changes in the HECM reverse mortgage program. Many of them were wondering whether they should try to finalize a HECM before the Oct. 2 deadline.
The bad news is that, by the time they read this, it will be too late. To close a HECM before the terms change, the lender would have had to record an FHA case number, which they could not do until they receive a certificate from an approved HECM counselor indicating that the senior has been counseled.
The good news is that the impending changes are modest and should not deter anyone from taking a HECM. Here are the major changes:
Increase in upfront mortgage insurance premiums
Borrowers pay two insurance premiums on a HECM. An upfront premium calculated as a percent of the property value was previously 0.5 percent, except where the borrower is drawing more than 60 percent of her total borrowing capacity upfront, in which case the premium is 2.5 percent. Most borrowers who pay the 2.5-percent premium have a substantial existing mortgage balance, which must be repaid with proceeds from the HECM.
The new premium is 2 percent for everyone, which increases the burden for all borrowers except those with large mortgage balances who now pay 2.5 percent. The upfront mortgage insurance premium typically is financed, as are all other upfront charges.
Reduction in annual mortgage insurance premium
The annual mortgage insurance premium, which is applied to the borrower's loan balance, has been reduced from 1.25 percent to 0.5 percent. This will slow the growth of borrower debt, and it will also slow the growth of unused credit lines. Both grow at a rate equal to the interest rate plus the annual mortgage insurance premium.
Reduction in principal limit factors (PLFs)
A PLF is a number that when multiplied by the property value equals the maximum initial HECM loan amount. PLFs are larger when the borrower is older and when the HECM interest rate is lower. HUD issues a table of PLFs for use by the industry, which was revised downward after Oct. 2.
Rationale for the Changes
HECM reverse mortgages are insured by FHA, which means that if the loan balance at termination exceeds the amount recoverable from sale of the property, FHA will pay the balance holder the difference out of its reserve fund. The increase in insurance premiums is designed to augment that fund while the decline in the PLFs is designed to cut losses by reducing the growth of loan balances.
This is a judgment call, presumably based on loss experience in recent years, but the FHA Mortgagee Letter announcing the changes contains no information on loss rates that would allow outsiders like me to second-guess the decision.
The negative impact on borrowers
To quantify the impact on borrowers, I compared monthly tenure payments, credit lines and credit line growth for borrowers who are 62, 72, 82 and 92, all of whom have a $300,000 house, before and after Oct. 2. I also distinguished the effect of changes in insurance premiums and changes in PLFs.
In general, younger seniors are impacted more than older seniors, and monthly payments are impacted more than initial credit lines. The largest change I found was in the monthly tenure payment to a 62-year old. (Tenure payments continue for as long as the borrower resides in the house).
The higher mortgage insurance premiums dropped the senior's monthly tenure payment from $730 to $639, and the new PLFs dropped it further to $613. That is a 16 percent reduction. For a senior of 92, in contrast, the payment dropped from $2,774 to $2,581, or by 7 percent.
Solace for heirs
Higher insurance premiums impact the borrower differently than lower PLFs. Higher insurance premiums reduce the amounts borrowers can draw by increasing costs that swell the loan balance. The higher the cost, the lower the draw. Lower PLFs reduce the amounts borrowers can draw but without increasing the loan balance. This increases the borrower's equity in the property when the transaction terminates.
The new PLFs will have that affect. For example, the borrower of 62 who could obtain a tenure payment of $730 before Oct. 2, after 20 years would have net equity of $354,958, assuming her house appreciates by 4 percent a year. The same borrower obtaining a tenure payment of $613 after Oct. 2 would have net equity after 20 years of $408,551.
• Contact Jack Guttentag via his website at mtgprofessor.com.
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