“Reverse Mortgage Product Choice”-A Planner’s Primer for Correct Perspectives

by Daniel J Turner NMLS#1016716; Geneva Financial LLC NMLS#42056

Copyright Daniel J Turner 2020 All rights reserved.

 

Many Financial Planners have recently started considering the use of Home Equity in the Retirement Planning process. It makes good sense since we know that 95%+ of retirees simply could not save (and or keep) enough money to sustain themselves for the next 30 -35 years without a job. While enjoying their lives. And enduring great sicknesses and frailties. And considering legacy ideas. Daunting. Just incredibly daunting. Further to this point is the average retiree owns $2-$5 of home equity for every $1.00 saved for retirement. Until recently, almost all planners were reluctant to use home equity; the primary reason for this reluctance is the program itself-the FHA Reverse mortgage (Home Equity Conversion Mortgage).

 

The FHA HECM program is one of those “Road to hell is paved with noble intentions” kind of program. It was structured brilliantly when it started, and as with any pilot program, improvements tweaks, and upgrades came along the way.

 

Today, it is comparably seen as the finest program in the free world when compared to other nations like Japan, Great Britain/Canada, Etc. Without regard to an invisible reputation, the program has been hampered also by the fact that “ANY regular old licensed loan officer” can originate (sell) a reverse. Since they mostly originate (sell) conventional “Forward” mortgages, they drag ‘forward thinking into the process. Combining that with a significant shortfall of the retirement income planning process, Bad things happen to Borrowers. Is it the loan’s fault? Or, was the wrong agent used to set up and structure the loan? (I would contend) that if you cannot demonstrate at least 5 years of Planning experience or back ground and be able to demonstrate (by test) basic planning concepts? You should not be allowed to offer this loan.

I have witnessed the other side of this transaction as well. Financial Planners advising Clients to the wrong type of reverse and thereby creating the problem they were paid to resolve, or complicating it beyond any capacity to resolve. It is very possible that a Planner can make or endorse choices to a Client that would create an uncomfortable legal circumstance; and that is just not necessary.

So, let’s proceed with this overview of the FHA Reverse mortgage program and this may help you see the difference and avoid uncomfortable problems.

 

***WARNING!!~It is very difficult to refinance a reverse mortgage. Furthermore, due to a hyper-extreme regulatory climate brought on by Dodd-Frank and the CFPB, rules involving disclosure and fees and charges and compensation are non-negotiable. We can all lose our licenses if we play games. Let’s not play games.

***During this presentation you will hear/read the term “originate” or, “origination”. In mortgage lending, the term “Origination” means the process of beginning and underwriting and closing/funding a (reverse) mortgage.

That said, Here is rule #1…There is no ethical or legitimate reason to use a fixed rate reverse mortgage; they do (in fact) eliminate the Borrower’s ability to manage the debt. It also forfeits an additional 25-35% of the available equity in exchange for the fixed rate (which you equate “Fixed rate” = “safety”); it is not safe, and there is no future access to equity in this “one-and-done” kind of loan. I consider the FHA fixed rate reverse mortgage to be an unethical use of the program, and I hope you will also.

CONSIDERATIONS FOR BUILDING AN EFFICIENT HECM HELOC PROGRAM 

1. PROGRAM SELECTION

The FHA presently offers 2 HECM programs. They are:

1. Fixed Rate-The Borrower may select from several rate options. Unlike all other forms of mortgage lending, the FHA Reverse does not allow “points”. This fact and consideration is never acknowledged by Advisors while comments about the “expenses” of a reverse are legend. The Fixed rate does not provide a HELOC. For that reason alone, the Fixed Rate plans are unsuitable for use in retirement planning as they eliminate any possible way for the Client to manage the debt. They also deny additional credit to the Borrower that would be available under the “Adjustable Rate” plans.

Due to Regulation Z of the Truth in Lending Act (regarding compensation), fixed rate reverse plans may only charge origination and waive lender credit; or waive the origination and receive Lender Credit. Origination for all FHA FHA Reverse programs are 2% of the first 200,000 of appraised value and 1% for all excess value capped at $6,000.00 up to the current FHA lending cap of $765,600. Lender paid compensation is typically a low end of 1.5% to 12% of the total loan amount (called “UPB”) presently. The rates may change at any time, and they do change often. It is unreliable, and causes concern for thinking Loan officers as many LO’s will offset Borrower expenses with the Lender Credit and run the risk of doing free loans (or worse) being legally committed to come up with resources to pay for disclosed expenses and having a market shock that eliminates possible credit.

“Banks” (Depository Institutions) are NOT required to reveal Lender Credit. Trust me-Almost ALL reverse mortgages provide Lender credit. I choose to disclose mine as compensation.

It is also very important for the Planner and Borrower to understand that Lender Credit does NOT come from the Borrower’s check book or home equity. Just like the compensation for most of the products offered by Planners? It is paid by the Lender as direct compensation. There is no residual income provided to anyone from a Reverse. There is no equity sharing allowed. Fees must be disclosed and must fit within a 110% figure if recommended by the LO. If the fees come in higher? The LO must pay for those overages.

2. Adjustable Rate– This plan offers two choices-

a. Monthly Renewal rates, and

b. Annual Renewal rates

Both plans offer the HELOC and equity growth from the day it funds and on for life. As long as the HELOC has a surplus balance? The Line balance is guaranteed to grow new equity.
Interest Rate Caps: apply to both “Annual” and “Monthly” programs. The Annual Cap interest rate is lower (which many Seniors find comforting for the wrong reasons) than the monthly cap rate and currently stands at approximately 7%; the Monthly Cap rate is approximately 10%. Depending upon the origination initial rate of interest, this cap is set at the origination of the loan program and stands at that mark for the life of the loan. On a day-to-day basis, new originations may have a different cap rate in the same manner that a conventional loan rate can vary until the Borrower “locks in the rate”. Currently (due to the covid nonsense) Reverse caps and interest rates cannot be locked, and will float until just before going “Clear-to-Close”. We anticipate this will change.

 

Closing Costs/ “POINTS”- NONE of the FHA HECM programs (and to my best knowledge) none of the private HECM programs (non-FHA insured “Jumbo” Reverse mortgages) charge “points”. This is (of course) a significant advantage for Borrowers as Lender profit does not come from the Borrower points (like conventional lending. This does make a loan less costly. To the point that many people think the reverse is expensive” do not realize this very real “expense” doesn’t exist in reverse lending.

Even if the mortgage being paid off (A reverse is a “stand-alone” mortgage and will not allow any other liens on title) and the loan limits are met, and no line of credit is available? Simply paying a dollar will create a $1.00 line of credit. A $10,000.00 payment made will reduce the debt by $10,000.00 and add $10,000.00 to the Line of credit (or create a new $10,000.00 line of credit), and is immediately re-available to the Borrower. Think about that for a minute.

***For our topic, we won’t address the monthly rates as Seniors are often reluctant to see interest rates change every month; it’s just too many “moving parts”. The irony is that the Monthly Rate plan offers a substantially higher interest rate cap that could allow for double digit HELOC growth potential.

2. INTEREST RATE SELECTION

The FHA (insured) HECM HELOC is the only loan model available where the interest rate serves two separate functions.

A. The interest rate is the debt accumulation measurement. High interest rate=higher debt accumulation. Lower rate= lower accumulation. As this may appear to be an obvious point, it has much deeper long term financial planning circumstances, and they’re not negatives.

B. The interest Rate is also the Line of Credit growth measurement. In a Reverse HELOC, the actual line of credit is federally guaranteed to add new equity to the available equity value balance on a daily annualized “annual” (or, rarely chosen “monthly”) renewable rate of interest. This should not be considered a “rate of return” as one could anticipate in an investment or Bank Certificate of Deposit or other similar device; it is the velocity at which new equity is added to the existing credit line as available new credit. It is irrevocable, and is always available for the Borrower(s). In fact, the proposal “Comparison” page clearly identifies this as the “Initial Line of Credit Growth” rate for the HELOC.

Building a HECM HELOC for planning should be considered from the  present and future need issues as several strategies may be built and used, or may be altered and redirected for other “surprise” events.

The interest rate in a Reverse HELOC has 3 components:

1. Index-The index rate is currently the Inter-Continental Exchange Rate (ICE) It is currently approximately .67% and may change daily (as of 9/2020). The index rate is the cost of funds.

2. Margin-Margin is the Lender’s profit. In the Reverse HELOC it is the only way one may accelerate the growth of the HELOC credit line. Higher margin? Higher equity growth. This raises a question regarding the program commonly (mistakenly) asked by Planners and Borrowers “What is the going interest rate for reverse mortgages?” The real question should be, Do you think you’ll need MORE or LESS equity in your future retirement?” The answer is typically more, so using the highest margin possible will aid in accelerating the HELOC growth. ***There IS a bit of a “balancing act” to the use of margin that I will discuss in this paper. However, the knee-jerk reaction by Planners and most Loan Officers unfamiliar with both the reverse and financial planning errantly choose the lowest possible margin and rob the Client of tens of thousands of dollars in future equity and income capacity.

3. FHA Mortgage Insurance Premium (MIP)-Currently, MIP is a contractually fixed rate of 0.50% of the debt balance. MIP provides all the unique qualities and promises and safety features contractually found in the Reverse Mortgage Deed of Trust.

Presently, Reverse Mortgage interest rates are between 2.8% to 3.5% and are a “simple interest” (Rule of 78) function. While the annualized debt and Line of Credit balances compound annually, for a skilled Advisor, these are wonderful advantages in the development of long term strategies.

 

 

RECAP: ALIEN NOTIONS to SUCCESSFUL STRATEGIC PLANNING

 

In a “reverse”? EVERYTHING is the opposite of conventional lending.

1. A higher interest rate will create a larger debt.  It will also create a larger Line of Credit balance. More simply, If you could control the rate of return on any given investment, would you choose 2%? Or would you opt for 3.25% (all other considerations/things being equal)?

2. The correct question for a Planner to ask a Client is simply: “Do you suspect that you may need more, or less money in your future financial years (30 year+ span)?

a. If they think “more”? (Which is logical), then use a higher margin rate. This may provide a lower availability to current equity at the close and next years credit line, and should be discussed for value with the Reverse mortgage Broker.

b. If they think they’ll need “less money” in their future retirement? They’re either incredibly rich, or delusional.

3. The Fixed rate is NOT the “safest” plan; it is the plan that costs 25-35% of the Clients available equity.

4. Like most programs in financial planning? The SOONER you start them? The more efficient they will be when you really need the values. It means there’s a very limited amount of assets that can be sheltered from Medicaid. It means the growth of the HELOC is very limited and by starting at age 72+ only $431/ month may be created as a dependable income stream when starting at 62 would have provided over $1,000/month for dependable life guaranteed income at 72. TIME means a LOT in a reverse.

In fact? If the reverse can’t solve the problem? It’s probably too young.