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

Copyright 2020 Daniel J Turner. All rights reserved.

I was out walking with my lovely Wife and our dogs this morning, and I began dwelling on a number of “moving parts” involving economics, reverse mortgages, and a couple of recent impressions.

Specifically, how would Federal Reserve negative interest rates affect FHA HECM HELOC balances if the drivers of HELOC equity growth are neutralized? At the time of this writing, The Fed Bank Rate is .25%…nearly ZERO. There has been current discussions from the Fed chair Jerome Powell regarding stability for the next 2 years. President Trump has literally FORCED Powell to take this low road to perdition by simply humiliating him into it. President Trump has also stated many times that we should have a negative interest rate market similar to Germany & Japan.

As you may know, the interest rate in a reverse mortgage HELOC plan serves two purposes:

1. It is the pace/velocity of the growth of the borrowed funds/debt. Ultimately, the Lender profit is tied directly to the accumulating interest in a reverse through the margin (as I will cover momentarily).

2. It is also the pace/velocity at which new equity is added to the line of credit value. In other words, if the Mortgage debt balance is $250,000.00 and the HELOC balance is $100,000.00 and the mortgage interest rate is 5%? In the first year, the mortgage debt would increase 5% x $250,000.00=$262,500.00 (+12,500.00); The HELOC would increase $100,000.00 x 5% =$105,000.00 (+5,000.00).

The primary thing to remember with a Reverse HELOC? Is there are TWO components to the same loan; DEBT and EQUITY.

***As I am writing this article, reports indicate that TIPS (Treasury’s w/ Inflation Protection) are presently bringing ZERO yield. Dead money.

Let’s look at a model of a newly funded Reverse HELOC in modern day rates and terms.

The interest rate in a reverse HELOC is different from Conventional or Agency mortgages in that it contains 3 components; not 2. Those are:

-Margin (Lender profit) Current margin for most Reverse HELOC loans is 2.385%. This will remain fixed for the life of the loan. (Reverse mortgages do not charge points).

-Index (purchase price of funds expressed as a decimal). This can vary daily (and during the early days of the pandemic, it was moving so irradically and fast that it was impossible to track).

-MIP (FHA Insurance accrued annually. Also a decimal expression)

Here is how a mortgage rate for a reverse HELOC is built:

If margin is 2.385%

And index is .156%

And MIP is .50%

This rate is locked in for a year. It renews on the anniversary of the loan funding date.

Think of a number line as a horizontal plane with -0- exactly in the middle.

Let’s move the index from the right from the current 3.041 (past -0-) to the left, down past -0- to  -3.042%. This represents a -6.083% rate reduction past -0- and into negative integers.

My thought is that negative interest (index) rates of zero plus margin & MIP (-3.042%+) would begin actually reducing line of credit balances. For this to happen, the positive driver effect of the margin rate and MIP must be exceeded (neutralized) by a rate reduction greater than the positive initial value.

In Other Words, a hypothetical initial $100,000 HELOC balance with a slightly simpler interest rate (for illustration)

-3.5% = $96,500 end of yr 1 vs. $103,500@ yrs end.

To use a broader example?

With -0- as the center point on a number scale, we are talking about a very substantial swing totaling a 7% movement from 3.5+ to 3.5-. I remember the Volker move from 9.27% to 21.5 in a year. Interest rates can move hard, and move fast. (Just ask “Jimmy”). 😉

I have substantial doubts that the FHA was clever enough to catch this possibility as a “covered risk” exposure they would guard against with their mortgage insurance. Perhaps I underestimate them.

Conversely, I see the sum debt of borrowed funds will reduce also just as if a payment had been made equal to the total negative interest rate response.

***As I completely understand and concur that the odds of having a negative interest rate environment (e.g. Germany, Japan, etc.) is HARDLY worth thinking about….well, here we are, thinking about it.

That stated? I see this as further evidence that when you’re (retirement planning with the reverse) setting the margin as absolutely high as possible makes this a less probable outcome. A market rate reduction would simply need to move even farther to neutralize a higher margin.

Starting early on (age 62) and developing a substantial HELOC balance means a lot in future income stream strategies. Making any kind of future equity accumulation progress within the HELOC may mean withdrawing ALL of the equity line, and letting the negative interest rates (that would normally create neg am) would now create a positive amortization that would reduce the debt AND substitute the potential loss of equity if the HELOC balance remained in the loan. The reduction of debt from negative interest rates beyond the mortgage expenses would perform the same job as the HELOC.

Literally.

I can be wrong; (I’ve been wrong before). That is proof I can be wrong again. I DO open the forum to your ideas on the possibilities. This loan does not exist in a vacuum; it will react one way or another, or possibly a 3rd dimension we cannot see.