As noted in the previous articles in this series, seniors now have useful options under the Home Equity Conversion Mortgage (HECM) program that they didn’t have before. While having options is good, it also makes HECM shopping a greater challenge. This article is a guide for seniors who want to shop for the best deal on a HECM.
HECMs are overpriced
I have been doing some informal HECM shopping recently, and found that HECMs are grossly overpriced! In early June, fixed-rate HECMs with rates from 4.25 percent to 5.06 percent could be sold in the secondary market at a premium of 7.625 percent. This provides an originator margin four to five times as large as the margins in the forward market. Some HECM loan officers are making commissions of 3-4 percent of the loan amount. HECM originators will pay four or five times as much for a lead as they would pay for a lead on a forward loan of the same size.
No price competition in the HECM market
The problem is that HECMs are sold, not purchased. Salesmanship and advertising rule the market. Celebrities who become seniors extend their careers by becoming spokespersons for HECM lenders.
The focus of interactions between seniors and originators is how HECMs might help the borrower. Most seniors evidently assume the price is what the originator says it is, and the possibility that they might do better with another originator doesn’t enter their minds.
The websites of HECM originators are not designed for shoppers. I visited the sites of 42 HECM lenders in California who belong to the National Reverse Mortgage Lenders Association. Only seven showed HECM prices without requiring me to identify myself, and on six of the seven, the data was incomplete and user-unfriendly. Only one — All Reverse Mortgage Company — provided data that was both complete and readily understandable.
Select your loan option before you shop
To shop effectively, you should know the loan option you want. Borrowers have four options: standard and "Saver" versions of both fixed-rate (FRMs) and adjustable-rate (ARMs) HECMs. The Saver option is for borrowers with short time horizons who want to minimize the loss of equity in their home. Those who plan to stay in their house indefinitely should opt for the standard HECM.
FRMs are for borrowers who want to draw as much cash as they can as quickly as they can. Those who intend to retain a significant part of their borrowing power as an unused credit line should select an ARM.
A potentially confusing feature of HECMs is that they use two interest rates. The "expected" rate is used at the outset to determine the net principal limit (NPL), which is the maximum amount the borrower can draw. The loan rate is applied to the loan each month to calculate the interest that is added to the balance each month.
This is not a problem on FRMs because the loan rate is the expected rate. Because a higher rate and higher fees reduce the NPL, borrowers can shop the NPL — the HECM offering the largest draw is the best.
Unfortunately, there is an important exception to this rule. The Department of Housing and Urban Development (HUD) does not recognize expected rates below 5 percent, so that an FRM at 4.5 percent and at 5 percent that are otherwise identical have the same NPL.
Hence, the simplest way to shop for an FRM is to seek the lowest loan rate. If you are faced with a choice between lender A who has a lower origination fee and lender B who has a lower rate, choose the one with the lowest future loan balance in the year that is your best guess as to how long you will have the mortgage.
On ARMs, the expected rate is a published rate selected by HUD, but the lender sets the loan rate margin – the amount added to a rate index to generate the loan rate. Margins now range from 2.25 percent to 3 percent. Lenders also set the origination fee subject to a ceiling set by HUD. Most lenders charge the ceiling amount except where they are running a promotion, in which case they will tell you about it.
Shopping ARMs poses a quandary for borrowers because a higher loan rate increases the rate at which the borrower’s debt rises, but it also increases the rate at which the unused portion of the credit line increases. Further, a higher loan rate increases the size of the lifetime annuity the borrower can draw. Since a higher-rate HECM commands a higher price in the secondary market, originators make more on higher-rate loans unless they pass the benefit on to the borrower in the form of lower fees. On this topic, stay tuned.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
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