Home Equity Reverse Mortgage Basics
Before I get into the meat of this article about the coming changes, I want to make sure that you understand the basics of exactly how reverse mortgages work.
The Home Equity Reverse Mortgage (HECM) is the name for the FHA reverse mortgage program.
The HECM makes up over 95% of the reverse mortgage market so this is the program that we will focus on in this article.
A reverse mortgage is an FHA insured loan specifically designed for homeowner’s age 62 and above, that allows you to convert a portion of the value of your home into tax free money, without having to sell the home, give up title or obligate yourself to a monthly mortgage payment. It is just a loan against your home. The lender has a lien against the title. You are still charged interest, just like any other loan, however, you do not have pay it on a monthly basis. The interest is deferred to the end of the loan, but since the home is still in your name you do have to pay the property taxes and homeowners insurance as well as maintain the home.
The loan only comes due when the last homeowner permanently leaves the home or passes away. When this happens, the lender does NOT automatically
take the home. The heirs inherit the home and if there is equity, the heirs can either sell the home or refinance it to and keep the equity.
A reverse mortgage gives you the benefit of no mortgage payments, but every month, the interest that is charged is added to the loan balance, so the balance continues to grow over the life of the loan. This is truly a 100% negative amortization loan.
Since the balance of the loan can grow over time, it is possible that the loan balance might exceed the value of the home. If this happens, nothing changes with the loan as long as you are living in and maintaining the home, as well as staying current with the property taxes and homeowners insurance.
However, when you permanently leave the home, the loan comes due. Your heirs inherit the home but they do not inherit any debt beyond the value. If you are upside down on the home (the balance on the loan is bigger than the value of the home), the heirs can simply give the home to the lender and walk away. The lender has no recourse on you, the heirs or the estate.
The reason this protection is in place is because there is mortgage insurance (MIP) on every HECM reverse mortgage loan. The MIP pays the lender if they lose money on the loan. Since the lender is not losing money, they cannot come after you, your heirs or your estate for more money.
The downside to this is that you are charged for the mortgage insurance premiums (MIP). The MIP is paid twice, once with the closing costs and again on a monthly basis. We will get into the amount of these charges later in the article.
What Are The Changes Coming To The HECM Program On October 2nd?
HECM’s are insured by the Federal Housing Administration (FHA). FHA is under the Department of Housing and Urban Development (HUD) so they set the rules the HECM reverse mortgage program has to follow.
On August 29, 2017 HUD announced new changes that take effect on October 2nd, 2017.
There are basically 2 dials that HUD uses to make adjustments to the HECM program – think of them as the two dials on a faucet. One is called the Principal Limit Factor (PLF) and the other is the Mortgage Insurance Premium, (MIP).
The PLF is the formula HUD uses to determine the amount of money that they will allow the lender to loan to the homeowner. The MIP is the amount of money that goes to HUD. Another way to think of it is the PLF is the “Risk” to HUD & MIP is how to “pay” for the losses.
The changes coming on October 2nd are to both of these dials.
The changes to the PLF will lower the amount of money that is available to you by about 15% - 20%. A couple weeks ago in a previous posting, I told you incorrectly that the changes would mean a reduction of about 5% - 10%. I apologize for mistake. The changes to the PLF “table” are between 5%-10% but the impact on the amount of money available is a reduction of 15% - 20%.
The amounts are dependent upon the age of the youngest spouse and the interest rate. There are two interest rates with reverse mortgages. One is called the “Initial Rate” and this is the rate the you are actually charged on the loan balance. The other is called the “Expected Rate” and this is the rate that we use to determine the amount of money we can loan. Think of it this way, as this “Expected Rate” INCREASES, the amount of money available DECREASES. Conversely, as the rate goes DECRESES, the amount of money available INCREASES.
This has always been the case with all reverse mortgages but in 2009, HUD set a floor rate of 5.06%. What this means is that as long as the “Expected Rate” is below this 5.06% rate, you would get the maximum amount of money available. This was great because the rate has been below 5.06% for the last 8+ years. But on the down side, lenders have no incentive to lower the rate unless they were competing for business.
However, the companies that were buying these loans from the companies that originated them, paid more for these higher interest rate loans so some lenders would be able to give some of this money back to the borrowers in the form of lender credits. These credit would be applied to the closing fees to lower the overall cost of the loan.
In addition to changing the PLF tables to reduce the amount available, the other change that HUD made to the PLF is that they lowered this floor rate from 5.06% down to 3.00%. What this means is that the lenders would have to lower their rate by about 2.00% in order to get you even close to the same amount of money that you would receive today. That is probably not going to happen anytime soon.
On the plus side, the rates will come down. How much? I can’t say exactly but they will come down. Unfortunately, most lender credits to pay for some of the closing costs will probably go away.
To summarize the PLF changes, HUD has made these “general” reductions to the tables and they lowered the floor rate from 5.06% to 3.00%. The net result is that the amount of money available from a reverse mortgage will be about 15% - 20% less.
If this stuff is just complete gobbly-gook and you are still reading, please call me and I can go over this in detail for your specific situation. Please call me at 303-467-7821.
The second dial, the MIP, changes are not nearly as convoluted as the what we just discussed.
The MIP goes into a reserve fund that HUD uses to pay the lender if they lose money on the reverse mortgage. They get this money from you, the borrower in two ways. As an “Initial” MIP (IMIP) charge, and also from and “ongoing” MIP that is charged monthly.
The IMIP is part of the closing cost and currently, the amount of the fee depends on how much money you pull out of the reverse mortgage during the first 12 months of the loan. If you have a big mortgage and need to draw out more than 60% of the money from the reverse mortgage, then your IMIP charge will be 2.50% of the VALUE of the home.
For example, let’s say you have a $300,000 home and qualify to receive $200,000 from your reverse mortgage. 60% of the $200,000 that is available is $120,000. If you have an existing mortgage that is more than $120,000, your IMIP would be 2.5% of the value of $300,000, ($7,500).
If you have a mortgage lower than $120,000, or own your home free and clear, then your IMIP is just 0.5%, ($1,500).
As of October 2nd, the IMIP will be a flat 2.00% of the value of the home. This means that if you have a big mortgage on your home, your new IMIP will be LESS. From $7,500 down to $6,000, (2% of $300,000). But if you have a small mortgage or no loan at all against the home, your IMIP will be substantially MORE. From $1,500 to $6,000. A $4,500 increase in closing costs.
As you can see, this change is kind of mixed blessing depending upon your situation. It could be good or it could be bad.
The same is true with the “ongoing” MIP. Currently, the ongoing MIP is 1.25% of the BALANCE of the loan. Remember the IMIP is based on the VALUE of the home but the ongoing MIP is based on the BALANCE of the loan.
For example, under the current rules, if you have a loan balance of $100,000 on your reverse mortgage, over the course of a year your ongoing MIP would be $1,250. This isn’t an exact figure because it’s charged to your account monthly (remember you do not actually PAY this fee, it is just added to your loan balance on a monthly basis).
However, under the new rules beginning October 2nd , the ongoing MIP will be lowered to just 0.5% of the balance. This means that under the same scenario with a $100,000 loan balance, you would only be charged about $500 over the course of the year, a $750 savings.
This is great news because everyone will be charged LESS over the course of the loan.
However, there is also a down side.
All reverse mortgages have what is called a growth rate on any unused Line of Credit. The way reverse mortgages work is that we have to make all of the amount of money that HUD says you qualify for available to you, but you do NOT have to take it all. If you qualify for $150,000 but only need $50,000, the $100,000 left over is still available to you in the form of a line of credit, (LOC). This line of credit currently has a growth rate the is equal to the interest rate you are charged on the balance of your loan, PLUS 1.25%.
If you have $100,000 in your LOC, and you are being charged 4.25% on the $50,000 you took out, your LOC of $100,000 will grow by 5.50% (4.25 + 1.25 = 5.50%).
However, on October 2nd the ongoing MIP will lower to 0.5%, the growth rate on your LOC will also be lowered. If your interest rate is 4.25%, the
growth rate on the LOC will only be 4.75% (4.25 + 0.5 = 4.75%). The growth rate is equal to the rate you are charged plus the ongoing MIP.
As you can see, there are positives and some negatives to these changes. Unfortunately, it is really going to hurt the people that have a big mortgage on their home because they may not be able to get enough to pay off the balance. Because the reverse mortgage must be the only loan against the home, if you can’t borrow enough to pay off the existing mortgage, you can’t get the loan. So these people will be out of luck.
Also, the people who want to use a reverse mortgage for financial planning purposes, for example to establish the stand-by LOC to use if other assets go down in value, it won’t be quite as attractive for them because the costs will be higher and the growth rate of the LOC lower.
The bottom line is that after October 2nd, the HECM reverse mortgage will be different. Some people who can get a reverse mortgage today, might not qualify under the new rules and the costs will likely be more for most borrowers. However, this is still a very beneficial program that can help a lot of people.