the bum raps against HECM reverse mortgages is that their
upfront fees are too high. It is a dumb rap as well, because
it is based on a comparison with standard mortgages, which
aside from the fact that both are secured by a property,
have very little in common.
Assessment of whether a service is priced too high can be
based on the value of the service to consumers, or on the
cost of providing it. HECM fees are not excessive on either
reverse mortgages provide more value to homeowners than
standard mortgages, and we should therefore expect them to
cost more. An integral part of standard mortgages is a
required repayment schedule. On mortgages that are fully
amortizing, as most are, the repayment process begins in
month one. To qualify for a standard mortgage, borrowers
must document sufficient income to afford the required
payment, sufficient asset s from acceptable sources to meet
the cash requirements, and a credit record verifying their
willingness to meet their obligations.
In contrast, there are no repayment schedules on HECMs. Loan repayment is deferred until the borrower dies or vacates her home. With no required payment, borrowers are subject to neither income nor credit requirements. There are no cash requirements, as all upfront costs can be financed. Relative to standard mortgages, HECMs are hassle-free.
major cost of producing reverse mortgages is the loss
incurred by the lender or the insurer who protects the
lender against loss. The insurer of HECMs is the Federal
Housing Administration (FHA), an agency of the Federal
Government, which also insures standard mortgages. The HECM
reverse mortgage is riskier for FHA, and it charges more for
the insurance to cover its losses.
standard mortgages that FHA insures, the borrower’s
repayment obligation is a first line of defense against
loss. Only in the event that borrowers default on their
repayment obligations do lenders/insurers fall back on their
second line of defense, which is the property that has been
posted as collateral. Lenders can take the property through
foreclosure in order to repay themselves the amounts owed.
reverse mortgages, there is no first line of defense against
loss. The lender/insurer has only the second line of defense
to protect against loss – sale of the property – AND they
cannot exercise this option until the borrower dies or moves
out of the home permanently.
takes a loss on a HECM when the property value is lower than
the loan balance at the time the balance is repaid. If
interest rates rise more than expected, or if the property
appreciates at a lower rate than expected, FHA can incur a
loss. Such losses are not offset by gains when interest
rates rise by less or properties appreciate by more than
expected. Any equity remaining in the property when the HECM
balance is repaid goes to the borrower or to her estate.
manages the risk by calculating HECM payments on the
assumption that the borrower lives to age 100. This safety
margin allows them to charge insurance premiums that are
only slightly higher than those on the standard mortgages it
insures. An annual premium of 1.25% of the HECM loan balance
compares to 1.20% on a standard 30-year loan with 5% down.
The difference in the upfront premium is a little larger --
on a HECM it is 2% of property value and on the standard
mortgage it is 1.75% of the loan amount. But HECM borrowers
can avoid the upfront premium almost entirely, as noted
origination fee HECM borrowers pay lenders is capped by law
at $2500 on house values of $125,000 or less, at $4,000 on
house values of $200,000 or less, and at $6,000 on values of
$400,000 or more. There are no caps on origination fees
charged on standard FHA loans. Some HECM lenders,
furthermore, charge $2500 on all HECMs, regardless of
third party fees including title insurance vary from one
part of the
country to another, there are no differences between HECMs
and standard mortgages.
This leaves the upfront mortgage insurance fee, which is slightly higher on HECMs than on standard mortgages. It is a small price to pay for a unique hassle-free mortgage with no required payment. Furthermore, HECM borrowers who want to leave a little more equity for their heirs don’t have to pay this charge. They can reduce the upfront premium from 2% to .01% by electing the “Saver“ version of whatever HECM option they want. The saver version cuts the risk to FHA by scaling down the amount the borrower can draw. It doesn’t get any fairer than that.