mortgages, called HECMs, can be a life-saver for
elderly homeowners short of income. While
after-shocks from the financial crisis have caused the
amounts that homeowners can draw under the program to be
reduced, as discussed in my previous articles in this
series, borrowers now have more options than they had before
On forward mortgages, borrowers have long had the option of
selecting from multiple combinations of interest rate and
points. Borrowers who expect to have their mortgage a long
time and have the cash to pay upfront charges can select a
low-rate/high point combination. Borrowers with a short
horizon and short on cash can select a high-rate/negative
point (rebate) combination.
The Saver provides a similar option for HECM borrowers with
short time horizons who don’t want to use up all their
equity in the house. The initial mortgage insurance premium
is reduced from 2% of home value to 0.1%, while the maximum
amount that can be drawn is reduced by 15-20%, depending on
the borrower’s age. The Saver is a useful option for owners
who intend to sell their home in a year or two and pay off
the HECM with the proceeds. It will be bypassed by owners
who expect to remain in their homes and want to extract as
much from it as possible.
For the first 20 years of the HECM program, borrowers were
offered only loans with adjustable rates (ARMs), but in
2008, FHA authorized fixed-rate HECMs. Today, borrowers have
a choice between HECM ARMs on which the rate adjusts
monthly, and HECM FRMs on which the rate is fixed.
An important difference between HECM FRMs and HECM ARMs is
that FRM borrowers must withdraw the entire amount for which
they qualify, called the Net Principal Limit or NPL, in cash
at the beginning. ARM borrowers, in contrast, have that
option along with others. They can take a lifetime or a term
annuity, or they can withdraw cash equal only to a part of
the NPL leaving the remainder as a credit line. The unused
credit line then grows monthly at the ARM rate. ARM
borrowers can also mix and match, using part of their NPL to
take an annuity while leaving the remainder as an unused
About two thirds of all HECM borrowers today are opting for
FRMs, which is the best choice for borrowers who want to
draw as much as they can as quickly as they can. This
includes those purchasing a house with a HECM, who usually
want to pay as much of the price as they can with HECM
proceeds. (Note: the HECM for purchase program, another
recent innovation, is discussed next week).
The borrower who takes a HECM FRM knows at the outset
exactly how his debt will grow. If in several years interest
rates and house prices begin to rise, which is widely
expected, the debt of the borrower with a HECM FRM will rise
at the same fixed rate. If the borrower maintains the
property and pays the taxes, an attractive refinance
opportunity will arise. That’s the case for the HECM FRM.
However, for those who don’t intend to use all or most of
the NPL at the outset, the FRM becomes expensive because
borrowers are paying interest on money they aren’t using.
Borrowers who want to use only a small part of their NPL at
the outset, leaving most of it for future years, will do
better taking a credit line on an ARM. As interest rates
rise, the unused portion of the line will increase at a
faster rate, more than offsetting the increased growth rate
of their debt. Borrowers who want a stream of income, either
for life or for a specified period, also must select an ARM
because this option is not available on an FRM.
I would like to be much more specific about the
circumstances in which an ARM would work out better than an
FRM, and vice versa, but it turns out to be a very
complicated problem that requires modeling to fully
understand. I’m working on a calculator that hopefully will
provide more precise answers.
A logical extension of the existing menu of HECM products would be one that carries a fixed-rate on an initial draw that does not use the full NPL, and a variable rate on the unused credit line that remains. This would be perfect for the borrower who wants to use part of the HECM immediately while reserving part of it for the future. I am told that such a product is now being discussed.