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Reexamining HECM Fund Distributions & Loan Recommendations
Today’s interest rates are at historic lows providing reverse mortgage borrowers with extraordinarily low rates. The borrower has a small mortgage balance to pay off. Should they secure this rate with a fixed rate HECM to take advantage of such an opportunity?
To begin with I hope our viewer’s collective answer is “no”. To chase after low interest rates while maximizing the initial draw or disbursement is akin to asking the borrower to walk over a dollar to pick up a dime. Such a scenario reinforces the need for HECM professionals to exercise the highest level of care when it comes to structuring a borrower’s initial disbursements.
Fixed Rate HECM. The fixed rate reverse mortgage was extremely popular until HUD revamped their product lineup in mid 2013. Without disbursement limits in place Standard Fixed Rate HECMs accounted for 70% of all loans originated at the time the Consumer Financial Protection Bureau drafted their report to Congress in June of 2012. The CFPB argued these loans placed more risk on FHA for potential defaults as the loan balances grew more quickly than their adjustable rate counterparts.
What about today’s fixed rate HECM? The fixed rate is now subject to HUD’s first year distribution limits and is…
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The worst enemy of the HECM borrower, negative arbitrage. So what is it? Let us look at a case that came my way not long ago.
A disabled woman who is now 71 years old asked about refinancing her fixed rate Standard. Asking why she wanted to do that, she explained she had taken the proceeds she did not need at closing and doing as the originator advised she invested it. As soon as she did, the investments went down. So now she invested in safer investments.
Over the last four years the borrower has earned about $8,000 but after allocating her accrued interest and MIP between other uses of the proceeds and her investments, she had incurred $57,000 in just accrued interest and accrued MIP and an additional $9,000 in upfront costs on the portion of the proceeds used to invest with. We have not determined how much she lost in her original investing. The interest rate on the fixed rate Standard is 5.06% and the MIP is 1.25%.
Negative arbitrage is earning less than you are incurring in costs. So is earning $8,000 less than the $66,000 the borrower has incurred in costs to date? That is a clear case of negative arbitrage. Sad to say she is not alone. But now let us take a look at her further predicament.
Her present balance due exceeds the principal limit on a new HECM. Since the borrower has the money to pay down the balance due she is OK on that front but now we come to Financial Assessment. Fortunately she has no credit flaws or no flaws for property charges but we are working on her MRI and will not be sure for a few days yet.
The borrower lacks the ability to assess risk and invest accordingly. Yet the first originator told the borrower that the fixed rate Standard was the best thing for her and not to worry about what a counselor might tell her about other products. So she followed the advice of the originator, got the first rate Standard HECM, and tried to invest. Today she is out over $58,000 when bringing in the loss in her original investing and has nothing to show for it except a lesson learned the hard way.
Negative arbitrage is not the friend of the HECM borrower.