Interest rate hikes are here. How to cope?
The Federal Reserve has already increased the benchmark federal funds rate and has telegraphed their intention for additional hikes this year. Do reverse mortgage lenders and borrowers need to worry?
Be careful what you wish for. Monetary policy dictates that as the economy improves, interest rates are adjusted to more normative levels in the efforts to curb inflation and prevent market bubbles triggered by cheap money.
Reverse mortgage borrowers reluctant to pay higher closing costs were often won over with lender pricing concessions. IBIS’s weekly rate updates show the gradual erosion of lender margins, eroding the ability of HECM lenders to reduce origination fees or to cut other costs….
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For several years, I have questioned many members of the industry about the research of the financial academicians not in any other way than the only payout with unlimited payouts throughout the life of a performing HECM was tenure payouts.
I am grateful to someone who pointed me HECM regulation 24 CFR 206.19(f). It places a cap on how much can be paid out of a HECM line of credit.
The third limitation is the maximum mortgage amount (MMA) which is 150% times the Maximum Claim Amount. The payout limitation which cannot be exceeded is the MMA minus the balance due. The third limitation normally will not apply until the total current principal limit equals or exceeds the MMA as shown in the first lien security documents.
So let us say a 62 year old has a home currently worth $600,000 but at an expected interest rate of 4.75% must take a fully funded LESA of $86,284 and will only finance the upfront costs of $10,000 taking no payouts and making no pay downs throughout the life of the HECM. The MMA is $900,000. The available line of credit will be $218,116 at closing. During the first year the total cash available from the line of credit during the first 12 months (the first limitation which cannot be exceeded) is just $171,440. In this example, the limit of all payouts during a month then becomes the available line of credit for the next 203 months. Based on an average effective interest rate of 4.75%, at the 216th month, the amortized fully funded LESA is about $19,822; the current principal limit is $923,320; the balance due is about $262,942; and the available line of credit is $640,556 and the regulation limitation is about $637,058; thus because the regulation limit is lower than the available line of credit, the regulation limitation is the limitation for how large total payouts for the 216th month can be. At the 215th month the regulation limit would have been about $638,967 but the available line of credit would be just about $637,370 so the maximum payouts for the month from the line of credit would have been limited to the available line of credit. So in this case the peak of the regulatory limitation is reached at the 215th month and diminishes from that month forward.
At the 217th month, we begin to see the impact of diminishing returns when the regulatory cap comes down to about $635,141 despite the available line of credit being about $643,760. So, yes, without any activity in the line of credit, based on the regulatory limitation, the maximum payouts in a month from the available line of credit can shrink.
The reason for using the modifier “about” in the prior paragraph is that the only payouts from a fully funded LESA are the actual real estate taxes and homeowners’ insurance which are not known until they become due and payable which in turn if different than the amount amortized as estimated above impacts the amortized LESA set aside, and thus the balance due, the available line of credit and even the regulatory limit.
Complicated? Yes, but the regulation also makes the HECM so that it is NOT “too good to be true” in respect to the growth in the line of credit.