Financial illiteracy challenges acceptance of a counter-intuitive mortgage
If there is one subject that cries for remedial instruction it’s financial literacy. Fortune.com found that nearly two thirds of Americans are in effect financially illiterate, unable to grasp basic financial concepts. As the Home Equity Conversion Mortgage has become increasingly complex in recent years, the knowledge gap has widened.
Before attempting to explain how a reverse mortgage works, we should perhaps conduct a quick assessment of the prospective borrower’s grasp of financial concepts. After all, who would want to jump from algebra straight to trigonometry? In reality, filling the role of a financial counselor is often impractical, nevertheless we should be mindful of many homeowner’s ability to absorb the information we are presenting.
Consider one question: if you take out a $1,000 loan that has a 20% interest rate, how much will you owe in one year in interest? Nearly two thirds could not answer correctly. The overall rate of American financial literacy findings come from the National Capacity Study by the FINRA Foundation.The very nature of reverse mortgages is counter-intuitive to the mortgages most have known and paid for most of their working years. That familiarity is fraught with myths and misconceptions. Take for example ….
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Seniors have enough problems understanding financial matters when stated correctly so why do we create our own language? HECM proceeds are not income!
Any bookkeeper will tell you that if they are keeping books for a borrower, cash from the lender increases some cash account of the borrower and increases the amount owed to the lender. The draw only increases assets and liabilities.
Yet when that Social Security “electronic check” comes in, the bookkeeper will tell you that the related bank account increases AND an income account goes up. The same is true for interest income, pensions, rents, royalties, and on and on. The only part of the HECM draw transaction that is the same is that some cash account of the borrower goes up; otherwise, they are very DIFFERENT transactions.
Then there is the stupid statement that the HECM line of credit is an asset of the borrower. That is nonsense. One can call it a contingent asset of the borrower but all the amount available in the line of credit tells the borrower is the amount of cash that the bank is contractually obligated to provide the borrower as further BORROWINGS. A savings account is an asset of the senior since it can be taken at any time with no strings attached; what is available in that account is an asset of the consumer.
As another example, a saving account can serve as collateral on a loan but the HECM line of credit cannot because the available amount is still the property of the lender until borrowed by the borrower.
Our customers are members of a protected class. The more we use our “less objectionable language” the more it shows why we will never be classified by the OMB or any other major classifier of occupations as professionals. Also the more we are asking to be attacked by the CFPB.
One side of things is the confusing, nonsensical language and terms used in our industry but we are also very weak in another very significant area, how the HECM works versus forward mortgages.
Some years back, three veteran HECM originators were superficially were putting down forward mortgages. They were saying how that even with no pay downs, the same initial amount owed at closing, the same fixed interest rates, the HECM would produce less interest in thirty years than a fully amortized 30 year forward mortgage.
Entering into the thread, I called them on their nonsense. None of them seemed to be able to use a business calculation or how to compute payments on a fully amortized mortgage. Yet all three seemed like they had originated forward mortgages in their careers.
Using a fixed interest rate of 6%, the fully amortized mortgage borrower would have paid out $231,676 in interest on a $200,000 mortgage and owes $0 at the end of 30 years. On the other hand the HECM borrower would owe $1,748,954 of which $1,281,893 is accrued interest and $267,061 is accrued ongoing MIP.
Each of the three had more experience in the industry than me yet they had no idea that the interest would even be more with a HECM let alone by over $1,000,000. Even the accrued ongoing MIP is more than the interest charged on the thirty year fully amortized forward mortgage. So even though 1.25% ongoing sounds like nothing, it can accumulate an amount equal to the interest on a conforming 30 year loan in 30 years and much more if outstanding any longer.
What this shows is that if veterans are not checking on the general accuracy of the amortization and TALC schedules, who is? Reliance on the vendor or proprietary software of your employer is far too lackadaisical when dealing with a protected class that is far less financially literate than its predecessors.
It is time that HECM originators become financially literate by a far greater standard than some nontechnical survey.