Be Careful What You Say

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*Note: Unintentional error mentioned in the video regarding the HECM line of credit calculation has been corrected in the transcript. The HECM line of credit growth rate is based on the current month’s interest rate charged + 1.25% FHA mortgage insurance charge. 

Borrowers are not the only ones who misunderstand the HECM

hand-over-mouthA few days ago I was speaking with a very skilled and experienced trainer in our industry. We both share a passion for educating, motivating and empowering reverse mortgage professionals. During our short chat we landed on the topic of key provisions of the HECM program that are often misunderstood not by borrowers, but by some well-meaning reverse mortgage professionals.

Educating our potential borrowers is key but it can be counterproductive if we are dispensing inaccuracies. Let’s examine two of the most commonly misunderstood aspects of the Home Equity Conversion mortgage.

1- Who FHA Insurance actually protects. Many loan officers mistakenly tell their borrowers of the wonderful protections that FHA insurance provides. After all who doesn’t like to see some benefit for the premiums they pay?

 

Download a transcript of this episode here.

Looking for more reverse mortgage news, commentary and technology? Visit ReverseFocus.com today.

8 comments

Scott Alexander August 21, 2015 at 4:42 am

Great video my friend…..and thank you. I have a question I think would be a great topic for another video….I was told that if a HECM borrower makes ANY payment on their reverse mortgage, then their LINE OF CREDIT is increased dollar for dollar of the payment made to the lender? Having been in the industry for many years, I’m surprised I don’t know the answer to this and even more surprised that others I have asked aren’t 100% either way. every one says to call the individual servicer for a direct answer. any light shed would be appreciated.

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James E. Veale, CPA, MBT August 21, 2015 at 10:58 am

Mr. Alexander,

The answer to question is yes; the line of credit increases dollar for dollar whenever a borrower pays down the line of credit. Be careful if the borrower pays more than the balance due, the HECM will terminate. For example, if the balance due is $145,000 and the borrower pays $175,000, the borrower will receive a $30,000 refund but the HECM will terminate.

HUD requires that servicers use a very simple math computation when determining the available line of credit. This formula is how we know that paying down the unpaid balance due increases the available line of

To easily comprehend it, the acronyms used in the formula are defined here:

ALOC = Available Line of Credit
CUPBD = Current Unpaid Balance Due
TOASA = Total of Amortized Set Asides
CMPL = Current Month’s Principal Limit

The formula is as follows:

ALOC = CMPL – CUPBD – TOASA

Since the vast majority of active HECMs no longer have set asides, we will assume the TOASA is zero; however, the remaining balance in a LESA is an ASA or amortized set aside as is the repair set aside and the old servicing fee set aside.

So if the current principal limit is $276,212.63 and the current unpaid balance due is $176,108.13, the available line of credit is $100,104.50.

Let us say that the borrower pays $35,000, so that the CUPBD drops to $141,108.13. So what is the available line of credit? Going back to our formula of ALOC = CPL – CUPBD – TOASA, let us fill in the numbers we know:

ALOC = $276,212.63 – $141,108.13 – $0

So the available line of credit now is $135,104.50 which is $35,000 higher than before the $35,000 payment was made.

Knowing that formula will greatly help you and make you be able to answer many questions about the line of credit and other issues. This formula can be found in the HUD HECM Handbook (Handbook 4235.1). You will need to carefully read through sections (HUD calls them paragraphs) 9 and 7 of Chapter 5 in that order.

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Scott Alexander August 24, 2015 at 6:19 am

Thank you so much my friend! took me a while to find this page again but glad I did! Great info!

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Ernie Lau August 24, 2015 at 7:41 am

Nice job, James, you always do a great job of explaining things properly and thoroughly, keep up the good work.

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Jim Warns August 21, 2015 at 8:38 am

Shannon, you suggest that the annualized growth of the line of credit is equal to the unused balance in the line times the interest rate + .5 percent. The .5 percent should be 1.25 percent to reflect the current rate of the on-going MIP.

Also, to be technically correct the growth rate is actually applied to the PRINCIPAL LIMIT, not the unused balance in the LOC. Growth of the LOC equals growth of the PL minus any outstanding loan balance. When there is no monthly service fee the two calculations yield the same result, but it is the actual calculation against the PL which can result in the possible decrease in an LOC with a small balance when there is a service fee being added to the loan balance in addition to the accrued interest.

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Shannon Hicks August 21, 2015 at 1:33 pm

Jim. Absolueltly corect. The growth of the PLF is the more accurate descriptions

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James E. Veale, CPA, MBT August 21, 2015 at 5:48 pm

Mr. Warns,

Your comment makes it appears that the only possible set aside where aberrations arise are the servicing fee aside but that is not true. For instance, for a period of time there can be a repair set aside which does not grow, meaning based on the residual formula for the available line of credit, the line of credit can have a substantially greater line of credit growth than would normally occur. For example, say the payoff of mandatory obligations and a repair set aside of $40,000 leaves but $500 in the line of credit. The interest rate for the current month is 4.25% and ongoing MIP is 1.25%, so what is the “growth” in the line of credit if there has been no activity in either the repair set aside account, the balance due, or the line of credit in that first full month? $185.63, making the available line of credit $685.63. That is an annual growth rate of 445.5% and a true aberration.

Now let us use the actual formula to see if this really occurs. Let us say the principal limit for the start of the month was $267,000 so that the balance due at the beginning of the month was $226,500. The balance due at the beginning of the next month would be $227,538.12, while the principal limit for that month would be $268,223.75 making the available line of credit equals $685.63 (or $268,223.75 minus $227,538.13 minus $40,000 which is $685.63.)

What does the following clause mean “…but it is the actual calculation against the PL which can result in the possible decrease in an LOC with a small balance when there is a service fee being added to the loan balance in addition to the accrued interest?” It does not explain why the alleged growth is negative.
It is the amortization of the servicing fee set aside which creates the problem when the available line of credit is low and the expected interest rate is greater than the note interest rate. So let us look at an example. Say the principal limit is $205,000, the balance due is $202,000, and the Servicing Fee set aside is $2,500 leaving the line of credit at $500. So let us look at the formula but first here is some additional information: the expected interest rate is 5.75%, the ongoing MIP is 0.5%, the monthly servicing fee is $25 and the note interest rate is 2.8% for the month.
The amortized balance of the servicing fee set aside at the start of the next month is $2,488.02 (assuming a full month). The balance due is $202,580.50. The principal limit for the month is $205,563.75. So the line of credit is $495.23.

So what mathematically actually caused the shrinkage? Based on the theory that the line of credit grows at the same rate as the principal limit, the growth for the line of credit should have been $1.38. Since the growth in the principal limit was 563.75 and the balance due grew by $555.50, the line of credit theoretically should have grown by $1.38, that leaves $6.87 for the servicing fee set aside. But the actual growth for the servicing fee set aside is $13.02 which is a difference of actual to theoretical of a negative $6.15. That difference must come out of the line of credit so that if the line of credit is $500 and grows by $1.38, the theoretical balance should be $501.38 but then that balance must be reduced by the adjustment for the actual growth in the serving fee set aside (since there is no other dependent variable to adjust) so that the total change for the month to the line of credit is $1.38 – $6.15 or a negative $4.77 making the ending balance in the line of credit just $495.23. The actual reduction to the line of credit comes from using one interest rate for amortizing the servicing fee set aside and a different one for the growth in the principal limit and accrued interest on the balance due.

The strange aberration caused by using a different interest rate to amortize set asides from the interest rate in calculating the principal limit growth and the balance due caused HUD to decide in Mortgagee Letter 2015-09 to use the note interest rate and not the expected interest for amortizing LESAs. (The next two sentences assume the HECM will be active at least through the year following the TALC life expectancy of the youngest borrower as of the date of HECM closing.) This decision eliminates the adjustment to the line of credit for different interest rates when it comes to LESAs but it also means that in most cases, the LESA in the year in which TALC life expectancy ends will distribute smaller amounts than it did in prior years. With HECMs where the actual average effective note interest rate exceeds the expected interest rate, the LESA should provide at least some distribution in the year after TALC life expectancy ends.

(The opinions expressed in this reply are not necessarily those of RMS or its affiliates.)

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James E. Veale, CPA, MBT August 21, 2015 at 3:18 pm

Based on the formula displayed in my reply to Mr. Alexander above, it seems that HUD is saying that if two neighbors get HECMs on the same day in 2014 where 1) the appraised values, 2) the age of the youngest borrowers, 3) the interest terms are identical, and no servicing fee set aside nor repair set aside are required, the principal limit on their respective adjustable rate HECMs will start at and grow to the same amounts, month by month. We talk about the growth rate but the total accrual rate is exactly the same which is the following: one-twelfth of the sum of 1) the interest rate on the note for the month plus 2) the ongoing MIP (which in 2014 was 1.25%). Both the growth and total accrual rates are charged monthly. (So it is entirely false the ongoing MIP is charged annually at the rate of 1.25%. The correct statement is charged monthly based on an annual rate of 1.25%. The first sentence of these parenthetical sentences means that ongoing MIP is only compounded annually but in fact as reflected in the next sentence the annual rate of ongoing MIP is divided by 12 and charged monthly.

So let us say that N1 (one neighbor of the example started in the first paragraph above) has mandatory obligations that equal 99% of the $300,000 line of credit. The borrower takes out the remaining line of credit of $3,000 at closing. N2 (the second neighbor in the example started above) decides to take $30,000 in total at closing. So here is how each of their loans look at closing.

For N1, ALOC = $0, CUPBD = $250,000, CMPL = $250,000, and TOASA =$0
For N2, ALOC = $220,000, CUPBD = $30,000, CMPL = $250,000, and TOASA =$0

So now we will look at the two HECMs at the end of five years where the average effective note interest rate has been 4.5% making the current month’s principal limit for each loan $333,044 and of course the TOASA remains $0.

For N1, ALOC = $0 and the CUPBD = $333,044 and
For N2, ALOC = $293,079 and the CUPBD = $39,965

After 10 years the only thing that the borrowers do with their respective HECMs is to pay down their respective CUPBD by $25,000 so what will the HECM look like on that day if the average effective note interest rate over the entire 10 year period has been 4.9% (i.e. the average effective interest rate for the last 60 months has been about 5.3%)? We know that the TOASA remains $0 and that the CMPL for each HECM will be $461,688. Here is the crucial other information for each of the two HECMs

For N1, ALOC = $25,000 and the CUPBD = $436,688 and
For N2, ALOC = $431,286 and the CUPBD = $30,402

Unless the adjustable rate HECMs are annual, we only know what the interest portion of the total accrual and growth rates will be month by month. To be clear the growth rate only applies to LESAs and the prior month’s principal limit.

If you use the HUD HECM calcultor available on its website at

http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/hecm/hecminst

you can actually see how the formula cited above works when you print its amortization schedule. Many HECM software calculators ignore printing out the principal limit in their amortization schedules. That is actually too bad since originators cannot see how the current month’s principal limit is equal to the sum of the parts for that same month as presented above.

(The opinions expressed in this comment and the reply to Mr. Alexander’s question are not necessary those of RMS or its affiliates.)

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