Pricing of HECM Reverse Mortgages
HECM reverse mortgages are unique in using two interest rates in every transaction. The two rates can be either fixed or adjustable rate.
The Two HECM Rates
One interest rate is used in calculating the borrower’s future debt and his future credit line if there is one. This is the “mortgage rate” and it is comparable to the rate on standard mortgages (though there is no credit line option on a standard mortgage). On one adjustable rate version, the rate adjusts monthly subject to a 10% lifetime adjustment cap. On another version, the rate adjusts annually subject to a 5% lifetime adjustment cap. In both cases, lenders may offer different combinations of initial rate and origination fee.
The second interest rate is called the “expected rate” and it is the rate used in determining draw amounts – the higher the expected rate, the less the senior can draw. This relationship between expected rates and draw amounts is set by HUD as the insurer of HECMs.
If the borrower elects a fixed rate, the mortgage rate and the expected rate are the same, but if the borrower selects an adjustable rate, the two will differ. During the years of very low rates, the expected rate was consistently higher than the mortgage rate.
Interest Rates, Origination Fees, and Lender Income
The price of a reverse mortgage to the borrower includes the origination fee as well as the interest rate. Under FHA rules, origination fees are capped, with the cap based on property value up to a maximum of $6,000. There are no caps on the rate.
The income of loan originators consists of the origination fee plus the premium received on the sale of the mortgage, which is expressed as a percent of the loan balance. On high balance transactions, which includes those with significant existing mortgage balances that must be repaid with proceeds from the HECM, premium income can be substantial.
The competitive lenders reporting their pricing to us will rebate part of their premium to the borrower as a negative origination fee, or rebate. Many if not most other lenders, however, will charge borrowers the maximum origination fee set by regulation, regardless of the size of their premium income.
Locking the Rates
The expected rate is locked as soon as the loan application has been submitted to FHA. The mortgage rate, however, is not locked until all processing has been completed, the property has been appraised, and the borrower has been counseled, which typically takes multiple weeks during which time HECM rates may change – the practice is to reset rates to the market every week.
The upshot is that borrowers draw the amounts they were promised, but the rate they were quoted may be different. Under these circumstances, lenders should lock at the rate they would quote to a new shopper with the identical transaction, but whether they do or not nobody knows. The temptation to pad the closing price must be very strong, especially when market rates have gone down and they can pad the current price while delivering the price they had quoted earlier.
HECM lenders who pad the final closing price are not likely to encounter any resistance from the borrower. Probably most borrowers focus on the draw amount, which conforms to what was promised, and there is no simple way for the borrower to check the price.