In 2010, when she desperately needed additional income, a woman named Sheila P. took out a reverse mortgage, even though her home in Nevada had fallen sharply in value during the previous four years. Home prices in Nevada rebounded sharply, however, and by 2016, her home had almost doubled in value. Sheila responded by refinancing her home equity conversion mortgage — the federal government’s reverse mortgage option — and the move increased the amount of money she receives each month substantially.
Most home equity conversion mortgage, or HECM, borrowers are aware of the refinance option because they had the same option on their standard mortgage. HECM borrowers also have other options, however, which are unique to HECMs and may not be known or fully understood. Those who take a monthly payment, as Sheila did, and find later that their needs would be better served by a larger or smaller payment for a different period or by a credit line on which they could draw as needed, can modify the transaction without charge. If they had originally taken a credit line and decide later that they prefer a steady monthly payment, they can make that switch as well.
Mortgage management is a challenge on reverse mortgages
For a consumer, getting a mortgage poses one set of challenges. Managing the mortgage after they get it poses a completely different set. The firms that service mortgages work for the lender and their major objective is to make sure that borrowers meet their payment and other obligations to the lender. Issues important mainly to the borrower usually are left for the borrower to work out.
On standard mortgages, such managerial challenges are not that difficult. In dealing with the challenge of paying down the loan balance early, for example, borrowers have access to a variety of internet-based tools. On my website alone, there are six calculators and four spreadsheets directed toward this problem.
With HECMs, on the other hand, it is a very different story. Except for borrowers who have drawn the maximum cash permitted on a fixed-rate HECM, the managerial challenges are greater. This is because the reverse mortgage has no terminal date — it can go on as long as the borrower lives in the house — and the borrower always has an option to change the deal in ways indicated above.
The servicer’s role is limited
I recently decided to see how the firms that service HECMs keep their clients informed. I did not get to look at all the servicing statements out there, but those I saw were very similar and I am sure they are typical. They do a good job of informing borrowers about the status of their HECMs at month’s end — including the loan balance, unused credit line, and interest rate — but they don’t project the transaction into the future. In particular, they provide no indication of how much home equity borrowers may leave in their estates. In addition, they do not indicate the borrower’s options to change the monthly payment or the unused credit line, or whether a refinance might offer better options.
A new tool
As a result of this research, my colleague Allan Redstone and I decided to fill this gap with a spreadsheet. To my knowledge, it is the only tool of its type out there. It is on my website for anyone to use.
The spreadsheet has three components. The first can be viewed as an extension of the servicing statement, projecting the loan balance, unused credit line and homeowner equity into the future. The user can also play “what if,” changing the future interest rate and property appreciation rate that are used in the calculations.
The second component shows the borrower’s options to modify the transaction, by changing the payment or the payment term, drawing cash or repaying previous draws, or a combination. As with component one, the spreadsheet shows the implications of such program modifications for future values of the loan balance, unused credit line and homeowner equity.
The third component of the spreadsheet deals with the question of whether the program modifications the borrower entered in the second component could be obtained more advantageously by refinancing into a new Kosher HECM. The borrower is a little older, which helps, and it is possible that the property appreciation rate during those years has exceeded the 4 percent rate that is used by the HECM program in calculating draw amounts; that would also work in favor of a refinance. Increases in interest rates, on the other hand, would work against a refinance.
The spreadsheet uses two live interest rates posted by the lenders who deliver rate data to my website. One is the lowest rate ignoring the origination fee. The second is the rate corresponding to the lowest origination fee. This provides two independent measures of whether or not refinancing would be in the borrower’s interest.
The spreadsheet is a management tool for those who already have a HECM, which is not a large group — about a million. The spreadsheet, however, also aims at the potential market, which is enormous. Knowing that it will be easy to keep tabs on future options may encourage seniors who are on the fence to take the reverse mortgage plunge.
ABOUT THE WRITER
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. Comments and questions can be left at http://www.mtgprofessor.com.
©2017 Jack Guttentag
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