Don’t think of reverse mortgages as complex. Think of them as unfamiliar. Borrowers can easily understand the basic concepts of a reverse mortgage, but many homeowners are unaccustomed to the language and terms used for these loans.
Originators will want to familiarize themselves with the concepts and terminology of reverse mortgages. Doing so will help them explain to prospects the key differences between reverse mortgages and their traditional (or forward) counterparts.
Loan repayment
In many ways, reverse mortgages are similar to traditional mortgages. If you treat a reverse mortgage the way you treat a forward mortgage, the results should be comparable. For example, if you make the same payments at the same interest rate over the same time period, a reverse mortgage will amortize in the same way and will end with no loan balance.
Most reverse mortgages, however, don’t require the borrower to make regular principal and interest payments. Consequently, the loan balance will rise over time. When the last borrower no longer occupies the home as their principal residence, the homeowner or their estate will often sell the home to repay the loan balance and receive any residual proceeds.
You’ll find that forward mortgages predominantly carry fixed interest rates. But the reverse mortgage insured by the Federal Housing Administration (FHA), known as a Home Equity Conversion Mortgage or HECM, will likely be an adjustable rate mortgage or ARM.
Fixed-rate mortgages account for more than 98% of the business done by Fannie Mae and Freddie Mac, according to the Federal Housing Finance Agency’s most recent annual housing report. By contrast, the most recent HECM report from the U.S. Department of Housing and Urban Development shows that adjustable-rate mortgages account for more than 99% of HECM business. The primary reason for this is that adjustable-rate HECMs allow for open-ended lines of credit in which homeowners have the flexibility to borrow funds over time as needed.
Common terms
Some of the terms used for reverse mortgages are not commonly found in traditional mortgages. Originators will want to become familiar with certain terms such as principal limit factors, mandatory obligations, financial assessment, life expectancy set-aside and nonrecourse.
Although forward loan originators use the term loan to value (LTV) to describe the percentage of the home’s value for which a borrower may qualify, HECMs use principal limit factors. This term is used because reverse mortgages must consider the relevant ages and expected interest rates to determine how much principal may be offered to the client.
Mandatory obligations are items that must be paid off at closing such as existing loan balances and closing costs. The reason reverse mortgages use this term is because it may dictate how much principal is available to the borrower during the initial disbursement period, which for most HECMs is the first 12 months.
All mortgages must go through underwriting to determine the sustainability of the loan. With HECMs, this process is called financial assessment. It includes a review of each borrower’s credit history, property charge history and residual income.
Depending on the results of financial assessment, the lender may set aside a portion of the borrower’s principal limit — what’s called life expectancy set-aside or LESA — to pay homeowners insurance and property taxes each year over their expected lifetime. This is different than the traditional escrow account established for forward loans, because it’s a one-time contribution rather than ongoing deposits.
All reverse mortgages in the U.S. are nonrecourse, meaning neither the borrower nor their estate will owe more than the value of the home when the home is sold. This should give homeowners peace of mind that they won’t be leaving their heirs with a bill if the loan balance rises above the value of the home or if the property value declines rapidly.
Planning tool
With a forward mortgage, the loan originator must match the client with the proper product and repayment structure. Therefore, finding the right interest rate and repayment terms are primary concerns.
Reverse mortgage professionals, on the other hand, are trying to match the client with the proper retirement-planning and cash-flow solution. As a result, the interest rates and repayment terms become secondary to the payout options.
In some cases, the reverse borrower has no immediate need for funds but wants a secure (and growing) line of credit that will be available to pay for home care in several years. Another homeowner, however, may wish to draw monthly cash flow from their home equity nest egg.
Still others may want to supplement their existing retirement income with regular monthly draws known as tenure payments. These payments will continue as long as the homeowner occupies the home and abides by the terms of the loan agreement.
Proprietary options
For some homeowners, a HECM may not be the best solution. Fortunately, many proprietary reverse mortgage products are available that offer tailored solutions and more flexibility than a HECM.
Some of these proprietary products allow homeowners to tap loans of up to $4 million and include features such as fixed-rate cash-out loans or a revolving line of credit. As reverse mortgages, these are still nonrecourse loans, and they don’t charge upfront or periodic mortgage insurance premiums.
As you can see, reverse mortgage originators must efficiently solve for the complexities of retirement cash flow and aging in place. In order to do that, mortgage originators need to understand the available products and loan terms, as well as the language of reverse mortgages. ●
