Insiders Review New HECM Changes' Benefits and Concerns
The Federal Housing Administration said it was responding to market demand when it started modifying its Home Equity Conversion Mortgage products. The result consists of several changes to the standard program; HECM Saver, a new option that requires lower upfront premiums; and new opportunity to use this affordable option as an REO disposition tool.
Jeffrey M. Lewis, chairman of the board of Generation Mortgage Company and senior managing director of New York-based Guggenheim Partners, told this publication it is too early to know exactly how the market will respond to HECM Saver, which will be available for all HECM loans assigned on or after Oct. 4, but it certainly is good news for the borrower base it serves.
As an FHA insured second reverse mortgage option HECM Saver not only allows older homeowners to tap into their equity to cover their expenses but also offers the option to lower upfront loan closing costs.
It differs from the HECM Standard in that the amount of money available to a borrower under the HECM Saver program is reduced to approximately 10% to 18% less than HECM Standard.
The benefit is twofold, according to the FHA, because the HECM standard gives homeowners the option to borrow a smaller amount and “substantially” lowers risk to the FHA insurance fund because this principal limit is reduced.
The new option lowers costs “by almost eliminating” the upfront Mortgage Insurance Premium required under the standard HECM option.
HECM Saver will have an upfront premium of only .01% of the property’s value, compared to the standard 2%.
The MIP for both products will be charged monthly at an annual rate of 1.25% of the outstanding loan balance.
FHA Commissioner David Stevens stated in a press release that HECM Saver was created in response to concerns reported by senior citizens who find the standard HECM fees “are too high.”
Changes allow HECM borrowers to receive funds as a lump sum at loan origination, establish a line of credit or request fixed monthly payments that are disbursed for as long as they continue to live in the home. Funds are advanced to the borrower and interest accrues, but the outstanding amount does not have to be repaid until the borrower dies, leaves the home or sells the property. At that time, if the balance due on the loan exceeds the value of the home, FHA insurance pays the difference.
However, changes will create “a little bit of uncertainty in the short term in the marketplace,” since HECM products are distributed as Ginnie Mae securities, Lewis said. The HMBS market has already determined market-clearing levels for these securities. Now the two new products also require the market to find a level on each of them. This may open up refinancing opportunities for holders of the old version of the HECM.
Lewis does expect to see “a lot of borrower activity” right away, which is why he said the industry has to get “the capital markets side of it straight as fast as possible.”
Barclays Capital analysts Sandipan Deb and Nicholas Strand warned in a recent report that HUD’s changes to HECM and the release of the HECM Saver program are “unlikely to trigger prepayments.” But they also note the reduced the principal limit factors for new HECM loans “creates some incentive to refinance.”
The new HECM Saver and updates of the standard HECM were anticipated, said Lewis. What was not anticipated was that in addition to reducing the principal standards or the LTVs that are available to our borrowers on the standard product today compared to what was available in the past, they also dropped the interest rate floor, Lewis told this publication –which is the point at which proceeds stop going up.
“The way HECM is built, the borrower gets less money as the expected rate rises, and vice versa. It makes sense because we are accruing interest on the loan and if we think that that interest is going to accrue at a higher rate then we can get people less money today and more in a future day and for a different amount,” Lewis said.
The benefit of moving the floor half a point from 5.5% to 5% is that if this loan is introduced with a lower rate compared to the average 5.5% rate than these other loans were being originated at.
“If we see a decline in the new 5.5% rate—which I anticipate we will see—then the proceeds that are available to customers versus the 5.5% of the old program, will be higher under the new program.”
According to Lewis “there’s a couple of negatives to be aware of.” The ongoing mortgage insurance premium or MIT all borrowers pay each year to FHA will change from half a point to 1.25 points so the net effect is that what the borrowers will pay will be higher.
Risk control is one reason behind the half a point reduction. Every year HUD’s programs are rated based on underlying economic assumptions from the Office of Management and Budget that requires HUD programs to be self-sustaining, he explained, so if in 2008 the principal factors or the LTVs were reduced by 10%, this year economic recovery concerns led to them adjusting the program to break even following rather conservative assumptions.
Ultimately, Lewis says, HUD’s new HECM Saver product and the updated standard product offer seniors and consumers needed flexibility and financially beneficial options for utilizing their equity wealth.
The Standard will provide an increase in proceeds to borrowers under 90, and the Saver will lower upfront costs for through reduced upfront Mortgage Insurance Premium.
Barcklay’s report defines the initial principal limit is the maximum loan amount that can potentially be taken out by a borrower at the start of a HECM loan, calculated from the maximum claim amount, which is the lower of the current value of the home or the prevailing FHA loan limit.
The theoretical framework consists of these principal amounts and other conceptual factors such as the expected lifetime of the borrower, all of which go under further real life adjustments, analysts wrote. HUD provides a table of principal limit factors for borrower of a certain age and loan amounts that help calculate the initial principal limit on a HECM loan. It is calculated based on the principal limit factor found and the maximum claim amount.
The principal limit factor increases with an increase in borrower age while the life expectancy of a borrower goes down hence the initial principal limit goes up.