Credit Line Shrinkage
Are Reverse Mortgage Credit Lines Really Shrinking?
August 3rd, 2009 | by Jim Veale
This article has been written in response to the Reverse Mortgage Daily (RMD) article titled Negative Loan Growth Hits Reverse Mortgage Credit Lines, that covered a news story on Mr. Donald Conn. If you have not read his story, it is worth the read. However, the story does not indicate what kind of reverse mortgage Mr. Conn has, HECM or Homekeeper.
A General Overview
The purpose of this article is to debunk the industry myth that the Home Equity Conversion Mortgage (HECM) credit line always increases by the “growth rate.” Unless otherwise indicated, the “growth rate” in this article is defined as:
- one-twelfth of the sum of
- the note rate (i.e., the interest rate used in computing accrued monthly interest for the prior month) plus
- the Federal Housing Administration (FHA) mortgage insurance premium (MIP) rate of 0.5% also charged on the balance due.
Part of the reason why the myth is so prevalent and difficult to eliminate is most loan officers were taught and are still being instructed that the line of credit grows by the growth rate. Authors and even some NRMLA basic course instructors ignore the correct formula in favor of this simple multiplication approach. Unfortunately the amortization schedule only reinforces this myth.
While the computation is simple, the convoluted explanation to the math formula contained in HUD Handbook 4235.1 (sometimes called “the HECM Handbook”) and the related appendices make it seem far more difficult than it really is. Examples would have been helpful.
For the last few months, it has been hoped that the U.S. Department of Housing and Urban Development (HUD) and the National Reverse Mortgage Lenders Association (NRMLA) would reach agreement on how to simplify the problem so that this article would be unnecessary. However, agreement and the resulting HUD Mortgage Letter (ML) may yet be months away.
Limitations on and Assumptions in the Example Below
ML 1997-15 modified the computation in the HECM Handbook for those HECMs “executed” after April 30, 1997. This article only addresses those HECMs executed after that date.
For ease of computation and clarity, the example reflects no activity in the line of credit for the month under consideration other than the change required by the monthly increase to the principal limit as provided in ML 1997-15. For simplicity, the only four components presented are: the principal limit (PL), the unamortized servicing fee set aside (USFSA), the line of credit (LOC) and the balance due (BD). No other potential components of the line of credit equation, such as the taxes and insurance set aside or tenure payments, are included in the example.
So How Is the LOC Computed?
As to this example, the LOC = CPL – BD – USFSA, where CPL is the current principal limit which is the principal limit for the prior month times (one + the monthly growth rate). For example if the prior month’s PL was $120,000 and the growth rate for the month is 0.5%, then the CPL is $120,000 X 1.005 or $120,600.
As a more formal example, assume the following as of the start of the prior month:
- PL (Principal Limit) — $119,537.34,
- BD (Balance Due) — $82,400.37, and
- USFSA (Unamortized Servicing Fee Set Aside) — $2,941.99 (being amortized over the remaining 143 months); thus the
- LOC (Line of Credit) — $34,194.98.
The expected interest rate on this HECM was 6.25% and the note rate for the month is 5.00%. The growth rate for the month is 0.458333% or ((5.00% + 0.5%)/12).
As to start of the current month the following results:
- CPL — $120,085.22.
- Growth in the CPL — $547.88 (or $119,537.34 times 0.458333%)
- BD — $82,808.03 composed of the following:
- the beginning balance of $82,400.37 plus
- the interest of $343.33 plus
- the MIP of $34.33 plus
- the monthly servicing fee of $30.00,
- USFSA — $2,928.54; thus
- LOC — $34,348.65 (which is the difference between $120,085.22 and the sum of $82,808.03 and $2,928.54)
So what is the controversy? The actual growth in the credit line in this example is only $153.67 while multiplying the growth rate by the prior month’s line of credit results in an expected growth of $156.73 for a -$3.06 difference. Because of this discrepancy some have accused lenders of charging borrowers a hidden service fee without disclosure, amounting to many millions of dollars each year.
So what creates the difference? In this example, it is entirely wrapped up in the amortization of the USFSA. Since the increase to the principal limit is based on the note interest rate and the amortization of the USFSA, the expected interest rate, a difference occurs. In this example if there were no USFSA, there should be no difference other than rounding. If the note rate were the same as the expected rate for a HECM, no difference should arise. However, this same difference phenomenon also occurs with tenure and term payouts combined with a LOC (along with other set asides that amortize based on the expected interest rate).
Where the USFSA is the only item being amortized by the expected interest rate, the difference in the actual and calculated growth can be calculated by 1) subtracting the expected note rate from the note rate, 2) dividing that difference by 12, and then 3) multiplying that quotient by the USFSA. From the example above, the difference is -1.25% (5.00%-6.25%) which when divided by 12 is ‑0.1042%. Multiplying -0.1042% times the USFSA ($2,928.54) for the prior month results in ‑$3.06 which is the exact difference between and the actual and calculated LOC.
If this concept is difficult to explain to the most experienced originator, it is even harder to explain to borrowers. However, the key issue is that the difference does not impact the balance due, just proceeds available from the LOC in this example (or the Net Principal Limit generally). However, for those who have assumed that their loan balance will exceed the value of the home at the time the HECM comes due, this is like taking sales proceeds.
While the difference can be negative as in the example above, it can also be positive when the note rate is greater than the expected rate. This can also occur where set asides are fixed and cannot be adjusted for increases to the principal limit. If positive adjustments occur will we hear cries that the lenders are offering too many proceeds to borrowers?
Conclusion
This purpose of this article was to describe, illustrate, and explain the computation of the monthly change to the HECM line of credit. To gain a better understanding, it is highly recommended readers refer to the HECM Handbook (4235.1), its appendices, and ML 97-15.
James E. Veale, CPA, MBT and SVP of Tax and Government Affairs & Director of Originator Recruiting for Security One Lending
Are Reverse Mortgage Credit Lines Really Shrinking?
August 3rd, 2009 | by Jim Veale
This article has been written in response to the Reverse Mortgage Daily (RMD) article titled Negative Loan Growth Hits Reverse Mortgage Credit Lines, that covered a news story on Mr. Donald Conn. If you have not read his story, it is worth the read. However, the story does not indicate what kind of reverse mortgage Mr. Conn has, HECM or Homekeeper.
A General Overview
The purpose of this article is to debunk the industry myth that the Home Equity Conversion Mortgage (HECM) credit line always increases by the “growth rate.” Unless otherwise indicated, the “growth rate” in this article is defined as:
- one-twelfth of the sum of
- the note rate (i.e., the interest rate used in computing accrued monthly interest for the prior month) plus
- the Federal Housing Administration (FHA) mortgage insurance premium (MIP) rate of 0.5% also charged on the balance due.
Part of the reason why the myth is so prevalent and difficult to eliminate is most loan officers were taught and are still being instructed that the line of credit grows by the growth rate. Authors and even some NRMLA basic course instructors ignore the correct formula in favor of this simple multiplication approach. Unfortunately the amortization schedule only reinforces this myth.
While the computation is simple, the convoluted explanation to the math formula contained in HUD Handbook 4235.1 (sometimes called “the HECM Handbook”) and the related appendices make it seem far more difficult than it really is. Examples would have been helpful.
For the last few months, it has been hoped that the U.S. Department of Housing and Urban Development (HUD) and the National Reverse Mortgage Lenders Association (NRMLA) would reach agreement on how to simplify the problem so that this article would be unnecessary. However, agreement and the resulting HUD Mortgage Letter (ML) may yet be months away.
Limitations on and Assumptions in the Example Below
ML 1997-15 modified the computation in the HECM Handbook for those HECMs “executed” after April 30, 1997. This article only addresses those HECMs executed after that date.
For ease of computation and clarity, the example reflects no activity in the line of credit for the month under consideration other than the change required by the monthly increase to the principal limit as provided in ML 1997-15. For simplicity, the only four components presented are: the principal limit (PL), the unamortized servicing fee set aside (USFSA), the line of credit (LOC) and the balance due (BD). No other potential components of the line of credit equation, such as the taxes and insurance set aside or tenure payments, are included in the example.
So How Is the LOC Computed?
As to this example, the LOC = CPL – BD – USFSA, where CPL is the current principal limit which is the principal limit for the prior month times (one + the monthly growth rate). For example if the prior month’s PL was $120,000 and the growth rate for the month is 0.5%, then the CPL is $120,000 X 1.005 or $120,600.
As a more formal example, assume the following as of the start of the prior month:
- PL (Principal Limit) — $119,537.34,
- BD (Balance Due) — $82,400.37, and
- USFSA (Unamortized Servicing Fee Set Aside) — $2,941.99 (being amortized over the remaining 143 months); thus the
- LOC (Line of Credit) — $34,194.98.
The expected interest rate on this HECM was 6.25% and the note rate for the month is 5.00%. The growth rate for the month is 0.458333% or ((5.00% + 0.5%)/12).
As to start of the current month the following results:
- CPL — $120,085.22.
- Growth in the CPL — $547.88 (or $119,537.34 times 0.458333%)
- BD — $82,808.03 composed of the following:
- the beginning balance of $82,400.37 plus
- the interest of $343.33 plus
- the MIP of $34.33 plus
- the monthly servicing fee of $30.00,
- USFSA — $2,928.54; thus
- LOC — $34,348.65 (which is the difference between $120,085.22 and the sum of $82,808.03 and $2,928.54)
So what is the controversy? The actual growth in the credit line in this example is only $153.67 while multiplying the growth rate by the prior month’s line of credit results in an expected growth of $156.73 for a -$3.06 difference. Because of this discrepancy some have accused lenders of charging borrowers a hidden service fee without disclosure, amounting to many millions of dollars each year.
So what creates the difference? In this example, it is entirely wrapped up in the amortization of the USFSA. Since the increase to the principal limit is based on the note interest rate and the amortization of the USFSA, the expected interest rate, a difference occurs. In this example if there were no USFSA, there should be no difference other than rounding. If the note rate were the same as the expected rate for a HECM, no difference should arise. However, this same difference phenomenon also occurs with tenure and term payouts combined with a LOC (along with other set asides that amortize based on the expected interest rate).
Where the USFSA is the only item being amortized by the expected interest rate, the difference in the actual and calculated growth can be calculated by 1) subtracting the expected note rate from the note rate, 2) dividing that difference by 12, and then 3) multiplying that quotient by the USFSA. From the example above, the difference is -1.25% (5.00%-6.25%) which when divided by 12 is ‑0.1042%. Multiplying -0.1042% times the USFSA ($2,928.54) for the prior month results in ‑$3.06 which is the exact difference between and the actual and calculated LOC.
If this concept is difficult to explain to the most experienced originator, it is even harder to explain to borrowers. However, the key issue is that the difference does not impact the balance due, just proceeds available from the LOC in this example (or the Net Principal Limit generally). However, for those who have assumed that their loan balance will exceed the value of the home at the time the HECM comes due, this is like taking sales proceeds.
While the difference can be negative as in the example above, it can also be positive when the note rate is greater than the expected rate. This can also occur where set asides are fixed and cannot be adjusted for increases to the principal limit. If positive adjustments occur will we hear cries that the lenders are offering too many proceeds to borrowers?
Conclusion
This purpose of this article was to describe, illustrate, and explain the computation of the monthly change to the HECM line of credit. To gain a better understanding, it is highly recommended readers refer to the HECM Handbook (4235.1), its appendices, and ML 97-15.
James E. Veale, CPA, MBT and SVP of Tax and Government Affairs & Director of Originator Recruiting for Security One Lending
- the note rate (i.e., the interest rate used in computing accrued monthly interest for the prior month) plus
- the Federal Housing Administration (FHA) mortgage insurance premium (MIP) rate of 0.5% also charged on the balance due.
- Growth in the CPL — $547.88 (or $119,537.34 times 0.458333%)
- the beginning balance of $82,400.37 plus
- the interest of $343.33 plus
- the MIP of $34.33 plus
- the monthly servicing fee of $30.00,