NMP - August 2017 - 80

Will Higher Rates Reduc
Depends on if you have HECMs in your product mix
By Dan Hultquist, MBA, CRMP

avvy mortgage lenders have always kept tabs on
interest rates, but their attention has been especially
rapt since financial markets rallied in the wake of
November's election. Even small rate spikes are
enough to make lenders wonder how loan volume will
be affected. Of course, the Federal Reserve does not
directly impact mortgage interest rates. But raising
short-term interest rates for the three times in six months has lenders
and brokers keeping an eye on the outcomes of future Fed meetings
this year.
Understandably, there is concern that rising interest rates will
reduce lending activity. And their apprehensions are somewhat valid
with traditional "forward" loans, especially refinances, which have
been the majority of originations volume in recent years. However,
there are other market factors that contribute to loan volume and
other mortgage products where rate increases have a reduced impact.
Consider the Home Equity Conversion Mortgage (HECM), the
leading reverse mortgage product. The relationship between loan
volume and interest rates is not as clear-cut when it comes to this
FHA-insured product. That's because rising interest rates affect these
loans in ways that can benefit lenders and borrowers alike.

S

AUGUST 2017 n National Mortgage Professional Magazine n

NationalMortgageProfessional.com

80

How do HECM interest rates work?
While the dominant "Forward" product is the 30-year fixed-rate
mortgage (FRM), almost all HECMs are adjustable-rate mortgages
(ARM). This is because HECM ARMs allow "open-end credit" where
the borrower can draw what they need, when they need it.
For HECM ARMs, initial interest rates are calculated in the same
manner as traditional ARM products. Simply add the lenders margin
and a market index, and reverse mortgages traditionally use the
London Interbank Offered Rate (LIBOR) index. For example, with a
2.75 percent lender margin, interest rates on July 31, 2017 would
look like this:
Product

Margin

Index

Interest Rate

One-Year LIBOR ARM

2.75%

+1.736%

= 4.486%

One-Month LIBOR ARM

2.75%

+1.232%

= 3.982%

When it's time to make periodic adjustments to the interest rate,
only the margin portion remains fixed. It is the index portion that
causes the effective interest rate to rise or fall.
However, there is one additional critical rate-the expected rate.
This is an estimate of the average interest rate for the life of the loan.
This is a key component in determining how much initial equity may
be accessed with a HECM. The 10-year LIBOR swap rate is viewed
as the market's best guess at long-term index rates. For example:
Margin

10-year SWAP

Expected Rate

2.75%

+2.23%

= 4.98%

When expected rates (at application) round to five percent or less, the
initial principal limit is maximized for that borrower. When expected rates
round to 5.125 percent or higher, principal limits are reduced according
to FHA tables. For this reason, 5.06 percent is considered a "Floor" rate
that lenders try not to exceed.
As rates go up, lenders and brokers will adjust their margins to keep
the expected rate at, or below, the floor. If SWAP rates get too high,
borrowers will qualify for less. But that's not necessarily a bad thing.
Using less loan proceeds leaves more equity in the house protecting
both the lender and the borrower.

Four ways that traditional lending and HECM lending
differ in a rising interest rate environment
1. Primary motive
With traditional home financing, the primary motive for refinancing is to
gain a lower interest rate. By contrast, with reverse mortgages the
primary motive for refinancing is access to additional home equity. HECM
borrowers could be looking to satisfy an immediate need, increase
retirement cash flow, or establish a secure and growing line-of-credit for
future needs. Consequently, interest rates are not as critical a concern.
2. Affordability
On the forward side, higher interest rates may impact the borrower's
ability to afford the home. Higher HECM interest rates generally have little
impact on the affordability because monthly principal and interest
mortgage payments aren't required. Higher interest rates may eventually
reduce principal limits for new HECM loans, but today's typical HECM
borrower doesn't need all their available funds.
3. Creditworthiness
Interest rates are often further impacted by a borrower's credit score on
traditional loans. On the other hand, credit scores are not considered on
HECMs and therefore do not impact the rate offering. Financial
assessment of the HECM borrower is primarily used to determine if funds
should be set-aside to pay for annual property charges.
4. Rate adjustments
Lastly, you'll find that rising rates after closing hurt traditional ARM
borrowers with higher monthly payments, and as a result, the dominant
forward product is a fixed-rate mortgage. By contrast, rising interest
rates after closing often help some HECM ARM borrowers who see their
available line-of-credit (LOC) grow at the same compounding rate as their
loan balance. As a result, the dominant reverse product is an ARM.
Ultimately, on the forward side, even small interest rates increases are
bad for the borrower because they increase monthly payment obligations
for new applicants, as well as existing ARM borrowers. They are bad for
loan originators because refinances simply stop.
On the reverse side, monthly principal and interest payments are not
required. Higher interest rates may eventually reduce principal limits for
new HECM loans, but today's typical HECM borrower doesn't need all
their funds upfront. And while higher interest rates do cause higher
interest accruals, the same compounding rates are applied to the line-ofcredit growth. When the primary motive is access to a portion of home
equity, rates are simply not as important.
With rates expected to rise and traditional HELOCs maturing, the
HECM is more attractive than ever for homeowners age 62 and older. Of
course, there are many other demographic and strategic reasons banks,
mortgage lenders, and brokers should enter the reverse market right
now, but the potential for rising interest rates may be high on the list.
Rising interest rates necessitate a more balanced product mix, and now
is the time to diversify lending product offerings.
Dan Hultquist, MBA, CRMP is Director of Learning and
Development for ReverseVision. His training sessions have
exceeded 21,000 in attendance over the last six years. He is
a Certified Reverse Mortgage Professional (CRMP) and CoChairs the Education Committee for the National Reverse
Mortgage Lenders Association (NRMLA). Dan also teaches
continuing education courses that serve as annual
requirements for CRMPs. Dan is author of the book,
Understanding Reverse, which answers the top questions he
has received as a national reverse mortgage trainer.



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