Why are so many HECM borrowers taking all their
available loan amounts in a single lump sum at closing?
Some lenders are concerned about the ethical and liability
issues involved
in requiring 100%
lump sums at closing.
In less than a year, the number of HECM borrowers selecting a loan requiring them to
take all their available loan funds at closing
has risen from 3% to 69%. Why?
Is it just a coincidence that these loans also generally happen to
earn more for lenders?
If not, and given the recent downturn in the number of loans closed, perhaps the explosion
in the number of HECMs requiring 100% draws
at closing reflects efforts by lenders to earn
more from each loan.
Or perhaps the upsurge in these HECMs can
be explained by depressed home values, which may be causing more borrowers to need all or most of their available loan amounts to retire existing debt on their homes.
While that may explain some of the trend, however, it's highly unlikely to account for the sharpness of the increase - from a scant 3%
in March of 2009 to a dominating 69% in February of 2010.
The secondary market's appetite for very low-risk but relatively high-yield investments clearly has been a major factor in driving lenders to offer these HECMs, which give investors a government-guaranteed loan with a substantial initial balance that accrues at an attractive fixed-rate and requires no future disbursements.
But if the 100% lump sum loans weren't so attractive to lenders and investors, would borrowers on their own have driven their share
of the market from less than 3% to a whopping 69% in less than a year?
Is it possible that the number of borrowers needing 100% lump sums at closing has spiked so sharply? Or that a similar surge has occurred in the number of borrowers preferring a fixed rate (even though it is about double the available adjustable rate)? Or that new masses of HECM borrowers are selecting fixed rates because they are expecting a near-term upsurge in interest rates?
Not likely.
But while these factors in concert may not have created the strong trend to 100% lump sum HECMs, they are likely to have contributed to it to some degree. And the 3% to 69% increase may not be as sharp as it initially appears.
Initial Loan Balances Up
In 2007, HUD found that initial HECM loan balances were already 58% of available loan amounts.
So the overall initial utilization rate may have increased from 58% to 87% - which is not as stark a rise as the 3% to 69% increase in the number of 100% lump sum loans.
But an increase in initial loan balances from 58% to about 80% would nonetheless mark an enormous change, and one highly unlikely to have been caused by borrowers alone.
The appetites of the secondary market and financial interests of HECM originators are highly likely to be the main factor in the dramatic increase in initial loan balances as a percentage of available loan amounts.
Ethical and Liability Issues
No matter what has caused the dominance of these "100% lump sum" loans, the increase has been so sharp that some lenders are concerned about the ethical and liability issues involved. In particular, they when the most profitable loan for them may not be the best choice for their customers.
Recently, a web-based training session for reverse mortgage lender discussed "how to fully inform your borrowers about the advantages and disadvantages of the fixed rate versus the adjustable rate product." In particular, it addressed these issues:
Why this is important
o Economic, ethical and liability
concerns of loan recommendations
o Are lower upfront costs
better than higher costs?
reduce liability issues"
To learn how five of the largest HECM lenders are handling this matter, Reverse Mortgage Monitor recently called the tollfree numbers of five of the largest reverse mortgage lenders .
This "mystery shopping" exercise presented each lender with a potential borrower who only needed about the half the available loan amount at closing, and had no real plans for the remainder.
Three of the five lender representatives clearly steered us away from the fixed-rate HECM with the 100% lump sum requirement. That is, they steered us away from the loan that would have been the most profitable for the lender.
One of them compared the fixed rate (about 5.5%) to the rate that the unused portion of the lump sum could safely earn (about 1%), and clearly recommended the alternative: a creditline HECM with an initial adjustable rate of about 2.5%.
Another focused on the magnitude of the unused funds that would be charged interest under the fixed-rate HECM but would not be charged interest under the adjustable-rate HECM. She also noted that the unused funds in the adjustable-rate creditline would grow larger each month, and clearly recommended this option.
The third lender provided less detail, but clearly indicated that the adjustable-rate HECM was the preferable choice.
As impressive as the direction away from the more profitable loan was, however, we were somewhat disappointed that these lenders did not even note what the effect of rapid interest
rate increases might be.
For example, a jump to 4% during the first year, up past 5% during the second, and solidly north of 6% thereafter.
On the other hand, we did not present them with an obviously savvy consumer, so perhaps they thought this "on the other hand" information might be confusing. It did leave us wondering, however, if they were prepared to deal with this type of analysis
Highly disappointing were the fourth and fifth lenders, as one of them represented a very well-known national brand, and both of them worked for companies whose websites promise a kind of service that they did not deliver.
The fourth lender was not remotely helpful. She provided information on each option very quickly, and then would not discuss why some consumers might prefer one choice versus the other. She just kept repeating that different people like different things.
The fifth lender unmistakably steered us to the fixed-rate HECM requiring a 100% lump sum, and only admitted the existence of another option when we asked if there were any other choices. And then he said that "98%" of borrowers were selecting the fixed rate "because they are scared to death" of rising interest rates.
Legal Basis
It should be noted that HUD has permitted lenders to require a 100% lump sum draw at closing requirement for fixed-rate HECMs in spite of the HECM statute at 1715z-20 (d) (9) and the HECM regulation at 206.25 (g).
The federal law says that HECM borrowers "should select from among" five specified payment methods - including a line-of-credit - or any other option that the Secretary of HUD considers appropriate. Here is the relevant section of the law:
(9) provide for future payments to the mortgagor based on accumulated equity (minus any applicable fees and charges), according to the method that the mortgagor shall select from among the methods under this paragraph, by payment of the amount--
(A) based upon a line of credit;
(B) on a monthly basis over a term specified by the mortgagor;
(C) on a monthly basis over a term specified by the mortgagor and based upon a line of credit;
(D) on a monthly basis over the tenure of the mortgagor; (E) on a monthly basis over the tenure of the mortgagor and based upon a line of credit; or
(F) on any other basis that the Secretary considers appropriate
And here is the federal regulation:
No minimum payments. A mortgagee shall not require,
as a condition of providing a loan secured by a mortgage insured under this part, that the monthly payments under the term or tenure payment option or draws under the line of credit payment option exceed a minimum amount established by the mortgagee.