Q: Can you shop for the best deal on a home equity conversion mortgage?
A: You can if you know exactly what you want and exactly where to find it. This article is designed to help.
THE ROLE OF INTEREST RATE AND ORIGINATION FEE
The first step is to rid yourself of the notion that in shopping for a reverse mortgage backed by the Federal Housing Administration – what's known as a HECM – the target shopping variables are the interest rate and upfront lender fees. We have all been conditioned to think that way by our experience in the standard mortgage market. The standard mortgage calculator on my website encourages potential borrowers to find the best price from competing lenders by taking the same rate for each one and comparing their fees. If five lenders all quote a rate of 4 percent, the one with the lowest fees is the best deal. This process is facilitated by the practice of denoting rates in even multiples of 1/8 percent, as in 4 percent, 4 1/8 percent, 4 1/4 percent, 4 3/8 percent and so on.
This doesn't work in the reverse mortgage market, where lenders do not adhere to the 1/8 percent rule, and one sees such rates as 4.99 percent and 3.23 percent. But even if lenders used the 1/8 percent rule, borrowers would not be able to find the best deal by shopping rate and fees for a more fundamental reason. In the standard market, in which borrowers use mortgages only to purchase houses, higher rates and larger fees always reduce their ability to pay, so they naturally look for the lowest rate and fees. Borrowers in the reverse mortgage market, in contrast, use the mortgage for a wide variety of purposes, which are affected in different ways by rates and fees. For example, some reverse mortgage borrowers do better with higher interest rates.
Bottom line, the shopping variables on which a reverse mortgage borrower should focus depends on her objectives. I am going to illustrate that in connection with two objectives that I have written about in recent weeks: purchasing a house and replenishing a loss of income expected in the future.
EXAMPLES OF A BORROWER'S OBJECTIVE DEFINING THE RELEVANT SHOPPING VARIABLES
In purchasing a house with a HECM, the objective of some borrowers is to minimize their cash outlay at the closing. Their shopping variable is the largest upfront cash draw. Other homebuyers with more flexibility in their finances will aim to minimize their cash outlay within the first year of their purchase. Their shopping variable, therefore, is the largest total cash draw available in the first year.
While the interest rate and origination fees affect the cash draws, the selection decision ignores them. There is no way for a shopper to know whether a quote of 4 percent plus $1,500 will provide a larger cash draw than 3.5 percent plus $3,500. In this case, the role of the price quote is to identify the loan that provides the largest cash draw.
The reverse mortgage borrower who wants to lay the groundwork now for replenishing her income X years in the future, when she expects her income to drop, has a very different shopping variable. Her interest is in obtaining the largest monthly tenure payment – a payment that will continue for as long as she resides in her house – beginning in X years. That could be the loan with the highest interest rate, but that is not relevant. This borrower should shop for the largest tenure payment available after X years, with the rate and lender fees merely identifying the loan that meets that objective.
These examples do not exhaust the list of reverse mortgage objectives and their shopping variables – there are at least eight more, which I will write about at another time.
A SHOPPING VARIABLE THAT MAY BE RELEVANT TO ANY OBJECTIVE
Every reverse mortgage transaction involves the creation of a debt secured by the borrower's home, which grows over time. That debt must be repaid from the proceeds of the sale of the home when the borrower dies or moves out. Only the amount remaining after the debt repayment is remitted to the heirs.
Some borrowers are concerned about that and want to leave as much house equity to their estate as possible. In that case, future debt, or estimated future debt if the reverse mortgage has an adjustable rate, is a shopping variable that the borrower must balance against the other shopping variables. Borrowers who have no heirs or whose heirs have no need for the equity in the borrower's home can ignore future debt.
WHERE CAN YOU SHOP THE VARIABLES RELEVANT TO YOUR OBJECTIVE?
So, where can you shop the variables relevant to your objective? One way is to shop individual lenders. You can't do that online, however, because the information is not on their websites. You will have to contact each lender directly and request the information, which they will probably provide only through direct contact with a loan officer whose mission is to sign you up as a customer. This will be a grueling and time-consuming process.
The alternative is to use my kosher reverse mortgage calculator, which does show the variables relevant to your objective, for each of the nine reverse mortgage lenders who deliver their price quotes to my site. None of them will contact you unless you contact them first.
ABOUT THE WRITER
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. Comments and questions can be left at http://www.mtgprofessor.com.