Reverse mortgage educators look to correct the record on credit lines, equity modeling

Reverse mortgage educators Dan Hultquist and Jim McMinn brought their “Rules of the Game” presentation back to this year’s National Reverse Mortgage Lenders Association (NRMLA) Annual Meeting and Expo in San Diego.

After starting with the importance of focused information and certain reverse mortgage product features, the pair went deeper into other longstanding elements that some industry participants might be misinformed about.

The interactive presentation features the presenters wearing referee shirts. They engaged the audience to call “fouls” on certain incorrect example statements by equipping them with whistles, with a goal of correcting the record based on the black-and-white reverse mortgage product and program regulations.

Partial prepayments and line of credit

The reverse mortgage line of credit is often seen by industry originators as a powerful and persuasive tool to bring customers into the fold. But some misconceptions about how the credit line is impacted by partial Home Equity Conversion Mortgage (HECM) prepayments was called out by Hultquist and McMinn.

“Mr. Wilson,” began McMinn to a hypothetical reverse mortgage customer. “Yes, partial prepayments will reduce your loan balance, but because payments are applied to mortgage insurance first, we can’t increase your line of credit until you pay back all the accrued MIP and accrued interest.”

The whistle blew immediately. Hultquist characterized this particular misconception as one that has lingered for many years.

“There’s still a lot of people in this industry who believe that if you make a prepayment on a reverse mortgage, that because of the servicing waterfall, it’s not going to increase your line of credit dollar for dollar,” he said. “You can go to any of the modeling software to model what happens if you make a prepayment — the line of credit will go up.”

There is definitely a servicing waterfall that is important to keep in mind for tax and accounting purposes, Hultquist explained. If payments above $600 are made in a calendar year, then the borrower will receive a Form 1098 from the Internal Revenue Service (IRS) that itemizes these amounts.

But the HECM adjustable-rate mortgage note says that the borrower “may specify whether a prepayment is to be credited to that portion of the principal balance representing monthly or the line of credit,” Hultquist explained.

If the borrower doesn’t specify, however, then the lender will “apply any partial prepayments to an existing line of credit or create a new line of credit,” Hultquist said.

But there are specific circumstances in which partial prepayments will not result in a line-of-credit increase. This makes it important to continue leaning away from definitive statements, as the pair previously explained.

Relationship between debt and equity

McMinn continued with the next misconception, speaking again to a hypothetical borrower.

“Mrs. Jones, a reverse mortgage is a ‘rising debt, falling equity’ loan,” he said. “As your debt — the amount you owe — grows larger, your equity gets smaller.”

Again, the whistle immediately rang out.

A reverse mortgage amortization schedule, Hultquist explained, is a “federally regulated document.” Industry regulators — including U.S. Department of Housing and Urban Development (HUD)-certified HECM counselors — are required to use similar language. The issue is the definitive statements made by such language. And there is a key element that is overlooked in such a statement.

“Home appreciation is the largest driving force in your equity position, your home equity,” Hultquist said. “Who in their right mind would model a flat home value over a 30-year period? You’d have to be clinically insane to do that, right? Historically, that would be extremely, extremely unlikely.”

Take the example of a $400,000 home with an assumed appreciation rate of 4% per year, which assumes roughly $16,000 in appreciation in the first year. If the reverse mortgage was for $100,000 — 25% of the home’s value — then the interest rate on the loan would need to be 16% or higher for the homeowner to lose equity.

“Is that likely? No, and yet, that’s how we sell it,” Hultquist said. “Just doing a quick Google search, you’ll find, ‘As your loan balance rises, your equity decreases.’ That’s a definitive statement that I would say is historically false.”