Refi City—Maybe, Maybe Not

Written by Gerald C. Wagner, Ph. D. and Ashok Shinde Monday, 10 November 2008 19:29

For several years we’ve thought HECM-to-HECM Refi’s would be beneficial to many borrowers. They’re older now and rates are lower than usual – age and rates determine benefits when applied to a Maximum Claim Amount (the lesser of the home’s appraised value or the HUD lending limit in that area). 30% of existing HECM’s are over-collateralized (original appraisal was higher than the original HUD lending limit). Then HUD announces a $417,000 lending limit – way over past limits. Great!

Not so great – home values have plummeted in the last two years and HECM’s have fast payoff rates so there are not that many ‘old’ loans. Many factors go into finding how many and which HECM borrowers would benefit with a REFI. In these notes, we explore this and more.

Over the last several years, HECM Refi’s have accounted for 6.4% of HECM originations. We thought this figure would explode with the new $417,000 lending limit. Maybe not! As a side note, HECM Refi’s account for 31.2% of HECM payoffs – there are five times more HECM originations than there are HECM payoffs.
 
Some Background

On April 23, 2004, HUD released Mortgagee Letter 2004-18. It provides that borrowers can receive credit for the initial Mortgage Insurance Premium (MIP) they paid when doing a HECM-to-HECM REFI. This is called a “Streamlined Refi”, but, as we shall see, it’s not all that streamlined.

Initial MIP is two percent of the Maximum Claim amount. If the original Claim amount was $250,000, the initial MIP on the existing HECM would have been $5,000. If the new Claim amount is $417,000, the initial MIP would normally be $8,340, but with credit for the $5,000 MIP paid on the original HECM, only $3,340 MIP is charged on the new HECM. 

Home prices have fallen materially in the pat couple of years. The Mortgagee Letter doesn’t specifically say what to do if the new Claim amount is less than the original Claim amount, but the final rule published in the Federal Register (75204, Vol. 69, No. 240) on December 15, 2004 says “the initial MIP paid by the mortgagee shall not exceed two percent of the increase in the maximum claim amount”. This implies that if there is no increase, there is no incremental MIP, and the HUD software won’t allow the new Claim to be less than the original Claim. So, basically, one cannot get credit for more than the new MIP. Ibis software simply converts negative incremental MIP to a zero. We’ve seen several examples where REFI HECM’s pay no initial MIP owing to declining home values. 

The Opportunity

With a HECM, the benefits increase whenever (1) the Claim amount is higher, (2) the borrower is older, or (3) the Expected Rate is lower. This month the HECM national lending limit is going to Freddie Mac ‘conforming limit’ of $417,000. A temporary increase in the conforming loan limits for high-cost areas is included in the 2008 economic stimulus package; it is the lesser of $729,750 or 125% of the average home value within a metro area. Unfortunately, HECM is stuck with the $417,000 limit. 

Claim Amounts

Last month, county-by-county 203(b) lending limits ranged from a national floor of $200,160 to a national ceiling of $362,790 (excepting Hawaii). There are 3,230 counties in the U.S. – 79% of them were at the national floor – now they are all at $417,000. A breakdown of the old 2008 limits is below. 670 of the Counties were classified as ‘high cost’.

 
The HECM program began in 1989. For the first three years, lending limits were low. From 1993 thru late 1998, the FHA county maximum and minimum lending limits were set at 75% and 38% of the conforming limit respectively. In late 1998, these were reset to be 87% and 48% of the conforming limit. Chart 1 shows the max and min lending limits over time as well as the average HECM home value and the average Claim amount.

Chart 1 shows that HECM borrowers have shared equally in the housing market down. Downturn is perhaps too soft of a word – perhaps a ‘market catastrophe that was waiting to happen.” In the last two years, the average home value of a new HECM has declined 17.0%, but interestingly, Claim amounts are down by only 7.9%. That’s because 30% of HECM’s are over-collateralized – when the home value is greater than the 203(b) lending limit, a fall in home value doesn’t necessarily mean that the Claim amount will fall.

Whenever a HECM’s home value is greater than its Claim amount, the loan is over-collateralized and a prime candidate for a HECM-to-HECM REFI. Of the 30% of HECM’s that are over-collateralized, 54% were over the then current lending limit in the 124 maximum limit counties. Only 13% of these over-collateralized loans were in Minimum limit counties.

Chart 2 shows the percentage of new HECM’s that were made with a home value greater than its 203(b) lending limit. This chart indicates that the ‘high-cost’ metro areas have the most over-collateralized homes. Those areas are where your REFI market is.

The Potential Refi Market

So the good news is that 30% of existing HECM’s are over-collateralized -- a great pool of potential Refi’s exist. The bad news is that HECM home values are falling along with the market. 77% of active HECM’s were originated in the last three years, and it’s safe to say that few are great refi candidates unless their original home value was higher than their original Claim amount.

One thing is for sure – the borrowers are older than when they got their original HECM. That means higher Principal Limits (Benefits). The Principal Limit on a HECM is found by multiplying the Claim amount by a factor which depends on the younger borrower’s age and the Expected Rate. The Expected Rate is the lender’s margin plus the 10-year Treasury or LIBOR rate depending upon which HECM product is offered.

Older borrowers mean Principal Limit higher factors. And lower rates mean higher factors – today rates are pretty low, but they were lower in 2003. To justify a HECM REFI, one must demonstrate benefits that are materially higher than the costs of doing the REFI. The next table shows the incremental benefits across borrower ages that just using current rates would give compared to the loan’s original Expected Rate. The high Expected Rates for loans made from 1989 thru 2002 make them good REFI candidates – they will enjoy considerably higher Principal Limit factors. Loans made in 2006-2007 also show a positive ‘rate’ benefit, but their homes have undoubtedly fallen in value and current rates are jumping around weekly.
 
So there we are. The HECM Refi market may be less than we hoped. The prime Refi loans are those originated in 2002 and earlier. This pool contains only 13,500 active HECM’s out of more than 450,000 total HECM’s (360,000 of which are active).

Of these 13,500 active loans originated from 1990 thru 2002, 30% were originally over-collateralized. In these 4,000 loans, the average appraised home value was 32% higher than the original lending limit. These are prime Refi candidates because although home values have fallen materially in the last two years, they haven’t fallen back to the original home values of these old HECM’s.

One caveat on old HECM’s: For loans originated before May 1, 1997, the Principal Limit grows at the loan’s Expected Rate (plus 0.5% MIP). After that date, growth is what the practice is now – the actual note rate (plus 0.5% MIP). The average Principal Limit growth rate on these pre May 1, 1997, HECM’s is 8.7%. In a Refi comparison of old and new Principal Limits, finding a benefit for the borrower may be tough. The borrowers are older, rates are lower, home values are likely higher – all pluses so the Refi’s Principal Limit will undoubtedly be much higher than the loans original Principal Limit. But the original Limit has grown by 8.7% per year for many years.

HECM Servicers and Refi’s

When doing a Refi proposal, the originator will have to contact the original HECM’s servicer to get three pieces of information. For the original HECM being refinanced, servicers are required by HUD to provide:
  

1. The Maximum Claim Amount (this allows you to calculate the original MIP).
2. The current Principal Limit (the original PL plus growth over the years). 
3. The current Payoff Amount.

Items (2) and (3) can generally be found on the latest monthly servicing statement. If you know the loan’s FHA case number, you can go HUD’s case number assignment screen to find the name of the servicer. Contact information for the various servicers is found at HUD’s website (http://www.hud.gov/offices/hsg/sfh/hecm/hecmservlist.pdf).

HECM’s are either “full service” or “sub-service”. Full service means an originator sold the servicing rights to a servicer and received a Service Release Premium (SRP). The servicer collects the full monthly service fee, and I believe legally the borrower is now ‘owned’ by the servicer, not the originator. So originators culling their lists of old clients should be careful to not get in a flap with the servicer they ‘sold’ the loan to.

In a sub-servicing situation, the originator ‘retains’ the client, gets no SRP, and splits the servicing fee with the servicer. So there should be no problem with the originator getting the information needed and making Refi proposals for their old clients.

Anti-Churning Disclosure
 
Along with the usual Good Faith Estimate, a HECM REFI requires a separate disclosure comparing the incremental costs and benefits of the new HECM vs. the existing HECM. This is done by estimating the Principal Limit (PL) of the new HECM and subtracting the PL of the existing HECM. The PL of a HECM grows each month, and you use the current (grown) PL of the existing HECM, not its original PL, in this calculation.

Then you find the cost of the refinancing by adding up the loan fee, the incremental MIP, third-party costs such as appraisal, title insurance, etc., and a zinger thrown in by HUD – the Service Fee Set-Aside (SFSA). Most of us know that the SFSA is a set-aside, not a cost – at least they could have given credit for the SFSA on the existing loan – that SFSA is going away.

One then divides the increase in PL by the new ‘costs’ to find a ratio of benefits to costs. Five is the magic number. The disclosure also shows the borrower the net amount that will be available. This is the new loan’s PL, less the costs above, and less the payoff on the existing HECM.

Counseling

It may be a good policy to always request your REFI client to go through HECM counseling again. But, if three conditions are met, new counseling is not required. The conditions are: (1) you give your client an Anti-Churning Disclosure, (2) the magic number from above (the benefit/cost ratio) is five or higher, and (3) that it hasn’t been more than five years between the closing date of the existing HECM and the application date for the new HECM.

There’s a catch to the five-year rule. The period begins with the original HECM if there has been a prior REFI in between the original HECM and the new HECM. If your client qualifies, and opts out of new counseling, the case binder must include a document showing that the three conditions were met.

Refi Recap

The housing crash has made a mess of what we thought was the opportunity of a lifetime – to refi 50,000 HECM’s. Still, the new $417,000 national lending limit opens up many HECM’s as potential candidates for immediate refinancing. We estimate the current number at 5,000 – a far cry from 50,000. When, and if, home values come back, the Refi market may bloom.

Jerry Wagner is President and Ashok Shinde is CTO of Ibis software based in San Francisco. Ibis has been the Standard of the reverse mortgage industry since 1995. Wagner graduated from Harvard Business School and has a Ph.D. in Economics from Harvard. But he’s still a fun guy and can be reached at 800-566-5077 or This e-mail address is being protected from spambots. You need JavaScript enabled to view it . To learn about Ibis software, see www.reversemortgagehomepage.com.