Written by Jerry Wagner Thursday, 03 April 2008 21:56

The first Home Equity Conversion Mortgage (HECM) loan was closed in the Fall of 1989 by James B. Nutter & Company of Kansas City. Since then 400,000 HECM’s have been originated. The current origination rate is 10,000 per month – about 6.0% of these are HECM to HECM refi’s.


HECM History

Until mid-1995 the only available HECM had rates that adjusted annually and had a margin of 1.60%. Annual-adjusting HECM’s have a 2/5 rate cap structure. An annual change cannot be more than plus or minus 2.0% and the lifetime cap is 5.0% over the initial loan rate. In 1995, monthly-adjusting HECM’s were introduced with a 1.05% margin and a 10.0% lifetime cap. Both plans used the one-year Constant Maturity Treasury (CMT) as their index. Fannie Mae was virtually the only HECM investor until recently. The investor sets the margins. Because of the caps, investors set high margins on annual-adjusting HECM’s. This materially lowers their LTV factors so few are originated.

In 2007, HUD added three new HECM rate options. A one-month CMT index and a monthly or annual-adjusting LIBOR product. More recently fixed-rate HECM’s have appeared.

HECM Pricing Depends on the Expected Rate

The five current HECM programs are shown in Table 1. Each has a Note Rate and an Expected Rate that are an index plus the loan’s margin. The table below shows the five combinations of indexes that are used today. One-twelfth of the Note Rate plus one-twelfth of 0.5% for MIP (Mortgage Insurance Premium) accrues onto the loan balance each month.

As opposed to the Note Rate, the HECM Expected Rate is based on a long-term index and does not change throughout the life of the loan. It is used to find the initial LTV ratio, the Service Fee Set-Aside (SFSA) and the HECM payment plans. For a borrower of a given age, the lower the Expected Rate, the higher the LTV.

In April of 2004, HUD imposed a 5.50% floor on the rate that is used to look up LTV factors. However, there is NO floor on the Expected Rate itself. Today rates are historically low, and the floor is in force. A monthly-adjusting HECM one-year CMT with a margin of 1.50% gives a 73-year old borrower a LTV of 71.5% -- without the lookup floor, the LTV would have been 77.5% -- that’s an $18,000 difference on a $300,000 home!

When the floor is in force, and rates go down, the LTV does not change. The SFSA is the present value of the loan’s monthly service fee to when the borrower turns age 100 discounted at the Expected Rate plus 0.50% MIP.

Because lower rates give higher discounted present values, the benefits to a borrower can actually fall as rates fall!

Most loan officers find it difficult to explain this effect to their clients. Adjusting rate HECM’s have a 120-day rate lock feature. In many cases, the client is better off using the higher rate! Table 2 shows a Treasury HECM example for a 73-year old in a $300,000 home with a $30 monthly service fee.

Even though rates fell nearly half a point between the client’s first proposal and their second presented three weeks later, the borrower’s benefit fell by $234. That’s because the present value of the monthly servicing fee went up by that amount.

LIBOR versus Treasury HECM’s

With LIBOR HECM’s the Expected Rate is the 10-year LIBOR Swap Rate plus a margin. With Treasury HECM’s it is the 10-year CMT rate plus a margin. Over the last six months, the Swap Rate has averaged 4.69% and the CMT 4.04% -- this implies that in order to have the same LTV as a Treasury HECM, a LIBOR HECM must have a margin that is 0.65% lower. We haven’t seen this in the marketplace because rates are so low that the LTV lookup floor distorts the calculations – for example, in the week of March 25th all HECM’s with a margin of 1.56% or lower have exactly the same LTV. Some lenders are taking advantage of this and offering LIBOR HECM’s with a 1.50% margin.

This brings up an interesting point – in this same week, the initial Note Rate on a LIBOR 150 (that’s the way lenders refer to margins) would be 4.11% and on a Treasury 150, it would be only 2.60%. Yet the LIBOR HECM offers several hundred dollars higher benefits than the Treasury HECM. Why? Because the LIBOR Expected Rate is 5.50% and the Treasury’s is 4.89% -- remember that there is no floor on Expected Rates.

The higher LIBOR rate gives the same LTV and a lower Service Fee Set-Aside. With each loan having the same LTV, the LIBOR benefit is higher because of the smaller SFSA. But, the benefit is only a few hundred dollars higher, and certainly not worth the borrower paying many thousands of dollars more in accrued interest.

Past, Present and Future

As we have seen, the Present is a strange situation because of the LTV lookup floor of 5.50%. The chart below shows the Past five years – the 10-year LIBOR Swap Rate has consistently been about half a point higher than the 10-year Treasury.

In the Future, when rates rise to more normal levels, the LTC lookup floor will no longer be a constraint. Then, in order to be a competitive product, the rate margins on LIBOR HECM’s will likely be about half a point lower than the margins on Treasury HECM’s.

The Fixed-Rate HECM

This new product has a rate that is generally keyed to the 5-year LIBOR Swap Rate plus a margin. Because investors want to immediately arbitrage interest rate risk, fixed-rate HECM’s require that borrowers withdraw all of the proceeds at closing – no lines-of-credit or payment plans are allowed. The actual rate is not set until just before closing – these fixed-rate loans do not have the 120-day rate lock feature used with adjusting rate HECM’s.

Without a rate lock, if rates rise between application and closing, the borrower’s benefits may fall materially. Because of this, some lenders show a comparison at application time that compares an adjusting rate HECM and the fixed-rate HECM using current rates plus a third column that shows the fixed-rate HECM with a rate half a point higher (this is a copyrighted feature of Ibis software).

About Jerry Wagner: Jerry Wagner is President and Ashok Shinde is CTO of Ibis software based in San Francisco. Ibis has been the Standard of 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