Wednesday, 07 May 2008 19:12

Articles - Opinion

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    Since the inception of the Home Equity Conversion Mortgage (HECM) program in 1989, the traditional loan was based on Constant Maturity Treasury (CMT) rates as published every Monday by the FED. The Note Rate was based on the one-year CMT rate plus an investor margin. The Expected Rate is used for finding how much money is available and in calculating Service Fee Set-Asides (SFSA) and payment plans. The Expected Rate was based on the ten-year CMT rate plus the same investor margin.

    In October of 2007, HUD authorized HECM’s based on the London Interbank Offered Rate (LIBOR). The Note Rate is based on one-month LIBOR as published every Monday in the Wall Street Journal, plus an investor margin. The Expected Rate is based on the ten-year LIBOR Swap Rate, as published every Monday by the FED, plus the same investor margin. For background, see our first article in this series, Interest Rates: How Today's Environment Can Impact Your Client.

What’s the Difference?

Table 1 compares the LIBOR and CMT HECM as shown on a seller/servicers website for the week of April 22. Note that this company is playing the LTV lookup game – Expected Rates are rounded to the nearest eighth for LTV lookups subject to a 5.50% lookup floor. The LIBOR margin here is the highest that will still allow the Expected Rate to round down to 5.50% (nice folks!).

The LIBOR HECM gives an extra $80 in available benefits because its higher Expected Rate gives a lower SFSA. But its initial Note Rate is 0.676% higher. If this spread holds, this 73-year old borrower will owe an extra $26,454 in ten years – all for an extra $80 up front!

What might we expect?

    We are in strange times – rates are low and the spread between short-term LIBOR and CMT rates is high. Historically the one-month LIBOR has been only 0.13% higher than the one-year CMT rate. If this spread comes back in the future, the borrower will be much better off in the LIBOR HECM. The chart below shows the history of the two Note Rate indexes.

    But the historical average spread in the Expected Rate indexes has been 0.58% (LIBOR higher than CMT). This means that in the future, when rates go up a bit and the annoying 5.50% HUD lookup floor has no effect, LIBOR HECM’s must have a margin that averages 0.58% less than the margin on CMT HECM’s in order to give similar benefits. The chart below shows the history of the two Expected Rate ten-year indexes. You can see how consistent the spread is between the LIBOR Swap Rate and the ten-year CMT.

What products should you offer?

    Wall Street has temporarily backed off from investing in reverse mortgages. Luckily for the reverse mortgage industry, Fannie Mae, the traditional investor, is still buying in a big way. But we believe that Fannie prefers CMT HECM’s. When Wall Street rehires their trading desks, LIBOR HECM could well move to the forefront.

    It all depends on the spreads between the ten-year indexes and your perception of the future spread between the two Note Rate indexes (“Short Spread”). We can pretty well predict that the ten-year spread will average 0.58% -- the wild card is the spread on the two Note Rate indexes. In the chart below you can see the material effect the sub-prime and rate spread melt-down has had on the Short Spread. The Long Spread has stayed fairly consistent averaging 0.58%. The Short Spread has gone haywire!

    If you believe that historical yield spreads will reassert themselves in the next few years, your client will be better off in a LIBOR HECM if their initial benefits are equivalent to those from a CMT HECM. The LIBOR HECM will need a 0.50% or so lower margin to match the benefits of a CMT HECM, and if the future Short Spread is less than 0.50% (history is 0.13%), the LIBOR HECM will have materially lower future loan balances.
Hopefully the “American Condition” will be a short-lived phenomenon.

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 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)