For many involved in reverse mortgage lending, one of the most difficult concepts to master and to explain is the calculation of the loan servicing set-aside fee.  As part two of this two-part series on reverse mortgage servicing, we will try to explain what the servicing set-aside is and how this concept (and perceived cost) should be explained to a borrower.

The servicing set-aside fee is disclosed on the reverse mortgage summary calculation that is typically provided to reverse mortgage borrowers.  This summary generally conveys the available loan proceeds to a borrower, under comparative reverse mortgage scenarios.  The servicing set-aside is a lump sum item listed separately and is often perceived as a closing cost or charge to the borrower.  Fortunately this large dollar amount is not a closing cost paid by the borrower.  Unfortunately, the originator will need to explain what the servicing set-aside is and why it is not a closing cost.  By the way, you will probably have this exact discussion with just about every reverse mortgage borrower you work with!

So what is a loan servicing set-aside?  I have heard a variety of answers from many reverse mortgage lenders across the country.  Interestingly, many experienced and inexperienced lenders do not explain this item properly.  This shouldn’t be a surprise to anyone as the servicing set-aside concept has been a murky subject to most!

By way of example, here are some common explanations provided to borrowers of what the servicing set-aside is:

With this variety of misinterpretations, let’s try to describe exactly what the servicing set-aside is.   HUD Handbook 4235.1 Rev. 1, Appendix 7 describes the servicing set-aside as:

 

2.3.4. {The} Lender shall initially set aside from the Principal Limit the amount indicated on the attached payment plan (Exhibit 1) to be applied to payment due for a fixed monthly charge for servicing activities of Lender or its servicer.  Such servicing activities are necessary to protect Lender’s interest in the Property.  A servicing fee set aside, if any, is not available to the Borrower for any purpose, except to pay for loan servicing.

This definition references that the “…servicing fee set-aside, if any, is not available to the borrower for any purpose, except to pay for loan servicing.”  In practice, the monthly servicing fee is not being withdrawn from the amount initially set-aside.  Instead, the borrower has a monthly service charge added to their outstanding balance each month for the cost of servicing.  Monthly servicing fees typically range between $20 and $35 depending on the loan and lender selected.  The servicing set-aside effectively creates an additional equity reserve in the property that is available to address the ongoing incursion of the monthly servicing fee.

The HUD Handbook 4235.1 Rev. 1, Section 5.7 goes on to describe how the servicing set-aside fee should be calculated as:

 

A set-aside for monthly servicing fees is calculated by determining a fixed monthly fee, and then determining the present value of that fee using the term used for a tenure payment plan (i.e. to the borrower’s 100th birthday) and the compounding rate defined below in 5-8B.2.  Example:  The present value of a fixed monthly servicing fee of $25, given a term of 300 months and a compounding rate of .0825 divided by 12 is $3,192.58.  This amount should be subtracted from the principal limit to arrive at the net principal limit that is used for determining monthly payments or a line of credit.

To better understand how much servicing expense a borrower would incur, let’s look at an example.  Using the numbers cited from the HUD Handbook, we will use a $25 monthly servicing fee and a calculated servicing set-aside of $3,192.58 for the example.  If a borrower obtained a reverse mortgage loan with this set of factors and the borrower moved out of the home at the end of 2 years, let’s calculate what the servicing charges would be in this example.

 

   
Although the servicing set-aside fee was initially calculated at $3,192.58, the actual servicing expense paid by a borrower who repays their reverse mortgage loan at the end of 2 years is $600.00.  The difference ($3,192.58 - $600.00 = $2,592.58) remains as equity in the home.  The lender never collected this excess amount and the borrower is not due a refund of this excess amount.    The excess amount was left as additional equity in the home and still remains as equity.

Sounds easy enough to explain to a reverse mortgage borrower, doesn’t it?  The reality of the servicing set-aside is that it is just part of the calculation or algorithm used to determine the borrower’s ultimate access to proceeds.  But unlike other parts of the algorithm the servicing set-aside is disclosed and appears to be a sizable, upfront cost or expense.

 

In the interest of full and complete disclosure to potential borrowers, the concept of disclosing the servicing set-aside makes sense.  The more information a potential borrower can have about the components of a loan transaction being contemplated, the better a decision that borrower can make.  But if that reasoning was the rationale for disclosing this part of the qualification equation, then shouldn’t we disclose the rest of the reverse mortgage algorithm?  To provide the balance of the algorithm, you would need to print and provide the contents of HUD Handbook 4235.1 Rev. 1 to your borrowers. 

Irrespective of the logic (or lack thereof) of disclosing the servicing set-aside to potential borrowers, and you are faced with the challenge of doing it.  Make sure that you a good understanding of what the servicing set-aside is and how it is calculated.  Then you should have a good chance of providing a clear explanation for your borrowers.

About David Cesario:  David Cesario is a national speaker and educator on Reverse Mortgage Lending.  He serves as the Executive Vice President of 1st Reverse Financial Services, LLC, a national wholesale reverse mortgage lender, located at 410 Quail Ridge Drive in Westmont, Illinois, 60559.  The company’s website is located at www.1stReverse.com where information can be found about 1st Reverse’s wholesale lending programs and options for lenders interested in offering reverse mortgage loans.