by Mark Schumacher, Home Equity Retirement Specialist, Security One Lending 

Last edition’s reverse mortgage article was a general review of how the FHA reverse program works, named HECM. This article is a deeper dive into an aspect of HECM that is not well understood – negative amortization.

With the HECM program, negative amortization means that the loan (Principle Limit) is growing larger instead of smaller. Here is a very critical aspect to understand – there are two parts to the Principle Limit: the Debt (the amount of the loan that’s actually been used) and Available Proceeds (the amount of the loan that’s not yet used but is available for use in the future). Both parts grow at the interest rate plus the 1.25% annual mortgage insurance premium (MIP) rate. This is true regardless of whether the loan starts out with a small debt and large available proceeds or vice-versa. This makes the HECM look very different to homeowners in dif-ferent situations. Let’s take a closer look at what this loan growth means for homeowners in contrasting situations.

Eliminating the mortgage payment

Homeowners with a sizeable mortgage and payment they want to get rid of might use all of their available HECM proceeds to pay off their mortgage. Let’s assume this is the case, thereby eliminating any required mortgage payment going forward, and leaving no available proceeds for future use. For these HECM borrowers their Principle Limit is comprised of Debt and none is Available Proceeds. The debt (amount needed to be paid back) grows at the interest rate plus 1.25%. The Debt doubles in about 10 to 15 years.

Guaranteed line of credit for future use (liquefying housing wealth)

For homeowners that owe nothing on their home this loan works the same but looks very different. That is, the Principle Limit grows at the interest rate plus the 1.25% MIP, and the Principle Limit is again made of two parts, the Debt and the Available Proceeds, and they both grow at the same rate. For example, this scenario could have a starting debt of $50 (the minimum required for a HECM) and a starting Line of Credit (available proceeds) of $150,000. Since the Principle Limit doubles in approximately 10 to 15 years that means the debt would become $100 and the available Line of Credit would become $300,000 assuming the line of credit had not been tapped and there are no escrows or set-asides. In other words, it cost only an additional $50 of home equity to secure access to an additional $150,000. That can help a lot of retirements feel a whole lot more secure. Whatever amount of the Line of Credit is tapped would be added to the Debt side and reduced from the Available Proceeds side. However, the Available Proceeds side would continue to grow for the benefit of the homeowner at the same rate as the Debt side is growing.

Many HECM borrowers are somewhere between the two above contrasting examples. They have a portion of the Principle Limit as Debt and a portion as Available Proceeds. Both parts grow at the same rate making the Debt grow higher and the Available Proceeds also growing for the benefit of the homeowner.

With interest rates where they are today, loan-to-value ratios typically range from 52% to 75% at the start of the loan. If interest rates rise 1% that makes the loan-to-value ratio range from 39% to 65%. If interest rates rise 2% that makes the loan-to-value ratio range from 31% to 58%. Therefore, there is a sizeable benefit to those homeowners that secure the HECM in a favorable interest rate environment.

The growth of a reverse mortgage loan creates a unique opportunity for homeowners, particularly those that have available proceeds for future use. Learn how to put your housing wealth to work for you, sooner rather than later.