Table 1: Which Loan Costs the Least?

Each of the four reverse mortgage loans described in Table 1 has been offered in the United States. But even though this table tells you all about the costs of these loans, you cannot tell which one costs the least. The categories of cost are different from one loan to another, which makes them almost impossible to compare.

Moreover, you don’t know how much money a borrower could get from one loan versus another. In “forward” mortgages, the dollar amount of major cost items is directly related to the amount of the proceeds a borrower gets from the loan. In a reverse mortgage this is not always true.

So now let’s simplify the matter by comparing one HECM loan to another. That way the cost categories would be the same, and that should make the loans much easier to compare.

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Table 2: Which HECM Costs Less?

So which costs less: the Loan A or Loan B? The categories of cost are the same, and both loans are HECMs. In fact, all of the itemized costs are exactly the same. But there is virtually no likelihood that these two loans will cost the same.

In the left-hand column you can see that three boxes are blank. This means that three cost factors are missing. Can you guess what they are? Let’s take a closer look at these “identical” loans.

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Table 3: Two HECMs at Closing

Here we are outside the bank when Borrower A and Borrower B emerge from their HECM closings with their “identical” loans. The first thing we learn is that Borrower A took the entire loan as an immediate lump sum of cash at closing, and Borrower B took it as a monthly advance only.

Borrower A has come away from the deal with $70,298, and when we ask how much it cost her to get it, she tells us $6500, which is the total of all the upfront costs back on Table 2. Now we ask Borrower B how much she paid for her loan, and she tells us the same thing: $6500. But when we ask how much money she got out of the deal, she tells us $562 – so far.

So who would you say has gotten the better deal – so far? Both have paid $6500 for the loan, but A now has $70,298 and B has has $562. So far, you would have to say that Borrower A has gotten more for the same amount of money – a lot more. But let’s not jump to conclusions. Let’s wait a while, and see how things develop. What will these “identical” loans look like two years later?

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Table 4: Two HECMs After Two Years

Two years later, Borrower A still has gotten only the lump sum she started out with. But now her loans costs total $21,464 – this includes the upfront costs, the monthly servicing fees, and the interest that has been charged on her large lump sum and on her other costs and fees. But the total amount of cash she has gotten is still more than three times greater than her total loan costs.

By contrast, Borrower B has now gotten $13,488 ($562 per month for 24 months). But that isn’t even anywhere close to two times as much as her total loan costs. So Borrower A has still gotten more bang for her buck. For every dollar in costs she has gotten $3.28 in benefits, while for every dollar in costs Borrower B has gotten only $1.38 in benefits.

Borrower B may be starting the long process of catching up to the deal that Borrower A got, but she has a long way to go. Borrower A – so far – has still gotten more for her money.

But how would you express that numerically? Take a look at the next table.

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Table 5: TALC after Two Years

Do you have a simple financial calculator? If you do, you can try this at home. For Borrower A, punch in $70,298 as the “present value” (how much she got at closing). Then punch in $91,762 as the “future value” (how much she owes after two years). Then punch in 24 months (two years). Now punch the “interest” button to find out what single rate of interest it would take to make $70,298 grow to become $91,762 after two years. The answer (after you’ve multiplied by 12 to change the monthly rate to an annual one) is 13.4% per year.

In other words, if the lender could not charge loan costs in different ways (interest, origination, insurance, closing costs, servicing fees, etc.) but had to roll all of the costs into the interest rate, what would that rate have to be to generate the same future amount owed as you would get by charging the separate costs? That’s the Total Annual Loan Cost (TALC) rate. Put another way, if you were charged 13.4% interest on $70,298 for two years, you would owe $91,762.

Now let’s try it for Borrower B to find out how much more her loan advances have cost her – so far. Punch in $562 as the “payment,” $23,239 as the “future value,” 24 months (making sure to set the calculator for “beginning of the month” which is when the loan advances are made), and then the interest button. Now multiply by 12. The TALC rate in this case is a whopping 49.5% – confirming our suspicion that Borrower B has paid a lot more for what she’s gotten – so far.

Why is Borrower B’s rate so high? Because her total costs so far ($9,751) are still a very large part of what she owes ($23,239). In fact, these costs are over 40% of her total debt. By contrast, Borrower A’s total costs are less than 25% of what she owes – and she had all of her money since the very first day of the loan. It’s taken Borrower B two full years to get her money.

So far, we have seen that the real cost of these loans depends on the type of loan advances you select, that is, how much money you get, and when you get it. Now let’s take a look at another factor you are probably starting see: time.

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Table 6: TALC Rates Over Time

The TALC rate comes down over time for two reasons. First, as the upfront loan costs get spread out over more and more years, they become a smaller part of the total amount owed. Second, as the loan balance rises over time, the likelihood increases that it will catch up to – and then be limited by – the home’s value. Remember, reverse mortgages are nonrecourse loans – so you can never owe more than the future value of the home. When a rising loan balance catches up to that value, the borrower cannot owe more than that value.

For example, Borrower B has taken monthly advances for as long as she lives in her home (“tenure” advances). Assume that her home value never increases after closing. When her rising loan balance catches up to that non-rising home value, her debt is then capped by the home’s value. If that value remains fixed, she will continue getting monthly advances every month, but her loan balance will not increase. And that will drive the TALC rate down at a faster rate. The nonrecourse limit accelerates the decrease in the TALC rate.

Even when a home’s value grows, the loan balance may still catch up to it and -when it does – be limited by its future value, which will most likely grow at a slower rate than the loan balance otherwise would have (without the nonrecourse limit). If a home’s value decreases, on the other hand, a borrower could have a declining debt despite continuing to receive loan advances every month.

So changes in a home’s value are a key factor in determining the loan’s total annual average cost. Table 7 shows the effect of home appreciation on the TALC rate. The smaller the appreciation rate, the lower the rate will tend to be over time – because the rising loan balance will catch up to – and then be limited by – the home’s value sooner. The larger the appreciation rate, the greater the TALC rate will tend to be over time – because the rising loan balance will not catch up to the home’s value as soon – if ever. And if it does, a higher appreciation rate will place less of a cap on the growing loan balance than a smaller rate would.

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Table 7: TALCs on 3 HECMs

Home Appreciate Rate =	0%	4%	8%
LUMP SUM
@ 2 years	13.4	13.4	13.4
@ 12 years	5.9	10.0	10.0
@ 17 years	4.1	8.3	9.7
CREDITLINE (50% at closing)
@ 2 years	19.4	19.4	19.4
@ 12 years	11.0	11.0	11.0
@ 17 years	8.5	10.4	10.4
TENURE (monthly)
@ 2 years	49.5	49.5	49.5
@ 12 years	8.4	10.8	10.8
@ 17 years	2.2	9.0	9.8

Table 7 also shows the impact of loan advances on the TALC rate. TALC rates on lump sum loans don’t vary as much as they do on monthly advance loans. Creditline loans generally fall somewhere in between, depending on how the borrower uses the creditline. If it’s used more like a lump sum, the actual TALC rates will be more like lump sum TALCs. If it’s used more like a monthly advance, the actual TALC’s will be more like monthly advance TALCs.

In the official TALC disclosure , however, lenders are instructed to assume that the borrower will withdraw 50% of the avaiulable creditline at closing, and none thereafter. This is the assumption used to poroject the TALC rates in Table 7.

So now we return to our original question. Can you name the three non-cost factors that affect the total annual average cost of a reverse mortgage? As we’ve seen, and as they are displayed in Table 8, they are

• the pattern of loan advances (“Payments”),

• how long the borrower lives in the home (“Term”), and

• what happens to the home’s value during that time (“Appreciation”).

Curiously, these key cost factors are not controlled by the lender. To the extent that anyone can know at closing how these factors will play out over time, the borrower may have a better sense of each than the lender. But then, the lender who originates the loan generally is not affected financially by its total annual average annual cost rate. The lender’s earnings on the loan typically equal the origination fee and some portion of the servicing fee. So lenders generally get paid the same no matter what the loan ends up costing the borrower.

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Table 8: Which HECM Costs Less?