Deciding On A Package Of Costs For A HECM Reverse Mortgage


Potential borrowers should ask lenders to provide a range of options to consider around different variations for up-front costs and lender’s margins.Retirement Researcher

The discussion of reverse-mortgage costs has several moving parts. Which type of cost combination to choose depends on how you plan to use the line of credit during retirement. Let me reveal the punch line for the following discussion: Those seeking to spend the credit quickly will benefit more from a cost package with higher up-front costs and a lower lender’s margin rate. Meanwhile, those seeking to open a line of credit that may go unused for many years could find better opportunities with a package of costs that trades lower up-front costs for a higher lender’s margin rate. These options must be considered carefully, and potential borrowers should ask lenders to provide a range of options to consider around different variations for up-front costs and lender’s margins.

For more information, download our Reverse Mortgage 101 Cheatsheet

To summarize the cost discussion, costs determined by the lender include:

  • Origination fees
  • Other closing costs
  • Servicing fees
  • Margin rate

Along with the up-front mortgage-insurance premium, which the lender does not control (though some lenders may provide a credit to cover it), the up-front costs include the origination fees and other typical closing costs. The maximum that can be charged for origination fees is set by the government and relates to the home’s value, as described before. Lenders have discretion to charge less than this amount. Smaller lenders with smaller marketing budgets may compete more on price, which can include a lower origination fee, or even credits to offset other fees.

For other closing costs, these fees vary and relate to the typical costs for opening a mortgage (e.g., titling and appraisal charges) as well as payment for the mandatory counseling session. Some lenders may also provide credits to cover some of these costs as well. The only exception is that lenders are not allowed to pay for the counseling session. As for servicing fees, lenders are allowed to charge up to $35 per month, but recently, it is common not to charge an explicit servicing fee and instead include such fees as part of the lender’s margin rate.

The final cost to consider is the lender’s margin rate. This is not an up-front cost but an ongoing cost charged on the outstanding loan balance. The choice of lender’s margin is important because it affects both the initial PLF and the subsequent growth rate of the principal limit. A higher lender’s margin reduces the initial principal limit as part of the expected rate, but this principal limit subsequently grows faster, as the margin is also part of the effective rate that determines principal limit growth.

Again, the lender’s margin is part of the expected rate, and a higher lender’s margin implies a higher expected rate, which in turn implies a lower principal limit factor. For example, if the ten-year LIBOR swap rate is 2.25 percent, a sixty-two-year-old with a $250,000 home could see his initial principal limit fall from $102,500 to $89,250 by choosing a 3.75 percent lender’s margin instead of 2.75 percent. This represents a reduction in the principal limit factor from 41 percent to 35.7 percent.

But, the lender’s margin is also included as a variable to determine the effective rate—the rate at which the principal limit grows. Remember that the effective rate defines the rate of growth for both the outstanding loan balance and the remaining line of credit. Those with a small loan balance benefit from a high lender’s margin because it allows their line of credit to grow more quickly, while those with a large loan balance—everything else being the same—prefer a lower lender’s margin so that the loan balance does not grow as quickly.

These four ingredients can be combined into different packages by the lender. The best choice depends on how the reverse mortgage is used. When funds will be extracted earlier, it may be worthwhile to pay higher up-front fees coupled with a lower margin rate. However, for a standby line of credit that may go untapped, it could be beneficial to lean toward a higher margin rate combined with a package for reduced origination and servicing fees. Again, some lenders may even offer credits to cover a portion of the up-front fees.

Exhibit 1.1 provides an example of these dynamics for a case of a sixty-two-year-old borrower facing a ten-year LIBOR swap rate of 2.25 percent and a one-month LIBOR rate that stays at 1.25 percent. The exhibit shows the initial principal limits and principal limit growth for three different lender’s margins: 1.75 percent, 2.75 percent, and 3.75 percent. For this example, age seventy-seven serves as the crossover point for all three cases. Prior to that age, the principal limit is the largest with the lower 1.75 percent margin, but after age seventy-seven, the principal limit is the largest with the higher 3.75 percent margin.

Note that this example implicitly assumes the same up-front costs for all three scenarios. The crossover age at which the net principal limit becomes larger would be sooner for the high-margin case if it is also accompanied by a package of lender credits to lower the up-front costs.

Exhibit 1.1: Comparing Line-of-Credit Growth with Different Lender’s Margins

Exhibit 1.1: Comparing Line-of-Credit Growth with Different Lender’s MarginsRetirement Researcher

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