Forward on Reverse: An equity-consuming home loanAtare E. Agbamu, CRMSreverse mortgage, negative amortization, equity-consuming home loan At a reverse mortgage presentation during the Minnesota Association of Mortgage Brokers 2006 Convention and Expo at the Hyatt Regency in Minneapolis in September, an industry colleague asked, "Atare, isn't a reverse mortgage a neg-am (negative amortization) loan?" I said, "No, it's an equity-consuming home loan." Well, how can I say that when everyone knows that they are neg-ams and that there is a negative amortization disclosure in a typical reverse mortgage Truth in Lending disclosure? Let's do some "reverse" analysis of neg-am vis-à-vis reverse mortgages. Negative amortization is a carryover concept from traditional forward mortgages where the purpose is to build equity by paying down or amortizing the loan through scheduled monthly payments. The mission of reverse mortgages is different. It is not to build, but to consume built-up equity. It is not to preserve, but to use home equity. Here is how Barron's Dictionary of Finance and Investment Terms defines negative amortization: " ... financing arrangement, in which monthly payments are less than the true amortized amounts and the loan balance increases over the term of the loan, rather than decreases; the interest shortage is added to the unpaid principal. In some cases, interest shortage is added back to the loan and payable at maturity ... As this definition confirms, traditional forward mortgage monthly loan payments are designed to reduce the loan balance; therefore, when monthly payments are less than required to pay down the loan balance, negative amortization results. With reverse mortgages, there are no scheduled monthly payments of interest and principal with the goal of eliminating the debt; there are monthly charges of interest, a servicing fee and other fees (and sometimes scheduled and unscheduled amounts of principal) to equity. These monthly charges decrease home equity and increase debt as designed. Again, the aim of a reverse mortgage is to spend equity, and a borrower goes into a reverse mortgage situation fully aware (thanks to mandatory consumer education) of this purpose. A typical forward mortgage borrower starts out home-equity poor, but a reverse mortgage customer begins the process home-equity rich. One needs shelter (and home equity), the other tax-free cash, shelter and no monthly payments. So calling a reverse mortgage a neg-am loan is a misnomer, because amortization is not a part of its design. A reverse mortgage borrower may choose to pay down (amortize) or pay off the rising debt at any time without penalty, but he has no contractual obligation to do so through regular fixed or variable monthly payments. "But Atare," you ask, "how come every reverse mortgage software in use has an 'amortization schedule'?" That's part of the confusion. What we now call an "amortization schedule" is a spreadsheet that shows essentially what a reverse mortgage borrower could owe in cash advances, interest and fees, offset by possible home appreciation, up to his 100th birthday. In the words of Connie Osman of BNY Mortgage, it is a "snapshot in time" of what a reverse mortgage borrower's loan could look like over time. In the place of "amortization schedule," I suggest the term "projected loan activity schedule" or "projected loan activity summary." A projected loan activity schedule or summary is a better description of what we now call "amortization schedule" in reverse mortgages. Besides which, it severs the murky conceptual link (and confusion) with the traditional forward mortgage amortization schedulethe real amortization schedule. A more accurate way to describe these fascinating home-equity loans is that they are equity-munching or equity-consuming home loans. We can also refer to them as rising-debt/falling-equity loans, as reverse mortgage pioneer Ken Scholen aptly describes them in his foundational books. So why should you care whether reverse mortgages are neg-am or equity-consuming loans? Because associating reverse mortgages with neg-am loans has implications for marketing reverse mortgages. Neg-am loans connote high costs as well as predatory and abusive loans, causing some professionals and consumers to recoil from even taking a fair look at them and putting the reverse-mortgage marketer on the defensive. A reverse mortgage marketer should not be ashamed to talk about one of the most important financial innovation of the last century because of an inappropriate program label. Never mind that layers of built-in consumer safeguards make reverse mortgages the antithesis of predatory loans and that their high initial costs decline over time, unlike your typical Section 32 loans. In fact, Section 32 of Regulation Z specifically exempts reverse mortgages, though they are subject to their own, more stringent set of disclosures under Section 33 of Regulation Z. In addition, their non-recourse feature guarantees that a borrower can never owe more than his home is worth. With traditional forward mortgage neg-am home loans, a borrower can easily owe more than his home is worth. The next time someone tells you reverse mortgages are neg-am loans, sit him down and share your better understanding of reverse mortgages as unique, equity-consuming home loans with him. Think reverse. Move forward! Atare E. Agbamu, CRMS is president of ThinkReverse LLC, a reverse mortgage training and consulting firm based in the Twin Cities and is a consultant with Credo Mortgage. Atare is regarded as an emerging authority on reverse mortgages and is frequently consulted by financial professionals and families across America. His reverse mortgage interviews have been Webcast on MortgageMag Live! He can be reached by phone at (651) 389-1105 or e-mail [email protected].
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