Forward on Reverse: An equity-munching home loan
“If you share a good idea long enough, it will fall on good people,” says Jim Rohn. In that spirit, we revisit an idea I have addressed in this column, but it keeps coming up in my interactions online, in-person, and on the phone with readers and industry colleagues, especially newcomers to reverse mortgages. At a recent gathering, an industry colleague asked: “Atare, aren’t reverse mortgages neg-am (negative amortization) loans?”
I replied, “No, they are equity-munching loans.” But how can I say that when there is a “negative amortization” disclosure in a typical reverse mortgage Truth-in-Lending (TIL) disclosure? Let’s do some “reverse” analysis of negative amortization loans versus reverse mortgages.
Negative amortization is a carry-over idea from traditional forward mortgages, where the purpose is to build-up home equity by paying down (or amortizing) the loan through programmed monthly payments. The mission of a reverse mortgage is different. It is not to build-up, but to consume built-up home equity. It is not to preserve, but to use home equity, trading it in for cash.
A typical forward mortgage borrower starts out home equity poor, but a reverse mortgage customer begins the process rich in home equity. 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 factored into its design. Of course, a reverse mortgage borrower has the right (and may choose) to pay down (amortize) or pay off the rising debt at any time without penalty, but there is no contractual obligation to do so through regular (fixed or variable) monthly payments.
A more relevant way to describe these innovative 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 calls them. In addressing the question, “What happens to your debt?” in his 1998 classic, Reverse Mortgages for Beginners, Scholen wrote:
“It grows larger and larger as you keep getting cash advances, make no repayment, and interest is added to the amount you owe (your “loan balance”). That’s why reverse mortgages are called “rising debt, falling equity” loans. As the amount you owe (your debt) grows larger, your equity (that is, your home’s value minus any debt against it) generally gets smaller.”*
Scholen was writing for consumers, and his explanation remains the simplest and the best I have read on what many in our industry understandably but mistakenly call “negative amortization.”
Now, why should you care whether reverse mortgages are neg-am or equity-munching loans? Because associating reverse mortgages with neg-am loans have unhelpful implications for marketing reverse mortgages. Neg-am loans connote high-costs, predatory, and abusive loans, causing some professionals and consumers to recoil from even taking a look at them.
Psychologically, it puts the reverse mortgage marketer on the defensive.
It encourages some well-meaning but mistaken public officials to propose increasingly doubtful and anti-consumer regulations (some provisions in the Minnesota Attorney General’s recent legislative proposal are good examples).
Never mind that layers upon layers of built-in consumer safeguards make reverse mortgages the opposite of predatory loans. Never mind that the Housing and Economic Recovery Act of 2008 (HERA) reduced reverse mortgage costs by capping lender fees at $6,000. Never mind that HERA 2008 built a firewall between reverse mortgages and other financial services products such as annuities. And never mind that their initial high costs decline steadily over time by design, unlike your typical Section 32 loans. In fact, Section 32 of Regulation Z (Reg. Z) exempts reverse mortgages, but they are subject to their own more stringent set of disclosures under Section 33 of Reg Z.
The next time someone tells you reverse mortgages are neg-am loans, sit them down and share your better understanding of reverse mortgages as equity-munching loans with them.
Think reverse. Move forward.
*Reverse Mortgages for Beginners: A Consumer Guide to Every Homeowner’s Retirement Nest Egg (Apple Valley, MN: NCHEC Press, 1998), p.13.
Author and columnist Atare E. Agbamu, CRMS is director of reverse mortgages at Minneapolis-based AdvisorNet Mortgage LLC. A member of BusinessWeek Market Advisory Board, Agbamu has published more than 100 articles on reverse mortgages. AllRegs recently released an online training resource—The Think Reverse Practical Guide—based on Agbamu’s recent book, Think Reverse! (The Mortgage Press Ltd., 2008). He can be reached by phone at (612) 436-3711.
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