The Reverse Mortgage Process
Are you ever confused by a lender claiming to be a “direct lender” and that they “loan their own money so they make the final approval decision”? Or others that claim to issue “no cost loans” and those that offer the “best rates”?
Well did you know that in the world of the HECM Reverse Mortgage, they are all actually describing the same loan? How can that be?
The answer is in understanding the process and food chain that ultimately produces a reverse mortgage.
Reverse Mortgage Securities
Let’s start from the end of the mortgage process.
Ultimately, ALL HECM loans are sold to investors in the Securities Market and this is where the loan money really comes from.
First, a large group of loans are packaged together and offered to individual and institutional investors who exchange their savings for an interest dividend (just like you do when you buy a certificate of deposit at your bank).
Now unlike the government issued treasury bonds you buy at your bank, these loans are not issued by the government, and are therefore NOT backed by the full faith and credit of the US government.
This is where the FHA comes in. In order to offer the lowest possible interest rate to you, the FHA and its affiliated insurance issuer Ginnie Mae, backs these loans and guarantees the lender that the loan will be paid in full.
So in other words, there is no risk to the lender when making this loan.
The Mortgage Issuer
There are tens of thousands of loan originators across the country.
The fact is that Ginnie Mae doesn’t want to (and doesn’t have nearly enough resources) to deal with all of them. Ginnie Mae then sets up a hierarchy to funnel loans up to them from the market in large blocks.
At the top of this food chain are the issuers and these few companies are the only ones authorized to deal directly with Ginnie Mae.
The issuer’s job is to:
- Gather the loans from the originators (mortgage banks)
- Place the loans in large pools
- Send the loan pools to Ginnie Mae to receive an insurance stamp
- Issue the loans to the securities market
- Make money on the mortgage backend (explained later in the blog)
It’s important to note that most issuers are also reverse mortgage bankers and they originate their own loans before adding them to the block for sale.
Reverse Mortgage Banks
This is where most of the loan origination action happens.
The role of reverse mortgage banks is fairly simple:
- They review the application and underwrite it by making sure it complies with all of the rules, requirements, and restrictions imposed by FHA.
- After reviewing the application, reverse mortgage banks arrange for money to fund the loan from their line of credit A.K.A, a warehouse line (these are the guys claiming to be direct lenders).
- Reverse mortgage banks then insure that the property has all necessary insurance and finally fund the loan (this is when you get your money!).
- Finally, the bank sells the loan to the issuer (this is where they make their money!).
It’s important to note that while not all mortgage banks originate loans, most of them do.
Reverse Mortgage Brokers
Reverse mortgage brokers are quite simply the selling side of originating a mortgage as they don’t underwrite, fund, or issue loans to the securities market.
Reverse mortgage brokers have three main responsibilities:
- Promote the program.
- Cultivate potential borrowers.
- Send the loan pools to Ginnie Mae to receive an insurance stamp.
- Take the loan application and push the application up to the mortgage bank.
These guys are at the bottom of the food chain and therefore make the least amount of money on a loan origination.
So after all that explanation I’m sure you’re wondering, “What difference does all this make? Why should I care about the type of lender I’m dealing with?”.
The Mortgage Backend & Yield Spread Premiums
When you apply for any loan, you will be given a statement called the truth in lending statement. This document shows you all of the loan charges, including the FHA premium, the 2% loan origination fee, title and Escrow fees, and appraisal fees.
You will quickly see that all of those fees are subtracted from the loan proceeds and reduce the net amount that you will get in actual money from the loan. What you usually don’t see, however, is the “invisible” money made on the loan that does not come out of your proceeds.
This money is what the industry refers to as the “back end.” It’s usually hidden from you because it really doesn’t affect the borrower but nevertheless it’s usually a substantial amount of money.
Let’s use a theoretical example to explain the mortgage back end.
Say a typical investment in a no risk product (like a 30 year treasury) pays 2.25%.
Now let’s assume that I’ve originated a loan from you that pays 5.6% and I want to sell that to an investor. Since I know that a $100,000 investment will yield 2.25% per year, and investing $100,000 in my reverse mortgage security is going to yield over twice that amount without risk (because of FHA), I’m going to ask for a Yield Spread Premium.
In other words, I’m going to ask you to pay (say $110,000) for my $100,000 security. That extra $10,000 goes to the issuer.
Follow The Money
Now if the issuer got the loan from a mortgage bank, it will pass a portion of the $10,000 (say $5,000) on to the mortgage bank. If the bank originated the reverse mortgage through an affiliated mortgage broker, the bank will pass along a portion (say $2,500) to the broker.
This would all have no impact on you the borrower if the issuer just issued, the bank just funded and the broker just originated but that’s not the case. As I pointed out earlier, in most cases the issuer also originates and funds, allowing them to keep the entire $10,000. The bank also originates allowing them to keep the entire $5,000.
I’m sure by now you’re beginning to see that the higher up the food chain you go to actually obtain your loan, the more bargaining power you have when it comes to negotiating a discount to offset origination fees.