Net Principal Limit (Npl) from Reverse Mortgages in the State of New York: A Comparative Analysis

By Bansal, Vipul K.; Ellis, M. E. | Journal of Business and Behavior Sciences, Summer 2014 | Go to article overview

Net Principal Limit (Npl) from Reverse Mortgages in the State of New York: A Comparative Analysis


Bansal, Vipul K., Ellis, M. E., Journal of Business and Behavior Sciences


INTRODUCTION

Home Equity Conversion Mortgages (HECM) or reverse mortgages are available to Seniors 62 years or older. The purpose of reverse mortgages is to allow seniors to take-out the equity in their homes and still be allowed to stay in the home. HECMs are available only through a Federal Housing Administration (FHA) approved lender. Under this mortgage, borrowers receive a lump sum, monthly payments, or a credit line that is not re-paid until the homeowner leaves the home.

To determine how much a homeowner can borrow, we begin with the average maximum claim amount (MCA) provided by the Department of Housing and Urban Development (HUD). It is based on the lower of the property's appraised value or the limit set at 95% of the median home price for the area of the house with a cap on that median set by the FHA. In 2001, the cap was $275,000, but by 2011 the cap had increased to $625,500. The cap is important for our study as New York has one of the highest home prices in the nation. Age of the borrower and expected interest rates are used to calculate Principal Limit Factor (PLF) tables. The Initial Principal Limit (IPL) is determined based on the PLF and the MCA. The idea is that the value of the loan should approach the MCA when the homeowner leaves the home and repays the loan. The Net Principal Limit (NPL) is the lump-sum amount available to the borrower at closing. The NPL is the IPL less the initial mortgage insurance premiums (MIP), third party closing costs, origination costs, and set-asides for service fees and home repairs.

This paper estimates the average NPL in the State of New York in 2011 versus 2001. From data provided by HUD, we can determine the average IPL and then estimate the MIP, closing costs and set asides to determine the NPL. The major objective of HECM loans is to enable older homeowners to use the equity in their homes and still be able to live in the home. But, the costs of the HECM have raised concerns in the academic and popular press (Bishop and Shan (2008), Tedeschi (2009), Bernard (2010)). If the HECM program is not providing a significant portion of the appraisal value of the home to the homeowner, this indicates the HECM program may not be accomplishing its objective. The purpose of this paper is to examine what changes have occurred in the appraised value, MCA, IPL and estimated NPL over the 2001 to 2011 period. The results provide implications for the benefits and consequences of HECM loans. We add to the academic literature by forcing on one state for the analysis (New York) instead of using national data and by beginning with actual loan values instead of using hypothetical data.

The next section provides a brief literature review concerning the closing costs and cash flows received from HECM loans. Section 3 provides a description of the HECM data obtained from HUD. Section 4 describes how the NPL is estimated for 2001 and 2011 and discusses the NPL relative to the IPL, MCA and the appraisal value of the home. The funds availability discussion is expanded to indicate the first year drawdown relative to the NPL, IPL, MCA and appraisal value. The conclusion is provided in Section 5.

LITERATURE REVIEW

McCarthy and Wise (2010) and Heam, Borstorff and Thomas (2005) study the retirement planning issues for the elderly in the United States. HECM as a part of retirement planning has been studied also in the popular press, but there is scarcity of academic papers. Sacks and Sacks (2012) found that reverse mortgages can be a very important tool for retirees. This study also suggested the optimal way to use reverse mortgages.

Most academic research on reverse mortgages including Venti and Wise (1991), Merrill et al. (1994), and Sinai and Souleles (2007) use examples of hypothetical borrowers. Weber and Chang (2006) also used hypothetical examples to show what kind of ethical concerns can arise from the use of reverse mortgages. Redfoot, Scholen and Brown (2007) studied reverse mortgages as a potential mainstream solution to the shortfall in retirement assets for seniors. …

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