Are HECM Reverse Mortgages Overpriced?

HECM reverse mortgages are reputed to carry high upfront fees, which raises two questions addressed here. First, are seniors getting real value in exchange for the high fees? The answer in most cases is "no". Second, can a senior who knows the ropes avoid paying excessive fees? The answer in every case is "yes."

Price Differences Do Not Necessarily Reflect Over-Pricing

In the early part of the previous century, when Coney Island was a playground for both the rich and famous and those who were neither, there were two restaurants that specialized in hot dogs. One was Nathans which charged 5 cents, the other was Feldmans which charged 10 cents. My father, who is the source of this information on Coney Island history, dealt only with Nathans. But Feldman had better furnishings and the clientele were better dressed, which induced many to pay the higher price for the hot dog.

The Feldman hot dog was not over-priced, at least for many years, because the information consumers needed to make a decision between a 5 cent dog delivered in cheap surroundings and a 10 cent dog delivered in elegant surroundings was available at no cost at the moment it was needed. The market worked. Ultimately, consumers reacted against paying for the elegance of a hot dog vendor, and Feldmans failed, while Nathans survived to this day.

Price Differences on HECM Reverse Mortgages

The price differences that prevail on HECM reverse mortgages are enormous by any standard. For example, consider the borrower of 70 with a home worth $600,000 and an existing mortgage balance of $200,000 who is looking to pay off that balance in order to rid himself of the required monthly payment. If on August 14 he responded to an advertisement on TV or on the internet, in all likelihood he would be offered a fixed-rate mortgage at 5.06% with a $6,000 origination fee. This is the market price on that day estimated by NRMLA, the trade association of reverse mortgage lenders, as quoted on www.nrmlaonline.org. If instead he shopped for the same HECM among a group of competitive lenders, he would have found the same loan available at 3.99% with a zero origination fee.

HECM Price Differences Reflect Over-Pricing

Unlike the hot dog case, there is no way that the price differences cited above could reflect a difference in the value that some borrowers attach to the different HECM delivery systems. While the hot dog buyer had all the information needed to decide between the 5 cent and 10 cent dogs, the HECM borrower does not for a variety of reasons.

One-Time Versus Recurring Transactions: In contrast to the purchase of a hot dog, a HECM transaction is a big one and the borrower has no opportunity to learn from repeated exposures. Very few HECMs are refinanced.

Multiple Price Dimensions: Where a hot dog has a single price, HECMs have two prices, the interest rate and origination fee, which can complicate the decision process.

The Focus of Consumers on Draw Amounts Allows Lenders to Obfuscate the Price: The major focus of most consumers is the amount they can draw on a HECM. Much of the advertising has this focus, especially the on-line advertising which invites the consumer to fill out a form on the basis of which the consumer is told how much they can draw. If the consumer does not ask for the price used in the calculation of the draw amount, she may not see it until receiving the various documents that require her signature.

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