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Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: Pixelshot on March 13, 2015, 08:46:00 AM

Title: Traditional vs HECM Loan - How exactly is a traditional home mortgage calculated?
Post by: Pixelshot on March 13, 2015, 08:46:00 AM
I have been trying to calculate the exact difference in cost between my mother's current traditional home loan (30 year fixed) and a reverse HECM mortgage which she qualifies for and is interested in. My initial investigation suggested that the HECM was a bad idea (see this thread: http://forum.mrmoneymustache.com/ask-a-mustachian/reverse-mortgage-refinance-bad-idea/?topicseen ) but after further study, it seems that it actually would be a good idea for her as long as she continues to pay the same amount of her current payment (or more). Even when factoring in closing costs (much of which are being waived by the lender) and mandatory mortgage insurance costs (calculated at 1.25% of principle balance).

My question comes in the comparison between the HECM and her traditional mortgage. As I have been told by the HECM lender, a traditional loan front-loads the interest payments in a way that means the first several years you pay more to interest. And, the HECM means more of that money goes to the principle. Here is the lender's explanation (referring to the HECM):

"Her payment is based off a 185K loan amount and a 2.9% [adjustable] rate is $447per month in just interest. There is also MI monthly that is roughly $192 (this will decrease if she pays towards principle) total payment is 639 + taxes and Insurance. Anything above this amount goes to the principle and then turns into a credit line availability
 
Since itís a monthly adjustable the balance will recalculate every month and she will be applying more to the principle if she maintains paying a 1200 per month payment"

That all makes sense to me. What doesn't make sense is WHY the two loans are different? Is it because the traditional mortgage calculates the interest payments a different way? Is it because the traditional assumes you'll pay the minimums for an entire 30 years (thus making the amount paid to principle much less because it takes so much longer to pay down the loan)?

in other words, WHY are the two loans different in the way they calculate payments?

thanks.


Title: Re: Traditional vs HECM Loan - How exactly is a traditional home mortgage calculated?
Post by: MDM on March 13, 2015, 10:28:36 AM
Even when factoring in closing costs (much of which are being waived by the lender) and mandatory mortgage insurance costs (calculated at 1.25% of principle balance).

"Her payment is based off a 185K loan amount and a 2.9% [adjustable] rate is $447per month in just interest. There is also MI monthly that is roughly $192 (this will decrease if she pays towards principle) total payment is 639 + taxes and Insurance. Anything above this amount goes to the principle and then turns into a credit line availability
 
Since itís a monthly adjustable the balance will recalculate every month and she will be applying more to the principle if she maintains paying a 1200 per month payment"

That all makes sense to me. What doesn't make sense is WHY the two loans are different? Is it because the traditional mortgage calculates the interest payments a different way? Is it because the traditional assumes you'll pay the minimums for an entire 30 years (thus making the amount paid to principle much less because it takes so much longer to pay down the loan)?

in other words, WHY are the two loans different in the way they calculate payments?
A traditional mortgage payment is calculated so that paying that amount per month will exactly repay the loan in the specified time.  See http://en.wikipedia.org/wiki/Amortization_calculator for a derivation.

It appears from your OP that this HECM payment is "up to your mother, provided she pays at least $639/mo."  Is that correct?

The $447 mentioned in the OP is 2.9% * $185,000 / 12.  Similarly, the $192 is 1.25% * $185,000 / 12.  Added together, she is paying 4.15%.  How does that compare to her current mortgage?

$1200/mo will pay a $185K, 4.15% mortgage in ~18.4 years.  Pay more per month and it is paid faster.  Pay less per month and it takes longer.
Title: Re: Traditional vs HECM Loan - How exactly is a traditional home mortgage calculated?
Post by: Pixelshot on March 13, 2015, 06:43:35 PM
@MDM - that's right. It's our understanding that she can pay as much or as little as she wants. The drawback, of course, is that if she pays nothing then the bank will eventually own all the equity of the house, to be surrendered when she no longer lives there. The payments, though, are pretty low compared to what they are for her current mortgage, so the upside is that each payment for the HECM would pay more to principle. She pays 1200 now on a 30 year fixed, and the HECM will have a break-even of $639/month for an adjustable @ 2.9% (just interest and mortgage insurance). So, that means that if she maintains a 1200/month payment, roughly 600 of that goes to principle every month, right off the bat. The math suggests that it's worth it.

I think what you're saying is that the system for calculating payments is exactly the same between HECM and traditional. It's just that the traditional actually splits up the costs (e.g. "minimum" payments) in a way that spreads the loan out over 30 years.  I still don't understand why the $1200/month payments wouldn't pay down the two types of loans at the exact same rate if both of the APRs were the same. Yet, I'm told that it would be much faster with the HECM.

Confused.

Thanks.


Title: Re: Traditional vs HECM Loan - How exactly is a traditional home mortgage calculated?
Post by: MDM on March 13, 2015, 07:22:37 PM
I still don't understand why the $1200/month payments wouldn't pay down the two types of loans at the exact same rate if both of the APRs were the same.
They would if everything about the loans is identical.

Quote
Yet, I'm told that it would be much faster with the HECM.
So something is not identical, or you are being told incorrectly.

Can you give all the details - Principal, Interest Rate (regular and PMI), Length - for each option?