Annuity

Key Takeaways

• An annuity is a stream of payments of equal size made at fixed, regular intervals, such as the same principal-and-interest payment on the same day of every month.
• Lenders and secondary-market investors price a closed loan as an annuity, because the predictable payment stream is what gets pooled into mortgage-backed securities and sold.
• A reverse annuity mortgage runs the payments the other direction: the lender pays the homeowner, and nothing is repaid until the borrower dies, transfers the home, or stops living there.
• Washington sets a minimum borrower age of 60 for a reverse mortgage loan as of the date the loan is signed (RCW 31.04.515).

What It Means

An annuity is a series of payments of equal size made at fixed, regular intervals. The word comes from finance rather than land law, but it describes the shape of nearly every loan a Washington broker will ever touch. A 30-year fixed-rate loan is an annuity: the borrower owes the same principal-and-interest amount on the same day of every month for 360 months. Amortization describes how each of those equal payments gets split between interest and principal. The annuity is the payment stream itself.

This matters to brokers because once a loan closes, the payment stream, not the house, is what gets bought and sold. Lenders sell closed loans into the Secondary Mortgage Market, where the loans are pooled into mortgage-backed securities. Investors are paying for cash flow they can count on, so steady equal payments are worth more to them than a payment schedule that wanders. That is also why the rate environment moves so much of the market, as our guide to interest rates and Washington home sales explains. A Reverse Mortgage, often called a reverse annuity mortgage, uses the same pattern backward: the lender sends the homeowner a monthly payment instead of collecting one.

How It Works in Washington

Washington brokers meet annuities in three places. The first is ordinary loan repayment, where the borrower's level monthly payment is the annuity the lender bought. The second is seller financing on a real estate contract, which RCW 61.30.010 defines as a written agreement for the sale of real property in which the seller keeps legal title as security for the purchase price. The seller collects an installment stream, and if the buyer stops paying, the seller's remedy is forfeiture under chapter 61.30 RCW. See our overview of the loan types brokers should know for how an Installment Contract sits next to conventional financing.

The third is the reverse annuity mortgage, and this is where Washington law diverges. RCW 31.04.505 defines a reverse mortgage loan as a nonrecourse obligation that comes due only when the consumer dies, transfers the dwelling, or stops occupying it. RCW 31.04.515 adds two state requirements: the borrower must be at least 60 years old on the date the loan is signed, and the lender may not accept a final application or charge fees until it has a certification that the applicant received counseling.

Example

Marla Vance sells her Spokane duplex to Ben Ortiz for $420,000 on a real estate contract rather than through a bank. Ben puts $60,000 down and signs a contract for the remaining $360,000 at a fixed 6 percent over 20 years. His payment is $2,579 a month, every month, for 240 months. That identical $2,579 arriving on the first of each month is Marla's annuity, and over the full term it pays her $618,960.

The equal payments are what make the stream easy to value. If Marla later wants cash instead of income, a note buyer can price the remaining payments the same way a secondary-market investor prices a pooled mortgage. If Ben stops paying, Marla keeps legal title as security and her remedy is forfeiture under chapter 61.30 RCW, which cancels Ben's rights under the contract.

Common Mistakes and Exam Traps

• An annuity is defined by the pattern of the payments, equal amounts at fixed intervals, not by who receives them. A borrower's mortgage payment and a reverse mortgage borrower's monthly draw both fit the pattern.
• Annuity and amortization are not the same idea. Amortization is the split of each payment between interest and principal; the annuity is the series of equal payments.
• Washington's minimum age for a reverse mortgage borrower is 60 under RCW 31.04.515, while the course materials cite 62 for federally insured reverse mortgages. Read the question to see whether it asks for the state rule or the federal program rule.
• A graduated payment mortgage is not a level annuity while its payments are still stepping up, because the payments are not equal until the schedule reaches its final level.