As to be expected, personal finance is not everyone’s strength; and that’s okay! Investigating financial products can be overwhelming, especially without the assistance of a trusted advisor. Although the reverse mortgage program was enacted in 1989, it is still a very new concept to many. Also, since this loan program is specifically for seniors, it’s not relevant for a large segment of the population. This is why we feel it is important to shed light on specific terminology that can cause confusion when researching the reverse mortgage program. We advise keeping this information nearby when reviewing a reverse mortgage quote or speaking with a lender. Let’s take a moment to review some of these terms used on reverse mortgage proposals.
Home Equity Conversion Mortgage– This is the formal name of the federally-insured reverse mortgage program. It is often abbreviated as HECM. When you see the term “HECM” or “home equity conversion mortgage”, know that it is in reference to the reverse mortgage program.
Maximum Claim Amount - The maximum amount the Federal Housing Administration (FHA) will insure on a reverse mortgage, capping out at $765,600. Maximum claim amount is one component used to determine the proceeds a borrower will be eligible for. In other words, it is the appraised value of the home, unless the valuation surpasses the $765,600 cap. Here are two examples:
1) If your home appraises for $385,000 – your maximum claim amount would be $385,000. 2) If your home appraises for $900,000 –your maximum claim amount would be $765,600.
As you can see, any value over the established cap creates no added benefit to the consumer.
Principal Limit - The amount of proceeds a borrower qualifies for. This is strictly based off of: the age of the youngest borrower/non-borrowing spouse*, maximum claim amount and current expected interest rate*. (Non-borrowing spouse and expected interest rate are defined later in this article) This number is very important! It is the amount of proceeds you’ll be eligible before any financing fees or mandatory obligation pay-offs are deducted.
Examples of common financing fees include: origination charges, third party expenses, mortgage insurance, etc. Examples of mandatory obligations include: pre-existing mortgages owed on the home, tax liens, etc. When shopping lenders, you’ll notice lower interest rates result in higher principal limits. Just like any other financial transaction, consumers that shop a few companies tend to get the most competitive offers.
Non-borrowing Spouse - This phrase is usually used to describe a person, under the qualifying age of 62, that is impacted by this loan. Although there are several varieties of non-borrowers, we are going to take a look at the most common situation. This particular situation arises when we have a married couple; one person is at least 62 years of age, while the other is not. GOOD NEWS: having one person under the age of 62 does not immediately disqualify you from being a potential candidate for the HECM program. Although non-borrowing spouses have many protections, there are two items to consider when investigating a reverse mortgage.
1) Non-borrowing spouses cannot access loan proceeds. The borrower that is at least 62 years of age is the only person that can tap into the loan.
2) Because the age of the youngest borrower impacts loan proceeds available, you will notice principal limits are lower when non-borrowing spouses are involved.
When in doubt, talk it over with a licensed loan officer. They can assess your situation and see if proceeding as a non-borrowing spouse is of tangible benefit.
Lien payoffs - Lien payoffs are considered monetary obligations that are owed against the property. This typically includes: existing mortgages, home equity line of credits, tax liens, or judgements. These items are usually paid-off when your reverse mortgage loan funds. If you have any liens against the title of the property, you can pay them with the reverse mortgage proceeds you are eligible to receive.
Interest Rate - Just like any other loan, reverse mortgage programs also have a rate of interest charged by the bank. Interest will accumulate on the funds you access. The beauty of this program is that repayment options are much more flexible than traditional home equity loans. Depending on the program you choose; interest rates can be adjustable or fixed. It is important to ask your loan officer which option best accomplishes your individual goals.
Expected Interest Rate - This factor is important when determining the loan proceeds a potential borrower may be eligible for. Simply put, this is the bank’s best guess as to what the interest rate will be over the life of your loan. It is primarily discussed when interested in reviewing an adjustable interest rate product.
Origination Fee - A Fee charged by lender to complete the loan process. Although some transaction costs are non-negotiable, the origination fee is usually one that can be negotiated.
Financed Closing Costs - The total of the initial mortgage insurance premium (defined below), origination fee and third-party costs. These costs are rolled into the loan’s balance. Typically, the only out of pocket costs with reverse mortgage loans are the HUD counseling session and appraisal. The appraisal expense often times varies from lender to lender. Some will require out-of-pocket deposits; others may finance the expense into the loan closing costs. Either way, this is an expense that ultimately is paid by the consumer. If you still have any lingering questions or uncertainties about this program after speaking to a loan officer, do not hesitate to consult a HUD approved counseling resource. It is common practice for lenders to provide contact information for counseling agencies within proposals. Although each counseling provider operates differently, the standard fee associated with the counseling session is roughly $125. Completing the required counseling session constitutes one of the first steps involved with proceeding. Most lenders will ask for you to do this before signing a loan application.
Net Principal Limit - This is the exciting number to look for! When the dust settles, this is the amount of proceeds that remain once the mandatory obligations are paid. Here is the simple formula: (Principal Limit – Outstanding Liens – Financed Closing Costs = Net Principal Limit). Let’s review an example – My reverse mortgage loan has a principal limit of $285,000. At this time, my lender is telling me the closing costs will sum about $9,000. I also want to pay off the current mortgage of about $96,000 I still owe. Following our formula above, my net principal limit should be $180,000; ($285,000-$96,000-$9,000=$180,000). I can then work with my loan officer to decide how I’d like to approach accessing the $180,000.
Initial Loan Balance-This one is pretty straightforward. Once your reverse mortgage loan funds, this is your new mortgage balance owed on the property. Here’s the formula: (Financed Closing Costs + Liens Being Paid Off + Cash Received at Closing). Let’s review an example- I am using a reverse mortgage to pay off my current home loan and access a
bit of cash to do home improvements. My previous mortgage balance was $100,000. My reverse mortgage lender will be charging me $9,200 in financing fees. I want to access $15,000 at closing for my bathroom improvements. Knowing this, what will my initial reverse mortgage loan balance be? $124,200 would be the correct answer: ($9,200+$100,000+$15,000=$124,200). It is now up to the borrower if they’d like to make periodic payments toward this loan or not. As we know, the only mandatory payment obligations are keeping current with property taxes, homeowner’s insurance, HOA dues (when applicable) and standard upkeep of the home.
IMIP (Initial Mortgage Insurance Premium)– The upfront amount the FHA charges to insure the loan. It is 2% of the home’s value on new HECM loans. This fee is financed into the loan balance at closing. This is one of those fees that are non-negotiable. Although substantial at times, it is going toward a good cause. First and foremost, this ensures you’ll have access to your funds if your loan servicer goes out of business. It also protects your heirs. Given this is a non-recourse loan, they’d never be liable for a debt larger than the value of your home. Lastly, it protects lenders from borrowers that default on loans. Ongoing Mortgage Insurance Premium- a 0.5% mortgage insurance premium that is tacked onto the loan’s balance. When reviewing a reverse mortgage proposal, make sure to review the amortization schedule. This table will show you how your loan will change over time, primarily if you plan on not making periodic payments toward your loan’s balance. On this table, you can see how much that ongoing mortgage insurance will cost, and how it is rolled into the ongoing loan balance.
Initial Interest Rate– This is applicable to those who may be looking into an adjustable rate reverse mortgage program. Here’s the simple formula on how to calculate an initial interest rate: (Lender’s Margin + L.I.B.O.R. Index Rate). The L.I.B.O.R. (London Interbank Offer Rate) is the interest rate banks charge to lend money to one another. As you can imagine, there is not much a lender or consumer can do to alter the index. However, the margin is a different story. Lending institutions can control the margins they charge. The higher the margin, the more money they’ll make on interest. When comparing a few offers, always make sure to compare lender margins. They play a pivotal role in the interest rate your loan will have.
Line of Credit Growth Factor - This figure is important for several reasons. It applies to the adjustable rate reverse mortgage loan option.
1) It is the percentage rate the line of credit fund grows by. As time progresses, your capacity to borrow more also increases. This is an incredible feature for retirees concerned about having enough saved for future expenses.
2) It also indicates the total rate of interest being charged on your reverse mortgage loan balance.
Many borrowers forget about the ongoing mortgage insurance of 0.5%. Although it doesn’t
seem like much, it can add up over the years. Here is the simple formula to calculate the line of credit growth factor: (Initial Interest Rate + Ongoing Mortgage Insurance Premium). Let’s review an example- I have decided the reverse mortgage line of credit program was the right choice for me. I currently have $85,000 available in my line of credit. The initial interest rate associated is 4.15%. What should I expect my line of credit growth factor to be? In this hypothetical, I should expect my reverse mortgage line of credit growth factor to be 4.65%. I come to this conclusion by adding my initial interest rate (4.15%) to the ongoing MIP (0.5%). From this example, it is made clear that my line of credit fund of $85,000 will grow by 4.65%. This also means that whenever I draw from my line of credit, I will be charged the same 4.65% on funds I draw.
We truly hope this information will help you feel more confident in the decision you are making. It is highly recommended you take the time to learn the facts, and educate yourself on this program before coming to a formal conclusion.
If you are open to learning more, or would like to be connected to a reputable lending institution, please click here. We’d be happy to continue the conversation and see if this might be a suitable option.