Learn how the HECM can help you live better in retirement. Click here for FREE REPORT.

Reverse Mortgage Glossary

Mandatory Obligations

What are reverse mortgage mandatory obligations?Mandatory obligations are items that have to be paid at closing as a condition of completing a HECM reverse mortgage. The most common mandatory obligations include existing mortgage balances, closing costs, and property charges due at closing.

Because mandatory obligations are paid out of the principal limit (the total pool of money available), they impact the amount of disposable cash available to the borrower. For example, if the mandatory obligations equal the principal limit, then no extra cash is available to the borrower. All of the proceeds are allocated to mandatory obligations, so no additional cash is available to the borrower at closing.

On the other hand, let’s assume the mandatory obligations are just half the principal limit. This means that fully 50% of the principal limit is potentially still available to the borrower. Such proceeds could be taken as term or tenure payments, line of credit, or lump sum, depending on the HECM program selected.

What is Included in Mandatory Obligations?

According to FHA Mortgagee Letter 2014-21, the following items must be paid as mandatory obligations at closing:

  • Initial mortgage insurance premium (IMIP)
  • Origination fee
  • Counseling fee
  • Recording fees and recording taxes
  • Credit report fee
  • Survey charges (if applicable)
  • Title examination and insurance fees
  • Appraisal fees
  • Repair administration fee
  • Delinquent federal debts required to be paid at closing
  • Mortgage or lien payoffs
  • Customary fees and charges for warranties, inspections, surveys, engineer certifications
  • Funds to pay contractors who performed repairs as a condition of closing in accordance with standard FHA requirements for repairs required by appraiser
  • Repair set aside
  • Required property tax, flood and hazard insurance payments
  • Fees and charges for real estate purchase contracts

Not all of these will apply to every reverse mortgage loan scenario. The typical mandatory obligations for most borrowers are mortgage payoffs, closing costs, and property charges due at closing.

Mandatory Obligations and the Fixed-Rate HECM

The fixed-rate HECM has a somewhat awkward relationship with mandatory obligations. If mandatory obligations are low, the fixed-rate HECM will usually offer far less money than the variable-rate HECM. If they’re really high (using all or nearly all of the principal limit), then the money available will usually be about the same for both HECM programs.

The bottom line is this: if you’re after the most money you can get, the fixed-rate HECM will probably only make sense if your mandatory obligations are really, really high. If they’re not, it’s a good bet the variable-rate HECM will offer you more money.

Less Than 60% of the Principal Limit

If your mandatory obligations are less than 60% of the principal limit, the fixed-rate HECM will give the difference up to 60% of the principal limit as a lump sum at closing. Remember, the fixed-rate HECM only offers the option to take all proceeds as a lump sum at closing. No more money is available in the future (unlike the variable-rate HECM, as I’ll explain in a minute).

As an example, let’s assume the principal limit is $100,000 and the mandatory obligations are $40,000. After the mandatory obligations are paid, you would receive an additional $20,000 lump sum at closing. This adds up to a starting loan balance of $60,000 (60% of the principal limit).

Greater Than 60% of the Principal Limit

If your mandatory obligations are more than 60% of the principal limit, the fixed-rate HECM will give you up to an additional 10% of the principal limit. If there’s not enough money available to give the full 10%, you’ll get whatever is available up to the principal limit. Let’s look at two examples to see how this works.

For the first example, let’s assume the principal limit is $100,000 and your total mandatory obligations are $70,000 (70% of the principal limit). Because you’re already over the 60% threshold, you’ll receive an additional $10,000 (10% of the principal limit) at closing. No more money will be available in the future.

For the second example, let’s assume the same $100,000 principal limit, but the mandatory obligations are instead $95,000 (95% of the principal limit). Because you’re over the 60% threshold, you should (theoretically) receive an additional 10% at closing, right? But because there’s not enough available to give the full 10%, you’ll receive whatever is available up to the principal limit. In this case, it’s just 5% of the principal limit, or $5,000.

Mandatory Obligations and the Variable-Rate HECM

Unlike the fixed-rate HECM, the variable-rate HECM will always give you full access to 100% of the principal limit. The only “catch” is that you won’t necessarily get access to all of it right away. Up to 40% of the principal limit could be unavailable for the first 12 months of the reverse mortgage. Once the 12-month mark has passed, all unused proceeds are available with no limitation.

Less Than 60% of the Principal Limit

If your mandatory obligations are less than 60% of the principal limit, you can take the difference up to 60% of the principal limit at any time within the first 12 months. The remaining 40% of the principal limit will come available at the one-year mark as a line of credit.

For example, if the principal limit is $100,000 and the mandatory obligations are $40,000 (40% of the principal limit), you can take up to another $20,000 in the first 12 months at your discretion. Once you reach the 1-year mark, the remaining 40% of the principal limit, more or less (see growth rate), will come available automatically as a line of credit.

Greater than 60% of the Principal Limit

If your mandatory obligations are more than 60% of the principal limit, an additional 10% will be available to take at any time in the first 12 months. At the end of 12 months, the remaining portion of the principal limit will automatically come available as a line of credit.

For example, let’s assume the principal limit is $100,000 and your total mandatory obligations are $70,000 (70% of the principal limit). Because you’re already over the 60% threshold, you’ll have an additional $10,000 (10% of the principal limit) to take at any time in the first 12 months of the loan. Once the 1-year mark has been reached, the remainder of the principal limit (roughly $30,000, depending on line of credit growth) will come available automatically.

How IMIP is Impacted

The initial mortgage insurance premium (IMIP) is a one-time fee paid at closing to FHA to insure the HECM reverse mortgage. This is what makes the HECM reverse mortgage a non-recourse loan. If the home isn’t worth enough to settle the entire balance at the time of repayment, FHA has to pick up the shortage.

FHA charges 0.50% of the maximum claim amount (which equals the appraised value for most people) if the mandatory obligations are less than 60% of the principal limit. If they’re over the 60% threshold, the IMIP jumps to a stiff 2.50% of the maximum claim amount.

As an example, let’s assume the appraised value (and the maximum claim amount) is $100,000. If the mandatory obligations are $40,000 (less than the 60% threshold), the IMIP rate is just 0.50%, which equals $500. However, if the mandatory obligations jump to $95,000 (well over the 60% threshold), the IMIP rate is 2.50%, which equals $2,500.

FHA charges a higher IMIP rate when you’re over the 60% threshold because there’s more risk the loan will be upside down in the future. This means FHA would be at greater risk of having to settle up part of the loan balance.

Is your retirement as good as it could be?

Learn how the HECM can help you live better in retirement. Download your FREE report here.