FHA has increased the HECM lending limit to $765,600 for HECMs with case numbers assigned on or after January 1, 2020. This is the fourth annual increase in a row and reflects the continuing trend of rising home values across the nation.
The new lending limit applies to the entire U.S., including Alaska, Hawaii, Guam, and the U.S. Virgin Islands.
Note that our HECM calculators have already been updated to reflect the change.
This latest lending limit increase means homeowners in high-cost real estate markets will have access to significantly more proceeds. However, the change also means higher closing costs for many homeowners as well.
Before I explain how the lending limit change impacts proceeds and costs, let’s first cover some basics about how a HECM reverse mortgage works.
How does a HECM reverse mortgage work?
The most popular reverse mortgage in America today is the home equity conversion mortgage, or HECM. The HECM is a federally-insured reverse mortgage that enables homeowners 62 or older to convert a portion of their home’s value into cash.
No mortgage payments are required as long as at least one borrower or non-borrowing spouse is living in the home and paying the required property charges.
You always remain the owner of your home and you’re free to leave it to your heirs. Your heirs will inherit any equity remaining in the home.
The HECM reverse mortgage is a non-recourse loan. That means the most that will ever be repaid is the value of the home. If the value of the home is not worth enough to pay off the entire loan balance, FHA will pay off the shortage out of its Mutual Mortgage Insurance (MMI) fund. You’ll never leave a debt for your heirs to pay off.
HECM proceeds can be received in the form of term or tenure payments, lump sum at closing, line of credit, or some combination of all three options.
Reverse mortgage borrowers commonly use the proceeds to get rid of existing mortgage payments, pay off other debts, finance home improvements, or supplement existing retirement income or assets. You can use the cash for pretty much whatever you need.
How the lending limit works
The FHA lending limit is basically a cap on the home value for purposes of calculating proceeds. It is not a cap on how much you can borrow (or the lender can lend) from the HECM over time. For example, if your loan balance rises to the lending limit, FHA and/or the lender are not going to call your loan due, require you to make payments, or take away any money still available in the reverse mortgage. Again, the lending limit is used solely to calculate proceeds. To see how this works, let’s first cover a few basic concepts and terms.
The total pool of money available from a HECM reverse mortgage is called the principal limit (PL). To calculate the principal limit, we need to first establish two values, the maximum claim amount (MCA) and the principal limit factor (PLF).
The MCA equals the lesser of the home value or the FHA lending limit. For most seniors, the MCA will equal the home value because most seniors own homes valued less than the lending limit. If your home is worth more than the lending limit, the MCA will equal the lending limit.
For example, if your home is worth $250,000, which is less than the lending limit, the MCA will equal $250,000. If your home is worth $900,000, which is more than the lending limit, the MCA will equal the new HECM lending limit of $765,600. Again, the lending limit effectively caps the home value for purposes of calculating the principal limit.
Once the maximum claim amount has been established, we need to determine the appropriate principal limit factor. The PLF comes from a table of PLF values published by FHA. The lender determines the correct PLF based on the age of the youngest borrower (or non-borrowing spouse) and the expected interest rate, or EIR. The EIR is an interest-rate value calculated by the lender that is used only to determine the correct PLF.
Once the MCA and PLF are established, they’re simply multiplied together to get the principal limit (the total proceeds available from the reverse mortgage). For example, let’s assume the home value is $200,000 and the PLF is 0.50 based on age and EIR. Because the home is valued less than the lending limit, the MCA equals the home value. The principal limit is then calculated as follows:
$200,000 (MCA) * 0.50 (PLF) = $100,000 (PL)
As you can see, the PLF is essentially a loan-to-value determined based on age and EIR. In this example, the PLF is 0.50, which equals 50% of the home value.
To see how the lending limit applies, let’s assume an appraised value of $1,000,000 and the same PLF of 0.50. Because the home value is higher than the lending limit, the MCA equals the lending limit of $765,600. The principal limit is then calculated as follows:
$765,600 (MCA) * 0.50 (PLF) = $382,800 (PL)
Because the home value is higher than the lending limit, the principal limit equals 50% of the lending limit, not the home value.
The term “lending limit” is a misnomer in my opinion because it implies there’s a cap on how much can be borrowed from the reverse mortgage. Again, the lender isn’t going to require mortgage payments, call your loan due, freeze your line of credit, stop term/tenure payments, etc., once your loan balances reaches the lending limit. The lending limit is simply a cap on the home value for purposes of calculating proceeds.
Increased proceeds and costs for some homeowners
The latest lending limit increase has no impact on seniors with homes valued less than last year’s lending limit of $726,525. However, if your home is worth more than last year’s lending limit, the change increases available proceeds by around $15,000 to $20,000, depending on age and interest rates.
However, the increased proceeds aren’t without cost. IMIP, or initial mortgage insurance premium, is calculated based on the maximum claim amount. IMIP (along with MIP) is what makes the HECM a non-recourse loan. IMIP premiums are paid into the FHA Mutual Mortgage Insurance (MMI) fund and used to settle shortages when homes aren’t worth enough to pay off HECM balances.
The current IMIP rate is 2%, which means the premium paid at closing equals 2% of the maximum claim amount. For example, if your home’s value is $300,000, the IMIP would be calculated as follows:
$300,000 (MCA) * 2% = $6,000 IMIP
Note that the IMIP premium is not paid out of pocket if you’re doing a reverse mortgage on a home you already own. It can be rolled into the new loan balance. However, if you’re purchasing with a HECM, the IMIP is paid out of pocket along with your down payment and other closing costs.
Under the old HECM lending limit, the maximum IMIP premium was $14,530.50. Under the new lending limit, the maximum IMIP is now $15,312 – an increase of $781.50.