January 12, 2019 by HECM Pro
There are a few different factors that determine how much equity is needed for a reverse mortgage to be workable.
Before I explain what those factors are, let me first cover a few basics so they make more sense.
A Few Reverse Mortgage Basics
The reverse mortgage I’m referring to here is the home equity conversion mortgage, or HECM (often pronounced heck-um by industry professionals).
The FHA-insured HECM is the most common reverse mortgage program in the United States today. If anybody you know recently got a reverse mortgage, it’s a good bet it was a HECM.
The HECM is a unique home loan designed to give seniors 62 and over the ability to convert a portion of their home’s value into cash without giving up ownership of the home or taking on a mortgage payment. As long as at least one borrower is living in the home and paying the required property charges, no mortgage payments are required.
Reverse mortgage borrowers always retain title ownership of the home and are free to leave it to their heirs. Their heirs will inherit any equity left in the home.
If the home isn’t worth enough to settle the entire balance at the time of repayment, FHA will cover the shortage. The HECM is a non-recourse loan, which means the most that will ever have to be repaid is the value of the home.
Reverse mortgage borrowers commonly use the proceeds from a HECM to get rid of existing mortgage or other debt payments, finance home improvements, or supplement existing retirement income or assets.
If you’d like some more in-depth information about how a reverse mortgage works, check out my article here.
How Much Equity is Required for a Reverse Mortgage?
Remember that the HECM offers just a portion of the value of the home. How much that portion is depends primarily on the age of the youngest borrower (or non-borrowing spouse) and current interest rates.
To determine how much you qualify for, the lender first establishes the maximum claim amount, which is equal to the lesser of the appraised value or the FHA loan limit.
A principal limit factor (PL factor) is then determined based on the age of the youngest borrower and the current expected interest rate. The PL factor is multiplied by the maximum claim amount to determine the principal limit (PL), which is the total pool of cash available. The principal limit is first allocated to pay existing mortgages balances, closing costs, and property taxes and insurance due. The remaining portion of the PL is then made available to the borrower in the form of term or tenure payments, lump sum, or line of credit.
When rates are lower, the PLs are higher. In other words, the HECM offers more money when rates are lower, which means you need less equity for the HECM to work.
PLs are also higher for older borrowers than for younger borrowers. Older borrowers qualify for more, which means they need less equity than younger borrowers for the HECM to be workable.
Having said all this, you theoretically can make a HECM work even if you have zero or negative equity. You’ll just need to bring the difference between what you owe and what the HECM offers in the form of cash to the closing table. For example, if you owe $75,000 on the house, but you can only get $50,000 from the HECM, you’ll need to bring $25,000 to the closing table to pay down your existing mortgage.
That’s essentially how a HECM for purchase works. The HECM finances a certain dollar amount and you bring in the rest as your down payment to purchase the home. Again, the down payment amount is impacted by your age and current rates. If rates are lower, your down payment will be smaller. If you’re on the older end of the age curve, your down payment will be less than somebody who is younger.
Most HECM borrowers qualify for somewhere between 40% to 50% of the home’s value in today’s market, based on age and interest rates. Borrowers in their late 80s or older can often qualify for as much as 60% to 65% of their home’s value.
I recommend checking out our HECM calculator for a more exact estimate of how much you can get.