How much equity is required for a reverse mortgage? Well, that depends. There are a few different factors that determine the equity requirements for a reverse mortgage to be workable.
A reverse mortgage is not a one-size-fits-all mortgage product. Proceeds are based on your age, home value, and the current interest rate environment. I’ll explain in more detail, but let’s first cover a few basics. There is lot of misinformation out there about reverse mortgages.
A few reverse mortgage basics
The reverse mortgage product 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 in America.
If you’re at least 62, the HECM enables you to convert a portion of your home’s value into cash without giving up ownership of your home or adding a mortgage payment to your budget.
No mortgage payments are required as long as at least one borrower (or non-borrowing spouse) lives in the home and pays 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 left in the home.
The HECM is a non-recourse loan; FHA will cover the shortage if your home isn’t worth enough to cover the entire balance at the time of repayment.
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.
Proceeds can be received in the form of a lump sum, line of credit, or term or tenure payments (or some combination of all).
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, the HECM offers a portion of the value of your home. How much that is depends on the age of the youngest borrower (or non-borrowing spouse), your home’s value, 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.
Next, the lender determines the correct principal limit factor (PL factor) based on the age of the youngest borrower (or non-borrowing spouse) and the current expected interest rate. The lender multiplies the principal limit factor by the maximum claim amount to determine the principal limit (PL), which is the total pool of cash available.
The proceeds first pay any existing mortgage balances, closing costs, and property taxes and insurance due. Any remaining proceeds are available for allocation to term or tenure payments, lump sum, or line of credit.
Equity requirements for a reverse mortgage vary
The equity requirements for a reverse mortgage vary depending on your age and interest rates. When rates are lower, principal limits tend to be higher. In other words, the HECM offers more when rates are lower. When rates are low, you need less equity for the HECM to work.
Principal limits 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 this, a HECM can theoretically work even if you have zero or negative equity. However, you’ll need to bring the difference between what you owe and what the HECM offers as cash to closing. For example, if you owe $75,000 but qualify for a net $50,000, you’ll need to bring $25,000 to closing.
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 (plus closing costs) to purchase the home.
Lenders determine your down payment based on the purchase price, 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 their home’s value in today’s market. Older borrowers can often qualify for as much as 60% to 65% of their home’s value.
How much can you get from a reverse mortgage?
How much equity you need depends on how much you can get from a reverse mortgage. If you’d like to estimate how much you can get from a reverse mortgage, check out our reverse mortgage calculator.
If you’re interested in HECM for purchase, check out our HECM for purchase calculator.
Or, if you prefer a simple principal limit calculator, you can find that here.