March 31, 2019 by HECM Pro
Now, before I fill you in on what this question is, let me cover a few basics first. If you want to be a savvy reverse mortgage shopper, it’s essential that you understand how the program really works. There is a lot of misinformation about reverse mortgages floating around out there.
If you’re already very familiar with reverse mortgages, feel free to skip ahead.
A few reverse mortgage basics
The most popular reverse mortgage in the United States today is the home equity conversion mortgage, or HECM. What I cover in this article could be applicable to other reverse mortgage products, but I’m going to focus on the HECM here.
The HECM is the official FHA-insured reverse mortgage that enables seniors to convert a large portion of their home’s value into cash without giving up ownership or taking on a mortgage payment.
No mortgage payments are required as long as at least one borrower lives in the home and pays the required property charges.
The HECM only has to be repaid when the last borrower passes away, sells the home, or permanently moves into a nursing facility.
You always remain the owner of the home and you’re free to leave it to your heirs, who will inherit any equity remaining in the home.
The HECM is a very versatile program that can be tailored to your financial goals and needs. Proceeds can be received in the form of a lump sum, line of credit, term or tenure payments, or some combination of all of these.
How proceeds are calculated
The total amount of money available through the reverse mortgage is called the principal limit, or PL. The PL is the initial portion of the value of the home the lender is allowed to lend under the FHA guidelines. It is basically the bag of money available to supplement existing income or retirement assets or pay off existing mortgages, other debts, closing costs, etc.
The PL is calculated based on home value, age of the youngest borrower (or non-borrowing spouse), and the expected interest rate (EIR).
Older borrowers tend to qualify for more than younger borrowers.
The HECM also tends to offer more when interest rates are low versus when rates are high. This is a big reason why HECMs have been particularly attractive in recent years. The combination of low rates and high home values in recent years has been a boon for seniors taking advantage of the HECM.
Most borrowers these days tend to qualify for somewhere between 45% to 55% of the value of the home, depending on age.
Now, why am I telling you all of this? Again, I think it’s important for you to be educated about how the HECM works. When you’re a savvy borrower, you’re better equipped to maximize the benefits of a reverse mortgage.
What I’ve covered so far also hints at how you can potentially get thousands or tens of thousands more from a reverse mortgage by asking one simple question.
One simple question
As I mentioned earlier, there are three main factors that determine how much you qualify for: age, home value, and prevailing interest rates.
Obviously, you have little control over your age. You’re as old as you are and not a day older or younger, right? 🙂
There’s also not much you can do about the value of your home. Sure, you can upgrade and maintain your home, but the market is ultimately going to decide the value of your home.
You also have little power over prevailing interest rates. The Fed and market forces largely drive interest rate movements.
However, you may have some power to influence the rate your lender offers you. You see, lenders don’t always offer you the lowest rate they have available. After all, they want to make a profit, right? They have a direct financial incentive to offer a higher rate whenever possible.
And again, let’s not forget how interest rate impacts the principal limit. See where I’m going with this?
So, here it is: the simplest way to potentially get thousands more from a HECM reverse mortgage is to ask the lender for a lower interest rate! Pretty easy, right?
To be sure, the lender doesn’t have to say yes. Maybe they’re unable or unwilling to reduce the rate, but it never hurts to ask. After all, they might say yes, right? And if they don’t, there are other lenders out there, right?
Let’s look at an example
To see how a lower rate impacts proceeds, let’s take a look at an example using our principal limit calculator.
Keep in mind the principal limit, or PL, is the total pool of cash available to pay off existing mortgages, cover closing costs, supplement income or retirement assets, etc. The PL is likely not going to be your walk away money. Think of it as the top line number before you pay off existing mortgages, closing costs, etc. The remaining principal limit after closing costs, mortgage balances, set asides, etc., are paid is the net available for lump sum, line of credit, or term/tenure income.
If you’d like to get an estimate of your walk away money or calculate potential lump sum, line of credit, or term or tenure income, use our traditional HECM calculator.
For our example, let’s assume our borrower is 70, owns a $300,000 house, and the current expected interest rate (EIR) is 5.25%. Based on these inputs, we get a principal limit of $135,600, or 45.2% of the home’s value.
Now, let’s assume this borrower is able to negotiate the EIR down to 4.25%. If we run that through the calculator, the resulting PL is $152,100, or 50.7% of the home’s value. Wow, that’s a difference of over $16,000!
As you can see, interest rate can have a big impact on the proceeds of a HECM reverse mortgage.
An important caveat
If you opt for the variable-rate HECM to get a line of credit (line of credit is not available on the fixed-rate HECM), keep in mind that chopping the interest rate will also reduce your growth rate on the line of credit. If you’re borrowing most of the proceeds at the start of the loan and don’t have a large line of credit to begin with, this probably isn’t a big deal.
However, if you intend to use very little of the proceeds over the next few years with the goal of maximizing line of credit growth, chopping the rate too aggressively may be counterproductive.Yes, you may get a bigger line of credit to start, but you’ll potentially lose out on growth in the future. I recommend having your lender run some scenarios with different expected interest rates to find the “sweet spot” that maximizes both the starting line of credit and future growth.