The Top 17 HECM Mandatory Obligations & How They Impact Your Proceeds

Mandatory obligations are expenses that must be paid at closing to complete a HECM reverse mortgage. We’ll explain the most common mandatory obligations and how they can impact the HECM product you select and the cash you receive at closing.

The Most Common HECM Mandatory Obligations

Mandatory obligations are expenses that must be paid at closing to complete a HECM reverse mortgage.

According to FHA Mortgagee Letter 2014-21, there are quite a few possible mandatory obligations, but the most common ones are existing mortgage balances, closing costs, and property charges due at closing.

Here is the full list for your reference:

• 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
• Life expectancy set-aside (LESA)

Obviously, not every item on this list will apply to every reverse mortgage transaction. Many of these items rarely come up, in my experience.

How Mandatory Obligations Impact Proceeds

Mandatory obligations are important because they impact how much cash is available at closing and what HECM product you’ll likely go with.

If your mandatory obligations are low, the variable-rate HECM will likely make more sense. If they’re high, the fixed-rate HECM may be an option. The reason for this is what I call the 60% rule.

FHA implemented the 60% rule in 2014 to discourage borrowers from using up the proceeds too quickly.

The rule change also targeted lenders who encouraged borrowers to take all the proceeds at closing even if they didn’t need the money right away. Lenders often encouraged full draws because it resulted in a higher starting loan balance that accrued more interest.

The 60% rule works like this: if your mandatory obligations are less than 60% of the principal limit, you can take up to the difference between the mandatory obligations and 60% of the principal limit at closing and/or during the first twelve months of the loan.

If the mandatory obligations are more than 60% of the principal limit, you can take up to 10% of the principal limit or the difference between the mandatory obligations and the principal limit, whichever is less.

Any remaining portion of the principal limit will be unlocked at the one-year anniversary of the loan, depending on whether you go with the variable-rate HECM or the fixed-rate HECM.

Yes, this is a bit complicated, but we’ll break it down with some examples in a moment.

Now, this is where a quirk in the HECM comes into play. The fixed-rate HECM offers only a lump sum payout at closing. The fixed-rate HECM does not offer any payouts after closing. Any principal limit not borrowed at closing from a fixed-rate HECM is essentially forfeited.

The variable-rate HECM typically offers more money than the fixed-rate HECM because payouts are allowed after closing (assuming the entire principal limit hasn’t already been borrowed). Any principal limit not available at closing via the variable-rate HECM will come available after one year.

To see the 60% rule in action, let’s check out a few examples.

Example #1: Mandatory obligations are less than 60%

For our first example, let’s assume the principal limit is $150,000 and the mandatory obligations are $50,000. To calculate the maximum allowed withdrawal at closing, we need to first calculate 60% of the principal limit:

$150,000 (principal limit) * 60% = $90,000

As you can see, 60% of the $150,000 principal limit equals $90,000. Because the mandatory obligations are less than 60% of the principal limit, this borrower can draw up to 60% of the principal limit at closing:

$90,000 (60% of principal limit) - $50,000 (mandatory obligations) = $40,000 (max withdrawal at closing)

As you can see, this borrower has up to $40,000 available at closing. If this borrower selects the variable-rate HECM, the $40,000 can be taken as any combination of a lump sum, line of credit, or term/tenure income. The remaining 40% of the principal limit, which equals $60,000, will come available automatically a year after closing.

If this borrower chooses the fixed-rate HECM, the entire $40,000 must be taken as a lump sum at closing. No additional money will be available in one year.

Example #2: Mandatory obligations are greater than 60%

If the mandatory obligations equal 60% to 90% of the principal limit, the maximum allowed withdrawal at closing equals 10% of the principal limit.

To see how this works, let’s check out an example. Let’s assume the principal limit again equals $150,000, but the mandatory obligations are $100,000. As before, we first calculate 60% of the principal limit:

$150,000 (principal limit) * 60% = $90,000 (60% of principal limit)

The mandatory obligations of $100,000 are more than the 60% threshold of $90,000, so the maximum allowed withdrawal at closing equals 10% of the principal limit:

$150,000 (principal limit) * 10% = $15,000 (max withdrawal at closing) 

If this borrower selects the variable-rate HECM, the $15,000 can be allocated to any combination of lump sum, line of credit, or term/tenure income. The remaining portion of the principal limit will come available in a year.

If this borrower selects the fixed-rate HECM, the entire $15,000 must be taken at closing as a lump sum. No additional money will be available in a year.

Example #3: Both HECM products offer the same amount of money

If the mandatory obligations are more than 90% of the principal limit, the total money available from both HECM products may be roughly the same.

To see how this works, let’s assume the principal limit is again $150,000, but the mandatory obligations are $140,000. Again, let’s first calculate 60% of the principal limit:

$150,000 (PL) * 60% = $90,000 (60% of PL)

The mandatory obligations of $140,000 equal much more than the 60% threshold of $90,000, so the maximum allowed withdrawal at closing equals 10% of the principal limit:

$150,000 (principal limit) * 10% = $15,000 (max withdrawal at closing) 

But wait, there’s a problem! There’s not enough left in the principal limit to pay out $15,000 at closing. If we pay out $15,000, the proceeds will exceed the principal limit by $5,000, which isn’t allowed by FHA. Therefore, the maximum allowed withdrawal at closing is $10,000.

If this borrower selects the variable-rate HECM, the $10,000 can be allocated to any combination of lump sum, line of credit, or term/tenure income. There is no remaining principal limit to be unlocked in a year.

If the borrower selects the fixed-rate HECM, the entire $10,000 must be taken at closing as a lump sum. No additional money is available in a year.

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