Mandatory obligations

What are reverse mortgage mandatory obligations?Mandatory obligations are expenses that must be paid at closing to complete a HECM reverse mortgage. The most common mandatory obligations include existing mortgage balances, closing costs, and property charges due at closing.

Once the mandatory obligations are paid, the remaining money is available to the borrower for allocation to term or tenure income, line of credit, lump sum, or some combination of these options.

What items are considered mandatory obligations?

According to FHA Mortgagee Letter 2014-21, the following items must be paid as mandatory obligations at closing:

  • 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)

Not all of these will apply to every reverse mortgage loan scenario. The common items are mortgage payoffs, closing costs, and property charges due at closing.

The 60% rule and the fixed-rate HECM

The fixed-rate HECM has a somewhat awkward relationship with mandatory obligations. If mandatory obligations are low, the fixed-rate HECM will usually offer far less money than the variable-rate HECM. If they’re really high (using all or nearly all of the principal limit), then the money available will usually be about the same for both HECM programs.

The bottom line is this: if you’re after the most money you can get, the fixed-rate HECM will probably only make sense if your mandatory obligations are really, really high. If they’re not, it’s a good bet the variable-rate HECM will offer you more money.

If your mandatory obligations are less than 60% of the principal limit, the fixed-rate HECM offers up to 60% of the principal limit as a lump sum at closing. No additional money is available in the future (unlike the variable-rate HECM, as I’ll explain in a minute).

As an example, let’s assume the principal limit is $100,000 and the mandatory obligations are $40,000. After the mandatory obligations are paid, you would receive an additional $20,000 lump sum at closing. This adds up to a starting loan balance of $60,000 (60% of the principal limit).

If your mandatory obligations are more than 60% of the principal limit, the fixed-rate HECM will give you up to an additional 10% of the principal limit. If there’s not enough money available to give the full 10%, you’ll get whatever is available up to the principal limit. Let’s look at two examples to see how this works.

For the first example, let’s assume the principal limit is $100,000 and your total mandatory obligations are $70,000 (70% of the principal limit). Because you’re already over the 60% threshold, you’ll receive an additional $10,000 (10% of the principal limit) at closing. No more money will be available in the future.

For the second example, let’s assume the same $100,000 principal limit, but the mandatory obligations are instead $95,000 (95% of the principal limit). Because you’re over the 60% threshold, you should (theoretically) receive an additional 10% at closing, right? But because there’s not enough available to give the full 10%, you’ll receive whatever is available up to the principal limit. In this case, it’s just 5% of the principal limit, or $5,000.

The 60% rule and the variable-rate HECM

Unlike the fixed-rate HECM, the variable-rate HECM will always give you full access to 100% of the principal limit. The only “catch” is that you won’t necessarily get access to all of it right away. Forty percent of the principal limit will be unavailable for the first 12 months of the reverse mortgage. Once the 12-month mark has passed, all unused proceeds are available with no limitation.

The variable-rate program works very similarly to the fixed-rate program at closing. If your mandatory obligations are less than 60% of the principal limit, you can take up to 60% of the principal limit at any time within the first 12 months. The remaining 40% of the principal limit will come available at the one-year mark as a line of credit.

For example, if the principal limit is $100,000 and the mandatory obligations are $40,000 (40% of the principal limit), you can take up to another $20,000 in the first 12 months at your discretion. Once you reach the 1-year mark, the remaining 40% of the principal limit, more or less (see growth rate), will come available automatically as a line of credit.

If your mandatory obligations are more than 60% of the principal limit, an additional 10% will be available to take at any time in the first 12 months. At the end of 12 months, the remaining portion of the principal limit will automatically come available as a line of credit.

For example, let’s assume the principal limit is $100,000 and your total mandatory obligations are $70,000 (70% of the principal limit). Because you’re already over the 60% threshold, you’ll have an additional $10,000 (10% of the principal limit) to take at any time in the first 12 months of the loan. Once the 1-year mark has been reached, the remainder of the principal limit (roughly $30,000, depending on line of credit growth) will come available automatically.