What if I told you there was one simple question that could get you thousands (or maybe tens of thousands) of dollars more from a reverse mortgage? Would you want to find out more? If so, read on!
Now, before I fill you in on what this question is, I need to lay some groundwork. Even if you’re familiar with reverse mortgages, resist the urge to skip ahead to the question. It’s important to understand a few basics so you can take the fullest advantage of the question I’ll cover shortly.
A few reverse mortgage basics
The most popular reverse mortgage in the United States today is the FHA-insured home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders). If somebody you know recently got a reverse mortgage, it’s likely they got a HECM.
The HECM is a unique home loan that enables homeowners 62 or older to convert a large portion of their home’s value into cash. No mortgage payments are required as long as at least one borrower (or non-borrowing spouse) is living in the home and paying 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 remaining in the home whether they wish to keep it, sell it, or let the bank sell it.
The HECM is a non recourse loan, which means the most that will ever have to be repaid is the value of the home. If the home isn’t worth enough to pay off the entire balance, FHA will cover the shortage.
The HECM is highly versatile and 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 income, or some combination of all of these options.
Seniors commonly use a reverse mortgage to get rid of existing mortgage payments, pay off other debts, finance home improvements, or supplement existing retirement income or assets.￼
How proceeds are calculated
The total amount of money available through a HECM reverse mortgage is called the principal limit. The principal limit is the total pool of cash available to pay off existing mortgages, closing costs, and any other mandatory obligations. The remaining portion of the principal limit after mandatory obligations are paid can be allocated to term, tenure, line of credit, or lump sum.
Remember, you always retain ownership of your home. The bank is not buying the home from you. The principal limit is always just a portion of the value of the home – not all of it. Most borrowers tend to qualify for around 45% to 55% of their home’s value. Older borrowers may qualify for a little more.
The principal limit is calculated based on your home’s value, the age of the youngest borrower (or non-borrowing spouse) and the expected interest rate.
The expected interest rate is calculated by adding together a base interest rate set by the financial markets and a margin set by the lender. Because the lender gets to choose the margin, they have some control over the expected interest rate used to calculated proceeds. This is an important point that I’ll circle back to later.
The amount of proceeds and the expected interest rate are inversely related. In other words, a lower expected interest rate generally results in higher initial proceeds. A higher expected interest rate generally results in lower initial proceeds.
The HECM has been particularly attractive in recent years because of low interest rates, which means the HECM has been offering more money than what might have been available in the past.
One simple question
Now that we’ve covered a few basics, let’s tie it all together. 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, right? 🙂
There’s also not much you can do about the value of your home. Sure, you can upgrade and maintain it, but the market ultimately decides the value of your home.
You also have little power over prevailing interest rates. The Fed and market forces largely drive rate movements.
However, you may have some power to influence the expected interest rate your lender offers you. You see, lenders don’t always offer you the lowest expected interest 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 the expected interest rate impacts the principal limit. See where I’m going with this?
So, here it is: to potentially get thousands more from a HECM, simply ask the lender to reduce the margin. Lowering the margin will reduce the expected interest rate used to calculate proceeds. Remember, a lower expected interest rate generally results in more proceeds. A higher expected interest rate generally results in less proceeds.
Obviously, the lender doesn’t have to say yes. Some lenders may be unable or unwilling to reduce the margin. But it never hurts to ask, right? And if they don’t accommodate, there are other lenders out there, right?
How the expected rate impacts proceeds
To see how a lower expected interest rate impacts proceeds, let’s take a look at an example using our principal limit calculator.
For this example, let’s assume a 70-year old homeowner, a $300,000 home value, and an expected interest rate of 5.25%. Based on these inputs, we get a principal limit of $135,600, or 45.2% of the home’s value.
Now, what if this homeowner is able to negotiate the expected interest rate down to 4.25%? In that case, the principal limit would be $152,100, or 50.7% of the home’s value. Wow, that’s a difference of over $16,000! As you can see, the expected interest rate can have a big impact on available proceeds.
An important caveat
If you opt for the variable-rate HECM to take advantage of the line of credit option, keep in mind that reducing the interest expected interest rate will also reduce the growth rate on the line of credit. If you’re borrowing most of the proceeds at the outset and don’t have a large line of credit to begin with, this probably isn’t a big deal.
However, if you will initially use a minimal amount of proceeds with the goal of maximizing future line of credit growth, reducing the rate may be counterproductive. Yes, you may get a bigger line of credit to start, but you may lose out on growth in the future. Have your lender run scenarios with different expected interest rates to find the “sweet spot” that maximizes initial proceeds and growth rate.