We wanted to provide a glossary to help you understand the terminology used in education materials and literature on Reverse Mortgages.
Home Equity Conversion Mortgage. This is the industry term for Reverse Mortgage.
A report that states an opinion on the value of a property based on its characteristics and the selling prices of similar properties in the area.
A service provided by an independent third-party, typically approved by the U.S. Department of Housing and Urban Development, to make sure the borrower fully understands the reverse mortgage and reviews alternative options, prior to application. Mandatory for the HECM program and in certain states for all types of reverse mortgages.
Initial Principal Limit:
Amount of funds you are eligible to receive from a reverse mortgage before closing costs are deducted.
Expected Interest Rate: The interest rate used to calculate the principal limit. It equals either the 10-year CMT or the 10-year LIBOR rate plus a margin.
Actual Interest Rate: The interest rate first charged on the loan beginning at closing; it equals one of the HUD-approved interest rate indices (1-month CMT, 1-year CMT, or 1-month LIBOR) plus a margin. Also called Initial Interest Rate.
Interest Rate Structure:
Index: Reverse mortgage interest rates are tied to one of two indexes, the Constant Maturity Treasury rate (CMT) or the London Interbank Offered Rate (LIBOR).
Margin: An amount added to the Index (CMT or LIBOR) to determine both the Expected and Actual interest rates. The margin is determined by the loan investor.
Variable Rate: An interest rate that adjusts monthly or annually.
Fixed Rate: An interest rate that remains constant over the life of the loan.
Lifetime Expectancy Set-Aside (LESA):
A Reverse Mortgage LESA, which stands for life expectancy set aside, was introduced as part of the new financial assessment guidelines rolled out by the Federal Housing Administration (FHA) in 2014. The idea behind the LESA is to help reverse mortgage borrowers with credit challenges or limited income to stay current with payments for property taxes and insurance (which is an important requirement of the reverse mortgage program).
Setting up a LESA involves carving out a portion of the principal limit (the total pool of funds available) into a set aside account that is preserved solely for the payment of property charges. The exact amount of the carve out varies widely from borrower to borrower because it is based on age and how much property taxes and insurance cost.
If property charges are low, the total reverse mortgage LESA carve out tends to be low. If property charges are high (such as in areas where property taxes are high), then the LESA can be a pretty substantial portion of the loan proceeds.
It’s possible that a LESA can make a reverse mortgage completely unworkable. If the home has a high mortgage balance, its possible there isn’t enough left in the principal limit to create the LESA. In such a case the loan would be short to close, which means the borrower would have to come up with cash to make the numbers work.
Line of Credit Growth Feature:
In some cases, the available line of credit increases over time according to the terms of the loan agreement.
Loan Closing Date:
Date on which your reverse mortgage is scheduled to close.
Maximum Claim Amount:
The lesser of a home’s appraised value or the maximum loan limit that can be insured by FHA. Used in determining the principal limit.
MIP (Mortgage Insurance Premium):
Under the HECM program, a fee charged to borrowers that is equal to a small percentage of the maximum claim amount, plus an annual premium thereafter on the loan balance. The MIP guarantees that if the lender goes out of business, FHA will step in and ensure the borrower has continued access to his or her loan funds. The MIP further guarantees that when the property is sold to pay back the reverse mortgage, the borrower will never owe more than the value of the home.
Net Principal Limit:
Amount of funds you are eligible to receive at closing after loan costs have been deducted.
A feature that limits the amount owed by the borrower, heirs or estate when the loan becomes due and payable to the appraised home value. For the HECM program, non-recourse only applies when the home is sold.
Open End Line of Credit:
A line of credit that allows the borrower to withdrawal funds, make payments back to the lender, and then have the ability to make subsequent withdrawals.
A fee charged by the lender to cover its expenses for originating the loan. A lender can charge the greater of $2,500 or 2% of the first $200,000 of your home’s value plus 1% of the amount over $200,000. HECM origination fees are capped at $6,000. Some lenders waive or reduce the origination fees on certain products.
Paying off a reverse mortgage early (that is, before the borrower permanently vacates the property). Under the HECM program, there is no penalty for paying all, or a portion, of the loan prematurely.
The total loan proceeds available at closing.
A type of insurance policy that protects a homeowner or lender against financial loss from defects in title to real property and from the invalidity or unenforceability of mortgage liens. The cost for the policy is typically paid at closing by the borrower.
How Does A Reverse Mortgage Work
If you’re like many older Americans, you’ve worked hard and saved money, but you may still have concerns about having enough to live comfortably throughout your entire retirement. If you’re retired, or close to retirement, the wealth amassed in your home equity likely represents a large portion of your net worth.
Understanding how to strategically and tax efficiently incorporate this wealth into your retirement plan may be the key to prolonging and protecting your overall portfolio. How we plan to fund our longevity is very different today than in decades past. Historically, many companies provided lifetime pensions, which provided retirees with certainty and peace of mind. Today, medical expenses, longer life-spans, long-term care needs and other issues have left many older Americans in Baltimore worried about the possibility of outliving their money.
Yet, older homeowners have amassed an unprecedented $7.14 trillion in untapped home equity as of the first quarter of 2019. (Source: National Reverse Mortgage Lenders Association and Risk Span) This begs the question: Is it reasonable to ignore your largest asset when developing a financial plan?
Simply put, a reverse mortgage loan enables homeowners age 62 or above the ability to borrow up to roughly 50 percent of their home’s value. Payouts can be made to the borrower in the form of a lump sum payment, line of credit with a guaranteed growth rate, monthly payouts or a combination of all three. (We’ll touch on how the line of credit grows in a future article.)
A reverse mortgage may also be used to purchase a home. The HECM for purchase loan combines a reverse mortgage with the equity from the sale of your previous home - or from other savings and assets - to buy your next primary home in a single transaction. Regardless of how long you live in the home or what happens to your home’s value, you only make one initial down payment towards the purchase, provided that you pay property taxes and homeowner’s insurance, and maintain the property.
Reverse Mortgage Misconceptions
A common misconception about reverse mortgages is that bank owns the home. This is not the case. The homeowners retain ownership of the home, just like they would with a traditional mortgage. Unlike traditional mortgages, there is no monthly payment requirement as long as the home remains the primary residence.
Another common misconception is that rates on reverse mortgages are higher than traditional home loans. This is also false. Reverse mortgage interest rates are in line with traditional mortgage rates. Borrowers have the option to make monthly payments or to defer payback until the last remaining borrower leaves the home.
The key here is flexibility. Reverse mortgage borrowers may access their home equity on demand. The flexible payment option is designed to provide homeowners, especially those on a fixed income with additional cash flow later in life when a mortgage payment can often be burdensome. They may also pay back the loan without penalty, or sell the home at any time. Borrowers must pay their property taxes, insurance and maintain the home to comply with loan guidelines.
Reverse Mortgage Pros
Reverse Mortgage Cons
The Bottom Line
As with any product or service, education is paramount. The reality is that the home is too large an asset to be ignored. Today’s reverse mortgages are not meant to be a Band-Aid or short-term fix to larger financial issues. In some cases, someone in financial distress may be better off selling the home to access more of equity, downsizing or moving to a care facility.
In other cases, a reverse mortgage is a powerful tool that can provide a more stable, comfortable and fulfilling retirement. If you’re considering a reverse mortgage, reach out to a specialist who has expertise in this specific program and who will take the time to understand your unique needs and situation.
Steven J. Sless (NMLS: # 298581 MLO: # 49963) is the reverse mortgage division manager with PRMI. He also oversees PRMI’s office in Owings Mills – one of the nation’s only consumer-direct retail branches that deals exclusively with reverse mortgages. For more information, Contact Us, call 410-814-7575 or follow morewithsless on Facebook, Twitter, LinkedIn and Instagram.