“Historically, the principal limit has been a measure of what HUD says a borrower with certain factors is able to borrow at closing. After the September 2013 changes to the program, however, that definition is not quite accurate. Homeowners may be restricted in the amounts they can borrow up-front. Fortunately, with the adjustable rate products, the remaining net principal limit will be accessible after that first year.”
One of the most common questions I get from borrowers is “What is the most I can borrow?” While borrowing it all up-front may not be the optimal strategy, it is important to know the amount of funds homeowners have available to them. It is also significant to note that this number increases with time. Therefore, technically what they really want to know is, “What is my initial principal limit?”
Initial principal limits vary from homeowner to homeowner and are based on AGE, RATES, and the HOME’S VALUE. Reverse Mortgage calculators will generate principal limits that are consistent from lender to lender. But let’s discuss how they are determined:
- Begin with the Relevant AGE
Older borrowers generally qualify for higher principal limits. While all borrowers must be 62 or older, non-borrowing spouses may be much younger. Therefore, HUD publishes tables that reference every age from 18 to 99. Keep in mind the relevant age will be the youngest borrower, co-borrower, or non-borrowing spouse. I often refer to this as the “Age of Youngest Participant.”
- Identify the Relevant RATE
For fixed-rate reverse mortgages, we will use the interest rate. With adjustable rate loans, however, FHA requires us to project what the rate for a particular reverse mortgage may be in the future. This number has been between 4% and 6% for quite some time, and is referred to as the “Expected Interest Rate.”
Using these two items (age and rate), we can look up the homeowner’s Principal Limit Factor (PLF) from HUD’s factor table.
In the chart below, you will see a small sample of selected ages and selected expected rates and the corresponding PLF% from the 2014 table.
- Multiply the Homeowner’s PLF by the Home’s Value
When the PLF is multiplied by the home value we get the initial principal limit in dollars. Bear in mind that higher home values will be capped at $625,500 (for calendar year 2015) for the purpose of this calculation.
Let’s look at an example. Linda is 74 years old, and she is younger than her spouse. Therefore, she is the youngest participant. She has an expected rate of 5.00%. Using these two pieces of information, we can look up a PLF of 60.6%.
60.6% of Linda’s home value of $200,000 will give her an initial principal limit of $121,200. This principal limit will increase for Linda every month that she remains in the home, regardless of future home values. She could borrow it if needed, or let it continue to grow. Eventually, her available funds my even grow to exceed the value of her home.
For those homeowners that use the product for financial planning purposes, this increasing principal limit can offer a secure collection of funds to be accessed later in retirement if needed. The compounding is working in the homeowner’s favor, and is a good reason to consider getting a reverse mortgage early in retirement.
To learn more about reverse mortgage guidelines and the advantages they offer older homeowners who use them properly, please purchase a copy of my book, Understanding Reverse.