When explaining a reverse mortgage to a senior homeowner, one of the most important terms a reverse mortgage loan officer will discuss is the “Principal Limit.”
What is the Principal Limit and why is it important?
The Principal Limit (PL) is the gross amount of money the lender is willing to lend to the borrower of a Home Equity Conversion Mortgage or HECM reverse mortgage, based on a formula derived from Congressional legislation and implemented by the Department of Housing and Urban Development (HUD) and using the following three criteria:
- The lower of the Maximum Claim Limit or the Federal Housing Administration (FHA) appraised value of the home;
- The age of the youngest borrower (must be 62 or older);
- The current expected interest rate (based on the current 10 year London Interbank Offered Rate, or LIBOR rate, plus a stated margin for the adjustable rate HECM and based on the current fixed interest rate for the fixed rate reverse mortgage).
The three listed criteria affect the PL in the following ways:
- The higher the value of the home (up to the maximum claim limit of $625,500) the higher the amount of the PL will be;
- The older the youngest borrower (age is always based on the youngest borrower’s age, not a blending of multiple borrowers’ ages) the higher the amount of the PL will be;
- And, conversely, the higher the current expected interest rate, the lower the amount of the PL will be.
The reason potential borrowers should become familiar with the term Principal Limit and what it means is because it is from this cash figure that all fees and set asides will be subtracted in order to arrive at the maximum cash or loan proceeds available to the borrower.
Congress Plans to Lower the Principal Limit
Congress lowered the Principal Limit for the fiscal year 2010 signifantly to make up for a perceived budget shortfall of approximately $798 million for HECM reverse mortgages put in place within that fiscal year. HUD has announced that for the fiscal year 2011 there will likely be decreases in the Principal Limit as well. The 2011 year begins in October 2010 for budgetary purposes.
Until the budget bill has made it through the joint Senate and House committee, been voted on and signed, we do not know what the exact amount of the cut in the principal limit will be. Senior homeowners who have investigated HECM reverse mortgages prior to October 1, 2010 should contact a reverse mortgage lender to learn how the decreases in Principal Limits could impact them personally if they pursue a reverse mortgage.reverse mortgage