What it means
When a homeowner applies for a reverse mortgage, the first question is how much the lender will allow them to borrow. The initial principal limit answers that question.
It is a ceiling set at closing, not the amount the borrower actually receives in cash. Three ingredients drive the figure, and the first is the age of the youngest borrower, because a younger borrower is expected to stay in the home longer and the lender allows a smaller percentage.
The second is the expected interest rate, because higher rates mean the debt grows faster and the lender lends less. The third is the home value, capped by the lending limit set under the federally insured programme in the United States.
The home value used is called the maximum claim amount, which is the lesser of the appraised value or the programme's lending limit. The initial principal limit is that amount multiplied by a percentage known as the principal limit factor.
Lenders look up the factor in tables published by the housing authority, so borrowers cannot negotiate it. In practice, the initial principal limit is the headline number in a reverse mortgage quote.
Older borrowers and lower interest rates generally lead to a higher percentage, which is why the same house can produce very different limits for different applicants. The limit then goes through deductions for existing debts and fees to produce the net principal limit.
It is worth remembering that the limit is not a promise of cash. The borrower's actual proceeds depend on what must be paid off at closing, such as an existing mortgage, as well as fees and any set-asides.
Always ask the lender to show the full breakdown. Because the limit is fixed at closing from the factors in place on that date, timing can matter.
A borrower who waits a year will be older, which tends to raise the percentage, but interest rates and home prices may have moved in the meantime. There is no guaranteed answer, so it is sensible to ask for quotes at different points and compare them.
In practice
Real-world examples.
Example
A 72-year-old homeowner has a house appraised at $400,000. The lender uses a factor of 52%, giving an initial principal limit of $208,000. This is the most she could access before payoffs and costs. She notes the figure in her planning spreadsheet.
Example
Two neighbours own identical $500,000 homes, but one is 64 and the other is 80. The older neighbour gets a higher factor, so her initial principal limit is larger even though the homes are worth the same.
Example
A retiree in a high-priced city owns a $1,200,000 home. Because the programme lending limit is lower than his home value, the maximum claim amount is capped at the limit, and his principal limit is calculated on that smaller figure.
Formula
Calculation
Initial principal limit = Maximum claim amount x Principal limit factor
Maximum claim amount = Lesser of (Appraised value, Programme lending limit)
Suppose a borrower owns a home appraised at $400,000, and the programme lending limit is higher than that, so the maximum claim amount is $400,000. Based on the borrower's age and the expected interest rate, the principal limit factor from the lender's table is 52%.
Initial principal limit: $400,000 x 52% = $208,000
The borrower can therefore have access to up to $208,000 in total, before deductions for existing debts, fees and set-asides.Case study
Seen in the real world.
Maple Ridge Lending is a fictional lender in an illustrative scenario. Ms Patel, aged 74, owns a home appraised at $360,000 and wants to know how much a reverse mortgage could provide.
The lender confirms the lending limit is above her appraisal, so the maximum claim amount is $360,000. Using a principal limit factor of 55% from its table, the initial principal limit is $360,000 x 55% = $198,000. The loan officer explains this is only the ceiling, and then walks her through the payoffs and fees that will reduce the cash she receives.
The loan officer also pointed out that a higher limit is not automatically a better outcome. Ms Patel did not need the full amount, and borrowing less would keep the loan balance and the interest costs lower. She decided to draw only what she needed for roof repairs and kept the rest of the limit untouched.
Watch out
Common mistakes.
- Believing the initial principal limit is the cash the borrower receives. Deductions for payoffs, fees and set-asides come off the limit first.
- Assuming the limit depends only on the home value. The age of the youngest borrower and the expected interest rate matter just as much.
- Expecting the limit to grow with a home price rise after closing. The limit is fixed at closing, although certain credit lines can grow under the loan terms.
Questions
People also ask.
Why does age matter?
Older borrowers are expected to have shorter time in the home, so lenders allow a larger percentage of the home value.
What is the principal limit factor?
It is the percentage taken from a published table that depends on the borrower's age and the expected interest rate.
Can I negotiate the factor?
No, the factor comes from official tables, although fees and margins on the loan can differ between lenders.
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