When explaining a reverse mortgage to a senior homeowner, one of the most important terms a reverse mortgage loan officer will discuss is “Principal Limit.”
What is the main 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 maximum claim limit or the home’s FHA appraised value, whichever is less;
- 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, plus a set margin for the HECM adjustable rate and based on the current fixed interest rate for the fixed-rate reverse mortgage ).
The three listed criteria affect PL in the following ways:
- The higher the value of the home (up to the maximum claim limit of $625,500) the higher the PL amount;
- The older the youngest borrower (age is always based on the age of the youngest borrower, not a combination of the ages of multiple borrowers), the higher the PL amount;
- And conversely, the higher the current expected interest rate, the smaller the PL amount.
The reason potential borrowers should familiarize themselves with the term Principal Limit and what it means is because it is from this cash figure that all fees and reserves will be subtracted to arrive at the maximum cash or loan income available to the borrower. .
Congress plans to lower the capital limit
Congress significantly lowered the principal limit for fiscal year 2010 to offset the perceived budget shortfall of approximately $798 million for HECM reverse mortgages implemented within that fiscal year. HUD has announced that for fiscal year 2011 there will also likely be reductions in the principal limit. The year 2011 begins in October 2010 for budgetary purposes.
Until the budget bill has passed through the joint Senate-House committee, been voted on, and signed, we do not know the exact amount of the principal cap cut. Senior homeowners who have researched HECM reverse mortgages before October 1, 2010 should contact a reverse mortgage lender to learn how reductions in principal limits might affect them personally if they apply for a reverse mortgage.