Reverse Mortgage Net Principal Limit

What Is a Reverse Mortgage Net Principal Limit?

A reverse mortgage net principal limit is the amount of money that a reverse mortgage borrower can receive from a loan once it closes after accounting for its closing costs. The net principal limit can depend on several factors centered around the home’s equity value and how much the borrower pays in up-front fees.

Understanding Reverse Mortgage Net Principal Limits

Reverse mortgages are available for people age 62 or older. Also known as home equity conversion mortgages (HECMs) when they are federally backed (which most of them are), they allow borrowers to receive cash for the equity in their homes with no monthly payments required. Lenders offer principal loan balances based on the appraised value of the borrower’s home, their equity value, and the borrower’s age. Depending on the reverse mortgage’s terms, money can be disbursed either in installments or as a lump sum.

Most reverse mortgages are backed by the Federal Housing Administration (FHA) and supported by the U.S. Department of Housing and Urban Development (HUD). Interested borrowers can find an FHA-approved lender online at HUD’s website.

A reverse mortgage is an alternative type of second mortgage with a borrower’s property used as the secured collateral. Interest accrues over the life of the loan at a specified interest rate. Most importantly, borrowers must fully repay the loan if they sell the property. Complete repayment is also required if a death leaves the secured property and any recourse assets to the lender.

A reverse mortgage net principal limit is the net principal that a borrower receives in a reverse mortgage loan after deducting any costs and fees. The net principal limit often will be higher than the reverse mortgage initial principal limit, which is the maximum amount that you can obtain in the first year.

Special Considerations

There are numerous costs associated with reverse mortgage loans. Costs include the origination fee, the up-front mortgage insurance premium (MIP), appraisal fees, title insurance, and home inspection fees. The FHA has detailed specifications for calculating principal offers, and borrowers are limited to a certain amount over their lives.

Reverse mortgages offer several customized options for a borrower. Perhaps the most attractive is that borrowers can choose a lump-sum payment with a fixed interest rate. Several options are also available with variable rates, including monthly disbursements and lines of credit. With all of these options, the borrower’s net principal limit is the total balance available after fees.

The net principal limit can also be compared with the current net principal limit. The current net principal limit is the revolving balance available on the borrower’s account. At the onset of the loan, the net principal limit and the current net principal limit would be the same.

Pros and Cons of Reverse Mortgage Net Principal Limits

A significant benefit of reverse mortgage net principal limits is that they ensure that homeowners retain meaningful stakes in their homes. Without a stake, the property holder might allow many nonessential parts of the house to fall into disrepair, preferring to save the money for heirs. Reverse mortgage net principal limits also help lenders avoid losing money if property values decline.

On the other hand, overly low reverse mortgage net principal limits can prevent older homeowners from fully tapping into their home equity. Suppose, as is often the case, that they cannot earn very much income anymore. Then, these owners may have to sell their houses or forgo nonessential repairs.

Example of a Reverse Mortgage Net Principal Limit

To qualify for a reverse mortgage, you will need to be age 62 or older and have enough equity in your home to make it profitable and affordable.

For example, let’s say the Smiths own a home worth $300,000, and the principal limit factor is 0.50. Their home value is less than the lending limit, so the lending limit has no impact on the calculation. In this case, the principal limit on their reverse mortgage is $150,000. This is the gross amount they can take out, and they will have to pay fees, closing costs, the rest of their existing mortgage, and any liens on the house.

Let’s say all of those costs add up to $30,000. The net principal remaining will be $120,000. They will owe $150,000 on their reverse mortgage, and they will walk away with $120,000 in either a line of credit or a lump-sum payment.

The Bottom Line

The net principal limit on a reverse mortgage is essentially the limit of funds available to borrowers after accounting for all the fees associated with taking out a reverse mortgage. Borrowers can access up to the net principal limit as part of a lump sum, as ongoing payments, as a line of credit, or as a combination of the three depending on the reverse mortgage terms. There are pros and cons to taking out a reverse mortgage, but a critical benefit for some older homeowners may be the ability to use the funds from a reverse mortgage to age in place.