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 legislation of Congress and implemented by the Department of Housing and Urban Development. (HUD) and using the following three criteria:
- The maximum claim limit or the appraised value of the home according to the Federal Housing Administration (FHA), 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 adjustable rate HECM and based on the current fixed interest rate for the fixed-rate reverse mortgage ).
The three criteria listed 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 PL amount;
- The older the younger borrower (age is always based on the age of the younger 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 lower the PL amount.
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 reserves will be subtracted to arrive at the maximum cash or loan proceeds available to the borrower. .
Congress plans to reduce the capital limit
Congress significantly lowered the capital 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 FY 2011 there will likely be reductions in the principal limit as well. The year 2011 begins in October 2010 for budget purposes.
Until the budget bill has passed the joint House-Senate committee, been voted on, and signed into law, we don’t know the exact amount of the cut in the principal cap. Senior homeowners who have researched HECM reverse mortgages prior to October 1, 2010 should contact a reverse mortgage lender to learn how reductions in principal limits could affect them personally if they apply for a reverse mortgage.