Upfront Costs of Opening a Reverse Mortgage
Upfront costs for reverse mortgages come in three categories. First, the mortgage lender can charge an origination fee. With the HECM program, these fees are currently allowed to be up to 2% of the home value for homes worth $200,000 or less. For homes worth between $200,000 and $400,000, the maximum allowed origination fee is $4,000 plus 1% of the home’s value above $200,000. For homes worth more than $400,000, the maximum origination fee is $6,000. If this calculation leads to a fee below $2,500, the lender may charge up to $2,500.
These fees are the maximum allowed by the government. Larger lenders with national advertising campaigns may charge the full allowed amounts, as their customers are less likely to engage in comparison shopping and may not recognize these fees as negotiable. Origination charges for smaller lenders may be much less, and some might even provide credits rather than charges for the origination fee as they earn revenue primarily by originating loans to sell on the secondary market rather than through charging origination fees.
I saw a lender that quoted total upfront costs of $125 for the required counseling session with a $0 origination fee, along with credits to cover the mortgage insurance and other closing costs described in the following paragraphs. Clearly, shopping around is important. Some lenders also offer lower origination fees for borrowers willing to accept a higher lender’s margin, which can be an attractive option for those thinking of opening a line of credit and saving it for retirement.
A second source of upfront costs is the initial mortgage insurance premium paid to the government, which is based on the value of the home. This fee has changed over time. Since October 2013, it has been sitting at 0.5% of the home value (up to $625,500) if the borrower takes out less than 60% of the PLF in the first year, and 2.5% if taking out more than 60% of the PLF in the first year. For those staying under the 60% threshold, the initial mortgage insurance premium is $500 per $100,000 of home value, up to $3,128 for the $625,500 limit.
The purpose of the mortgage insurance premium is to cover the guarantees provided by the FHA to the lender and consumer. The protection ensures the consumer will have access to their full principal limit even if the lender goes out of business, and the lender is protected for the non-recourse aspect of the loan. If the home value cannot cover the loan balance, the government will make up the difference for the lender.
Finally, you have closing costs. These will be similar to closing costs experienced with any type of mortgage. These costs include the FHA-mandated counseling session, home appraisal costs, credit checks, and any costs related to titling.
If the appraisal shows shortcomings for the home that could impact health or safety, then additional home repairs may be required as part of setting up the reverse mortgage. A 2011 AARP report estimated that typical closing costs fall into a range of $2,000 to $3,000. This range is also consistent with the numbers found on the calculator created by the National Reverse Mortgage Lenders Association.
The upfront costs could be paid from other resources or financed from the proceeds of the reverse mortgage loan and repaid later with interest. If upfront costs are financed, the remaining net PLF available through the reverse mortgage would be the amount left after subtracting these costs. You should plan to remain in your home for a sufficiently long period to justify payment of any upfront costs.
Ongoing Credit and Costs
The ongoing costs for a reverse mortgage relate to the interest accruing on any outstanding loan balance, as well as any servicing fees. Servicing fees can be up to $35 per month, though they are generally now incorporated into a higher margin rate rather than charged directly to the borrower. Interest on the loan balance grows at the effective rate:
Effective Rate = One-month LIBOR Rate + Lender’s Margin + Annual Mortgage Insurance Premium (1.25%)
In January 2016, the one-month LIBOR rate was about 0.4% and the 10-year LIBOR swap rate was about 2.1%. If we assume a 3% lender’s margin, that gives us an expected rate of 5.1% and an effective rate of 4.65%:
Expected Rate = 2.1% + 3% = 5.1% (for initial principal limit)
Effective Rate: = 0.4% + 1.25% + 3% = 4.65% (for principal limit growth)
Once determined through the PLF, the initial line of credit grows automatically at a variable rate equal to the lender’s margin, a 1.25% mortgage insurance premium (MIP), and subsequent values of one-month LIBOR rates. These LIBOR rates are the only variable part for future growth, as the lender’s margin and MIP are fixed at the beginning. The effective rate is adjusted monthly to reflect updated LIBOR rates. It is capped at 10 percentage points above its initial rate. The next table summarizes how the expected rates and effective rates are calculated and reviews when these rates apply.
|Reverse Mortgage Interest Rates|
|Expected Rate||10-year LIBOR Swap Rate +
|Initial Principal Limit Factor|
|Set-Asides for Servicing Costs in Old Mortgages|
|Effective Rate||One-month LIBOR Rate +
Lender’s Margin +
Mortgage Insurance Premium (1.25%)
|Ongoing Principal Limit Growth Rate|
|Loan Balance Growth Rate|
|Line of Credit Growth Rate|
|Post-2014 Set Asides for Financially Strained|
The margin rate and the ongoing mortgage insurance premium are set contractually at the onset of the loan and cannot change. Especially for lenders who have forgone the origination and servicing fees, the margin rate charged on the loan balance is the primary way the lender—or any buyer on the secondary market—earns revenue. Estimates for reasonable margin rates are generally between 2.25% and 4%, with higher numbers typically being associated with lower origination and/or servicing costs.
Meanwhile, the ongoing mortgage insurance premium helps ensure the government can meet the obligations for the guarantees it supports through the HECM program to both the lenders and borrowers. The government supports two guarantees: that the borrower will be able access their fully entitled line of credit regardless of any financial difficulties on the part of the lender; and that the insurance fund will make the lender whole whenever payment is due and the loan balance exceeds 95% of the appraised value of the home. The government fund also bears the risk with the tenure and term payment options as distributions are guaranteed to continue when the borrower remains in the home even if the principal limit has been fully tapped.
The insurance premiums protect the homeowners from not having to pay back more than the value of the home in cases where the home balance exceeds this value. The lender is protected as well, as the FHA pays the difference in such cases. While this could potentially leave taxpayers on the hook if the mortgage insurance premiums are not sufficient to cover these cases, the government attempts to stay on top of this matter.
Mortgage insurance premiums and principal limit factors have been adjusted over time to help keep the system in balance. However, if the option to open a line of credit and leave it unused for many years will grow in popularity, further changes may be needed to keep the mortgage insurance fund sustainable.