On October 2, 2017, the Department of Housing and Urban Development’s new rules on reverse mortgages went into effect. These rules changed up-front mortgage insurance premiums, monthly mortgage insurance premiums, and principal limit factors. These rules don’t affect existing borrowers, only new ones. If you’re considering taking out a reverse mortgage, here’s what these terms mean and what these changes entail for you.
Changes to Insurance Premiums
Reverse mortgages have two types of insurance premiums. HUD has made changes to both of them.
Up Front Mortgage Insurance Premiums
Borrowers pay an up front mortgage insurance premium (UFMIP) when they take out the loan. This premium goes to the Federal Housing Authority’s loan guarantee fund, called the Mutual Mortgage Insurance Fund. The fund encourages lenders to make riskier loans than they otherwise might by offering a source of repayment if lenders lose money on their reverse mortgages.
Before October 2, UFMIPs for most borrowers were 0.5 percent of the maximum loan limit of $636,150 or your home’s appraised value, whichever was less. Homeowners who borrowed a large lump sum in the first 12 months of their loan were paying 2.5 percent up front. Now, UFMIPs are 2.0 percent regardless of how much homeowners borrow at closing or in the first 12 months. The result is that up-front costs have increased for most reverse mortgage borrowers.
Monthly Mortgage Insurance Premiums
This is the second insurance premium that reverse mortgage borrowers pay. Before October 2, these premiums cost 1.25 percent of the loan balance per year (divide that by 12 to get the monthly amount). Now, they cost 0.5 percent per year. This change saves borrowers about $333 per year for every $100,000 in their loan balance.
Borrowers have a number of different options for accessing reverse mortgage proceeds. One option is to take a large sum up front, then borrow more later. This choice is popular with homeowners who need to pay off their first mortgage or other debts to free up monthly cash flow in retirement. Another option is to open a line of credit and draw on it as needed in case retirement funds come up short.
Borrowers who use a reverse mortgage as a standby line of credit and don’t plan to borrow unless they absolutely have to are likely to pay more under the new rules, since they’ll be paying higher up-front premiums without benefiting from the lower monthly premiums. Borrowers who take out a large lump sum up front are more likely to save money under the new rules since they’ll be paying lower up-front premiums and lower ongoing premiums.
Changes to Principal Limit Factors
The principal limit factor is a percentage that lenders multiply by your home’s appraised value or the maximum claim amount of $650,100, whichever is less, to determine how much you can borrow when you first take out a reverse mortgage. (Principal limit factors get complicated fast, but what you need to know for the purposes of this article is that changes the government has made to them mean homeowners will be able to borrow less under the new rules—about 6 percent less, by the Wall Street Journal’s calculations. Also, borrowers who choose a line of credit will not see their line grow as quickly as borrowers under the old rules did.
The other things that affect how much you can borrow haven’t changed: your age, your home’s value and interest rates. The older you are, the more your home is worth, and the lower market interest rates are, the more you can borrow.
Should you be upset that you won’t be able to borrow as much under the new rules? Not really, because the alternative is not being able to get a reverse mortgage at all, as we’ll explain next.
Why HUD Changed the Reverse Mortgage Rules
When the government guarantees a program, taxpayers are on the hook if that program loses money because taxpayers are the ones who fund the government. The changes to mortgage insurance premiums and principal limit factors are designed to keep the reverse mortgage program financially viable.
Why do reverse mortgages put lenders at risk in the first place? Because reverse mortgages are what are called nonrecourse loans. That means the borrower will never owe more than the house is worth. However, the loan balance does sometimes grow to more than the home is worth. When this happens, the lender loses money and files a claim with the government to cover the loss. The loss gets paid out of the fund made up of mortgage insurance premiums.
If lenders file claims for losses too often, the government loses too much money and the program becomes unsustainable. That is exactly what has happened: The reverse mortgage program has become financially unstable in recent years because the government has lost too much money on loan guarantees, so the government is now trying to shore up the program.
If the government has to make good on its guarantee on too many loans and doesn’t have enough money in its loan guarantee fund, the money will have to come from another government program or taxes will have to increase. The program could also go under if it becomes too much of a liability for the government.
Keep in mind that these rule changes don’t affect whether taking out a reverse mortgage is a good choice or a bad one for any particular homeowner. That decision should be based on your financial needs in retirement and the assets you have to cover those needs.