By Rudri Bhatt Patel
Published Wed, Jul 26, 2023
With a reverse mortgage, a borrower can convert a portion of their home equity to cash. One of the key factors determining the amount of loan proceeds borrowers can receive is the reverse mortgage principal limit.
Reverse Mortgage Principal Limits Explained
The amount of money borrowed with a loan is called the loan’s principal. The reverse mortgage principal limit is the maximum amount available to borrow.
In 2023, the U.S. Department of Housing and Urban Development (HUD) caps the amount any borrower can receive through a home equity conversion mortgage (HECM) at $1,089,300. Though the principal limit for any HECM must be lower than this number, the actual principal limit varies by loan depending on multiple factors.
Factors Impacting the Reverse Mortgage Principal Limit
The lender determines the individual loan’s principal limit with a formula that considers multiple factors about the borrower’s financial situation and the property. The following factors will impact a loan’s principal limit:
Valuation of the home. The value of the home depends on the property’s appraisal. A higher appraisal value of the home means a higher principal limit. A lender can access more equity with a higher property value.
Equity. The amount of equity that a borrower has built in the home influences the reverse mortgage principal limit. The more equity a borrower has in a home, the more likely the reverse mortgage principal limit will be greater.
Age of borrower. Older borrowers will have a higher lending limit since they have had a chance to build more equity in their homes. Younger borrowers will have a lower principal limit because they will presumably live longer. Lenders will use actuarial tables to determine those limits.
Current interest rate. A higher interest rate will lower the principal lending limit because the rate will be charged for a longer period. Market fluctuations can impact the interest rate.
Understanding Principal Limit and the 60% Utilization Rule
The principal limit is the maximum amount a borrower will ever be able to take over the life of the mortgage. Because a reverse mortgage has multiple payout options, the amount borrowers are eligible to take at a given time can vary greatly.
One factor which influences how much a borrower can take at the beginning of their loan is the 60% utilization rule. HUD sets this guideline to help ensure borrowers don’t take all their proceeds too soon.
The rule states that in the first year of a HECM, a borrower is only allowed to take the lesser of 60% of the principal limit or their mandatory obligations +10%. In other words, many reverse mortgage borrowers must use their proceeds to pay off other loans or “mandatory obligations.” Borrowers whose mandatory obligations exceed 60% of the principal limit may take the amount of their obligations + 10% in the first year.
How Payout Options Affect the Principal Limit
Because a reverse mortgage offers a range of payout options, the amount available varies depending on the borrower’s selected payout option. Broadly, here is how each payout option works with the 60% utilization rule.
Lump Sum. Borrowers who take a reverse mortgage with a variable rate will only have access to a portion of the full amount in the first year (detailed above). Borrowers with a fixed-rate reverse mortgage are only eligible to take a single lump sum payment and are not eligible for any further payouts regardless of the principal limit.
Monthly Payment. Monthly payment structures differ depending on the borrower’s strategy. Regardless, monthly payments will be structured to not exceed 60% of the principal limit in the first year.
Line of Credit Option. Many borrowers will choose a combination of payout options, including a line of credit. Like all payout options, no matter how much of the loan they receive as a line of credit, the borrower can only access a portion of the total principal limit in the first year.
Understanding the Net Principal Limit
The principal limit is the maximum amount a borrower can receive from a reverse mortgage. However, most borrowers will never receive the home’s full appraised value or the full principal limit quoted by the lender. These amounts don’t consider the costs that are rolled into the loan. These costs may include the origination fee, real estate closing costs, credit checks, surveys and inspections, taxes, and mortgage insurance premiums. This new amount is the reverse mortgage net principal limit.
Borrowers will have to ask the lender for the net principal limit, which should be provided in the loan documentation prior to closing.
This article is intended for general informational and educational purposes only and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.