Reverse Mortgage Loan Glossary: Key Terms You Must Know
As you continue to learn about what reverse mortgages are, how they work and whether one could improve your financial situation in retirement, you no doubt will encounter many terms, abbreviations and acronyms. Here is a helpful reverse mortgage loan glossary to make your navigation a little easier:
Adjustable-Rate Mortgage: A mortgage loan with an interest rate that varies or adjusts periodically throughout the life of the loan.
Age-in-Place: The ability to live in one’s own home and community safely, independently and comfortably, regardless of age, income, or ability level.
Appraisal: A real estate appraisal is the process of developing an opinion about a particular property’s value. The opinion is necessary because every property is unique, unlike corporate stocks that are traded daily and are identical.
Closing Costs: Closing costs with a reverse mortgage are similar to costs associated with a traditional mortgage loan. These fees may include a credit report fee, flood certification fee, escrow fee, document prep fee, recording fee, courier fee, title insurance, pest inspection, and survey.
Consumer Financial Protection Bureau (CFPB): The Consumer Financial Protection Bureau is an agency of the United States government responsible for consumer protection in the financial sector.
Counseling: The federal government mandates that all HECM reverse mortgage loan candidates meet with an impartial, HUD-approved counselor before submitting a reverse mortgage application. This is to ensure that all borrowers have all the information they need to make the right decision before moving ahead with the loan. This is an important consumer safeguard.
Default: Default is a failure to fulfill an obligation. Although a reverse mortgage does not require monthly mortgage payments, it does require that the borrower maintain the home and pay property taxes and homeowners insurance and otherwise comply with loan terms. Failure to do so is a violation or default of contract terms. If steps aren’t taken to remedy the default, the lender may start foreclosure proceedings.
Expected Interest Rate (EIR): The Expected Interest Rate is what the lender estimates the average rate will be over the life of the reverse mortgage. The EIR is used to determine how much money a reverse mortgage borrower may qualify for based on the value of the home and age of the youngest borrower. The EIR does not determine the amount of interest that accrues on the loan balance. The initial interest rate performs that function (see IIR).
Federal Housing Administration: The Federal Housing Administration (FHA) provides mortgage insurance on loans made by FHA-approved lenders. Thus, as an FHA-approved lender, AAG can make FHA-approved reverse mortgage loans.
Financial Assessment: A lender conducts a financial assessments of each reverse mortgage applicant’s income, debt and credit history to ensure that person has enough money to pay ongoing costs, such as property taxes and homeowners insurance, over the life of the reverse mortgage loan. If the borrower’s resources or credit history don’t meet the lender’s guidelines, the lender may require as a condition of the loan that a cash amount be set aside (Life Expectancy Set Aside or LESA) to pay for these ongoing obligations.
HECM: HECM stands for Home Equity Conversion Mortgage, which is a type of reverse mortgage insured by the Federal Housing Administration (FHA). Borrowers, 62 or older, may use a HECM to convert some of their home equity into cash. The actual cash amount received is based on several factors, such as the age of the borrower, the appraised value of the borrower’s home (not to exceed HECM lending limits), the equity in the home (home value minus what is owed on the home), and the current interest rate. Interest accrues on the money that is advanced, but loan repayment (principal, interest and insurance) is not required until the borrower sells, moves out of the home for longer than a year, or passes away. The borrower is obligated to maintain the home and pay property taxes and homeowners insurance throughout the life of the loan.
HECM for Purchase: Whereas a majority of borrowers use a Home Equity Conversion Mortgage or HECM to convert some of their home equity into cash that they don’t have to pay back until they leave the home, borrowers can also use a HECM to buy a new home. In this HECM for Purchase option, the reverse mortgage lender would base its loan amount on the age of the youngest borrower or eligible non-borrowing spouse, the current interest rate and the value of the home for purchase. The additional money needed to complete the purchase (sale price of the new home minus the lender’s loan amount) would typically come from the borrower’s previous home sale or other assets such as savings and investments.
Home Equity: Home equity is the current market value of your home, minus what you owe. If, for example, the property is worth $500,000, and the loan is $300,000, then you have $200,000 (40%) of equity remaining in your home.
HUD: The Department of Housing and Urban Development (HUD) is the nation’s agency committed to creating opportunities for quality and affordable homes for all. It’s also the primary agency involved in rulemaking and oversight for HECMs.
Initial Interest Rate (IIR): The initial interest rate is the actual note rate on a HECM reverse mortgage. Interest accrues on the loan balance (assuming the borrower doesn’t make payments) at an annual rate equal to the IIR. The IIR on the variable-rate HECM can change over time based on the underlying index, up to the lifetime interest rate cap. The fixed-rate HECM has an IIR that never changes for the life of the loan.
Initial Principal Limit: Amount of funds the borrower is eligible to receive from a reverse mortgage before closing costs are deducted.
Interest: Interest is what you are charged to borrow money from a lender. This amount is usually expressed as a percentage. Unlike the principal and interest on a traditional mortgage that the borrower partly pays down monthly, the principal and interest on a reverse mortgage typically do not have to be repaid until the borrower leaves the home, which could be years or even decades later. This is, of course, provided the borrower fulfills their part of the loan terms, which includes paying property taxes and maintaining homeowners insurance. On a reverse mortgage, you can choose a fixed-rate loan, meaning the rate of interest will never change over the life of your loan, or you can choose an adjustable-rate loan, meaning the rate can vary over the life of the loan. The current interest rate environment will likely be an important factor in the choice you make. A lower rate, of course, will lead to less interest paid over the loan’s life, and will thus directly affect how much equity could be left at the end of the loan. If you elect to go with a fixed interest rate, you must select a lump-sum payment, whereas if you choose an adjustable interest rate, you have the option of receiving payouts as a lump sum, line of credit, monthly payments, or a combination of all three.
Interest Rate Cap: This is a ceiling that an adjustable interest rate cannot exceed, regardless of how high interest rates were to rise.
LESA: This is an acronym for Life Expectancy Set-Aside, which the reverse mortgage lender may require if it determines during the Financial Assessment that the prospective borrower does not have the income, assets or credit history to pay their ongoing property taxes and homeowners insurance. Although the money set aside, based on the borrower’s life expectancy, will reduce the borrower’s payout, the borrower’s yearly property taxes and homeowners insurance are thereafter taken care of, making planning and budgeting easier. In the event the borrower outlives the money in the LESA, the borrower would take over the payment of their property taxes and homeowners insurance. The majority of reverse mortgage borrowers, however, do not exhaust their LESA funds in their lifetime.
LIBOR Index: The LIBOR Index (London Interbank Offered Rate) is the rate at which banks borrow money from other banks, and this is the index off of which variable rate reverse mortgages are based. The 1-month and 1-year LIBOR rates are most commonly used.
Line of Credit: This is the most popular reverse mortgage payout option, likely because it is also the most flexible. When you have a reverse mortgage line of credit, you can draw upon it as you need it, up to your principal limit. There are no minimum or maximum amounts that your lender requires you to take to keep the line open. And unlike a traditional home equity line of credit, your reverse line of credit cannot be revoked, even if your home’s value decreases or your financial situation worsens. Of course, you have to continue to maintain your property and keep paying your property taxes and homeowners insurance. You are charged interest only on the portion of the line you use. So, you could simply keep your line open for 10, 20 or 30 years, saving it for a rainy day, and never be charged a penny of interest. Furthermore, your unused line continues to grow year after year.
Line of Credit Growth Rate: The growth rate is 0.5% above the initial interest rate, which is the annual rate that interest accrues on the loan balance. If the interest rate on the loan balance were 3.50%, then the growth rate on the available credit line would be 4.0% (3.50% + 0.50%).
Loan Origination Fees: These are fees that cover the lender’s operating costs and expenses. Lenders charge the greater of $2,500 or 2% of the first $200,000 of your home’s value to process your HECM loan, plus 1% of the amount over $200,000. The FHA caps HECM origination fees at $6,000.
Lump Sum: This reverse mortgage payout plan can be selected as a fixed-rate loan or an adjustable-rate loan. Both options offer a first-year maximum draw of 60% of the principal limit, with an additional 10% of the limit made available if maximum obligations exceed the 60% limit. If the fixed-rate option is selected, you retain the other 40% as home equity. In other words, a lump-sum, fixed-rate reverse mortgage payout is a one-time draw. With the adjustable-rate option, your remaining 40% will automatically be set up as a line of credit (unless you state otherwise), which can be accessed in the second year of your loan.
Margin: This is the interest percentage that is added to the index by the lender. The margin rate is permanent, meaning that after loan origination, the margin stays the same throughout the loan term, regardless of what the index may change to.
Maturity Event: A reverse mortgage becomes due and payable when a maturity event occurs. A maturity event occurs when a borrower:
- Sells the home
- Conveys title of the property to someone else
- Passes away
- Resides outside of the principal residence for more than 12 consecutive months
- Fails to maintain the home, or
- Fails to maintain the mandatory obligations of the loan (such as failing to pay property taxes or insurance premiums) and all options to bring the loan current have been exhausted.
- Failed to comply with loan terms not listed above.
Non-Recourse Loan: This is a loan, secured by a pledge of collateral, typically real property, for which the borrower or his heirs are not personally liable. A federally-insured Home Equity Conversion Mortgage is a non-recourse loan, meaning the lender or the government can’t ask you or your heirs to make up the shortfall should the loan amount owed be greater than the value of the home.
Maximum Claim Amount: The lesser of a home’s appraised value or the maximum loan limit that can be insured by FHA. It is used in determining the principal limit.
Miscellaneous Costs: Catchall term comprising such upfront borrower costs as counseling, the appraisal, mortgage insurance premium, loan origination fee, and other lender service fees and services. Also referred to as settlement costs.
Modified Tenure: With modified tenure, the borrower can combine two payment methods: a tenure plan with a line of credit. The “tenure” portion makes it possible for the borrower to receive monthly payments for life for as long as the borrower lives in the home as their primary residence and complies with all loan terms, which include maintaining the home and paying all property taxes and homeowners insurance. The line of credit portion allows the borrower to draw upon it as needed. By combining the two options, the borrower is able to address both short- and long-term cash flow needs.
Modified Term: The borrower may combine a line of credit with monthly payments for a fixed period of months selected by the borrower. In exchange for reduced monthly payments, the borrower will set aside a specified amount of money for a line of credit that can be drawn on until the line of credit is exhausted.
Monthly Payments: This option allows borrowers to choose a fixed monthly payment for a specified amount of time (see Term payments). However, borrowers also have the option to receive fixed monthly payments for as long as they reside in the home and comply with the loan terms (see Tenure payments). The amount received each month will not change, even if the home decreases in value. A monthly payments option is only available on a variable interest rate.
Mortgage: A mortgage is a loan from a financial institution that the borrower is obligated to pay back. The collateral for the mortgage is the home itself. As such, a mortgage is considered a lien against the property until such time that it is repaid.
Mortgagee – The lender
Mortgage Insurance Premium (MIP): The MIP financially protects both the HECM borrower and the HECM lender. It guarantees to the borrower that if the servicer managing your payments goes out of business, the government will step in and make sure you continue to receive your money. Furthermore, the MIP guarantees that you will never owe more than the value of your home when the HECM must be repaid. For lenders, the MIP means the government will pay them back if they lose money on loans that default. At the loan closing, the borrower pays a one-time MIP equal to 2% of the home’s appraised value or FHA lending limit, whichever amount is less. Borrowers can use their loan proceeds to pay for this upfront insurance cost. The borrower is also responsible for an annual MIP equal to 0.5% of the outstanding balance. This annual fee doesn’t come out of your available loan proceeds. Rather, it accrues over time and you pay it once the loan is called due and payable.
Mortgagor: The borrower.
Net Principal Limit: Amount of funds you are eligible to receive at closing after loan costs have been deducted.
Non-Borrowing Spouse: One of the requirements for obtaining a Home Equity Conversion Mortgage is the borrower must be 62 or older. However, in the case of a married couple, where only one spouse is 62 or older, they can still be eligible for a HECM by listing the underage spouse as a “non-borrowing spouse.” Although this option will reduce the couple’s payout — because reverse mortgage proceeds are based on the youngest spouse’s age — the non-borrowing spouse receives important protections. Namely, if the older spouse dies, the non-borrowing spouse may remain in the home, provided that the surviving spouse establishes within 90 days that they have a legal right to stay in the home. The surviving spouse also must continue to follow all terms and conditions of the existing reverse mortgage, such as paying property taxes and homeowners insurance. The non-borrowing surviving spouse, however, has no legal right to the remaining loan balance after the borrowing spouse passes. Payouts would cease.
No Prepayment Penalty: Borrowers can pay off their reverse mortgage anytime without penalty.
NRMLA: The National Reverse Mortgage Lenders Association (NRMLA) is the national voice of the reverse mortgage industry, serving as an educational resource, policy advocate and public affairs center for lenders and related professionals. NRMLA was established in 1997 to enhance the professionalism of the reverse mortgage business.
Principal Limit: The total loan proceeds available at closing.
Proprietary Reverse Mortgage Loan: This option is for senior homeowners with high-value properties who wish to access more equity than the HECM federally-set borrowing limit allows. For example, AAG’s Advantage Proprietary Reverse Mortgage makes loans up to $4 million. Proprietary reverse mortgages are not insured by the FHA.
Reverse Mortgage Calculator: By inputting such variables as age, home value, and mortgage balance into a reverse mortgage calculator, potential borrowers can estimate how much money they might receive from a reverse mortgage.
Refinance: This option is designed for senior homeowners with a current reverse mortgage loan. Popular reasons for refinancing include taking advantage of a lower interest rate, adding a spouse to the mortgage, or accessing more cash when the equity in the home rises due to an increase in the home’s value.
Right of Rescission: A borrower’s right to cancel a reverse mortgage loan within three business days of closing.
Sequence of Returns Risk: A retiree’s retirement account may be negatively impacted if they begin taking withdrawals in down market years early in retirement. While the average return or percentage earned on investments is important to portfolio performance, when those returns occur — the sequence in which they occur — can be just as important. For example, a retiree making regular withdrawals who experiences good, then poor, market years early in retirement will have more money left in their portfolio than a retiree making regular withdrawals who experiences poor, then good, market years. To offset sequence of returns risk, some investors in down markets choose to make withdrawals from other accounts or sources of income, such as a tax-free reverse mortgage loan proceeds or a guaranteed annuity, that are not subject to stock market swings.
Settlement Costs: These costs typically refer to closing costs from third parties, which can include an appraisal, title search, insurance, surveys, inspections, recording fees, mortgage taxes, credit checks and other miscellaneous fees.
Term Plan-In this payout plan, you choose to receive equal monthly payments over a finite period, such as 10 or 20 years. Although your payments will stop at some point, you can continue living in the home as your principal residence until a maturity event occurs, such as selling, moving out, passing away or otherwise failing to live up to your loan terms, such as paying your property taxes and homeowners insurance.
Tenure Plan- In this payment plan, you receive equal monthly payments for life as long as at least one borrower lives in the home as a principal residence and all loan terms continue to be met, which include maintaining the home and paying all property taxes and homeowners insurance, and comply with all other loan terms.
Third-party charges: Third parties charge their own fees for closing costs, such as the appraisal, title search, inspections, recording fees and the like. These are not lender charges, but fees charged by a third party.
Total Annual Loan Cost (TALC) Rate: The Total Annual Loan Cost or TALC is an estimate, expressed as a percentage, of what a reverse mortgage could cost the borrower over the years. The TALC rates are projected based on several factors, including future value of all advances, life expectancy, current property value, and potential future property appreciation.