Almost all the costs of a Home Equity Conversion Mortgage (HECM) can be "financed," that is, they can be paid from the proceeds of this reverse mortgage loan. Financing the costs reduces the amount available to you, but it also reduces your out-of-pocket cost. The itemized costs of a HECM loan include an origination fee, third-party closing costs, a mortgage insurance premium, a servicing fee, and interest. We'll explain each in detail.
An origination fee pays the lender for preparing your paperwork and processing your loan, also known as "originating" a loan. If your home is worth less than $125,000, a lender can charge up to $2,500 for this fee. If it is worth more than $100,000, the fee is limited to 2% of the first $200,000 of your home’s value plus 1% of any amount over $200,000, up to an absolute limit of $6,000.
Example: On a $250,000 home the origination fee limit would be $4,500 (2% X $200,000 = $4,000 plus 1% of $50,000 = $500). Origination fees vary from one lender to another, so it can pay to shop around and negotiate this fee with lenders.
3rd-Party Closing Costs
A "closing" is a meeting at which legal documents are signed to "close the deal" on setting up a mortgage. The date of closing is the day on which a mortgage begins.
Closing a mortgage requires a variety of services by people other than the lender. These people are called "third parties." Their services include an appraisal, title search and insurance, surveys, inspections, recording fees, mortgage taxes, credit checks, and others.
Third-party closing costs on a HECM loan vary with the value of the home and from one state or area to another. But all the HECM lenders in a given area are likely to charge about the same closing costs on any specific loan. The total of all these costs generally ranges from about $2,000 to $3,000, although they are greater that $3,000 in some states, and less than $2,000 in others.
A lender may require a cash application fee to pay for an appraisal and minimal credit check. Some will refund this fee to you. Others will apply it to your origination fee or third-party closing costs.
Mortgage Insurance Premium (MIP)
HECM insurance guarantees that you will receive your promised loan advances and not have to repay the loan for as long as you live in your home, no matter:
• how long you live there;
• what happens to your home's value; and
• what happens to your lender.
You pay for this insurance in two parts:
• 2% of your home's value (or 2% of HUD’s home value limit, whichever is less) is charged "upfront" at closing; and
• 0.5% is added to the interest rate charged on your rising loan balance.
This two-part mortgage insurance premium (MIP) can be financed with the loan. The MIP also guarantees that your total debt can never be greater that the value of your home if it is sold to repay the loan. It makes it possible for you to keep getting your monthly loan advances or growing creditline as promised even if:
• you live much longer than others your age;
• your home's value grows very little, not at all, or declines, or;
• your loan balance catches up to—and then is limited by—the value of your home.
As a government program, HECM insurance does not make a profit. The premiums paid by all borrowers are used to continue making loan advances to—and limit the amount owed by—the borrowers who live the longest and whose home values grow the least or decline.
But the MIP is a substantial cost. The upfront portion on a $250,000 home, for example, would be $5,000. The cost of the 0.5% added to the interest rate depends on how much money you borrow, when you borrow it, and the interest rate on the loan. For a 75-year-old borrower living in a $250,000 home who borrows one-half of the maximum loan amount at closing at an expected rate 7%, the cost during her remaining life expectancy (12 years) could be about $7,900.
"Servicing" a loan is everything lenders or their agents do after closing it. This includes sending payments to you, making or changing loan advances at your request, transferring insurance premiums to the Federal Housing Administration (FHA), sending account statements, paying property taxes and insurance from the loan at your request, and monitoring your obligations under the loan agreement.
FHA limits the servicing fee to $30 per month if the loan has an annually adjustable interest rate, and to $35 if the rate is monthly adjustable (see below). But the amount of this fee can vary from lender to lender within these limits. So it can pay to shop around.
To finance this fee with the loan, a lender is required to "set aside" a prescribed dollar amount and deduct it from your available loan funds. But this total amount is not added to your loan balance at closing. Instead, the monthly fee is added to your loan balance each month.
The FHA requires lenders to "set aside" enough to pay the monthly fee every month until the borrower would reach age 100. Since few borrowers live to age 100, the total amount set aside overstates the actual amount likely to be charged on most loans.
The total amount actually paid in servicing costs depends on the amount of the monthly charge plus how long it is paid. For a 75-year-old borrower who pays $35 per month for her remaining life expectancy (12 years), that would be $5,040.
On traditional "forward" mortgages, the cost of servicing is added to the interest rate. So you may not have seen this fee before, but you've paid it.
Total Non-Interest Costs
If you’ve been keeping track of all the upfront and ongoing costs described for a 75-year-old borrower in a $250,000 home, you know that the total—not including interest—could be about $25,000. For the youngest borrowers (aged 62) in higher-valued homes ($625,500 or more) in the areas with higher 3rd-party closing costs ($4,000) the total of all non-interest costs could be over $70,000.
Interest Charges and Total Costs
The largest single cost of any reverse mortgage is generally the interest that is charged on these loans. For example, a 75-year-old borrower living in a $250,000 home qualifies for a HECM creditline of about $135,484 at 7% expected interest. If this homeowner takes one-half of that amount ($67,742) as a lump sum at closing, she would immediately owe that $67,742 plus about $12,000 in upfront costs, for a total of $89,742.
The remaining life expectancy of a 75-year-old borrower assumed in the HECM program is 12 years. If this borrower lives in her home that long, the total amount of interest added to her loan balance at 7% interest would be $111,056 if the interest rate does not change over the life of the loan. So after 12 years, at age 87, she would owe the initial $67,742 she borrowed plus $12,000 in upfront costs, $7,933 in monthly mortgage insurance premiums (MIPs), $5,040 in servicing fees, and $111,056 in interest charges for a total of $203,771.
AARP does not endorse any reverse mortgage lender or product.