What Are the Costs?
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.
Origination Fee
An origination fee pays the lender for preparing your paperwork and processing your loan, also known as "originating" a loan. HECM rules limit this fee to 2% of your home's value or 2% of your county's 203-b limit, whichever is less. If this amount is less than $2,000, a lender is allowed to charge up to $2,000.
Example: On a $250,000 home the origination fee could be as high as $5,000, the 2% maximum. But some lenders charge less, so the amount may vary from one lender to another. It can pay to shop around or to negotiate 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 the 203-b limit in your area, 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 at the time the loan is repaid. 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, can be as much as $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 74-year-old borrower living in a $250,000 home in May of 2006 who borrows one-half of the maximum loan amount at closing, the total amount paid during her remaining life expectancy (12 years) could be about $7,800.
Servicing Fee
"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 74-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.
Interest Rates
Almost all lenders charge adjustable interest rates on HECM loans. This means that the rate can go up or down. But lenders don't have any control over what the rate will be when the loan closes, or how it will change over time, because it's tied to the current one-year U. S. Treasury Security rate.
HECM lenders must offer you a rate that can change once each year. But any change in this rate:
- must be the same change (up or down) that occurred in the one-year Treasury rate;
- is limited or "capped" at 2 percentage points per year and 5 total points over the life of the loan.
A HECM lender may also offer a lower rate that can change every month. Changes in this monthly adjustable rate also must be tied to the one-year Treasury rate. But the only limit is a 10 percentage point cap over the life of the loan.
During any given week, all HECM lenders currently (December, 2006) charge the same interest rates on each adjustable rate option. At present, they charge the current one-year Treasury rate plus the "margin" set by Fannie Mae. The advantages of each interest rate option and more information on the Fannie Mae margin are discussed in an article on "Picking an Interest Rate" in the Key Decisions section of this web site's Reverse Mortgages information.
Total Loan Costs
If you've been keeping track of all the upfront and ongoing costs described for a 74-year-old borrower in a $250,000 home in May of 2006, you know that the total—not including interest—could be about $25,000. For higher-valued homes, the non-interest costs could exceed $30,000, and for the youngest borrowers (aged 62) in higher-valued homes ($362,790 or more) in the areas with the highest 3rd-party closing costs (Broward, Collier, Palm Beach, and Miami-Dade Counties in Florida), the total of all non-interest costs could exceed $50,000.
But the true, total cost of a reverse mortgage depends on factors other than the kind of itemized costs discussed in this article. In fact, it is highly unlikely that two reverse mortgages with exactly the same itemized costs at closing will end up costing the same when the loan is finally repaid. To find out why, read the article on "Total Costs & Model Specifications" in the Basics section of this site.
AARP does not endorse any reverse mortgage lender or product.
