The current article will delve into the **liquidity benefits of a reverse mortgage**, but to do so, we need to understand how liquidity is tapped from a home's equity by the owner utilizing a reverse mortgage. We need to understand the calculations to know how much equity a HECM reverse mortgage can provide. Please read the previous three articles on reverse mortgages before delving into this section on liquidity. Here is a list:

Mathematically, What is a Reverse Mortgage?

This article gives a brief numeric description of a reverse mortgage versus an amortizing mortgage.

Comparing an Amortizing Mortgage to a Reverse Mortgage

This article compares the amortization schedule of an amortizing mortgage to a reverse amortization schedule of a reverse mortgage.

Reverse Mortgages in a Low Interest Rate Environment

This article highlights the effects of interest rate levels on the economics of a reverse mortgage versus an amortizing mortgage.

Let's discuss the "**principal limit factor**" and the "**initial ****principal limit**," two variables used to determine a home's equity accessibility via a HECM reverse mortgage.

The "**principal limit factor**" is used in determining the "**initial ****principal limit**," which further drives the "**initial cash advance**" and the available "**line of credit**."

The "**principal limit factor**" is based on the "**age of the youngest borrower**"** **and the "**expected rate.**" The "**age of the youngest borrower**" and the "**expected rate**" are used to obtain the "**principal limit factor**" from a table with HUD.

The "**initial ****principal limit**" is based on the "**principal limit factor**" multiplied by the "**maximum claim amount**." The "**maximum claim amount**." is the lesser of the "**initial property value**" or $1,149,850. $1,149,850 is the maximum claim amount available for a HECM FHA reverse mortgage.

In the previous article there was an "initial cash advance" of $21,400 in our 2nd example forwarded to the borrower at closing. In addition, there is a growing "**line of credit**", $78,968, at the end of year 1.

The reason for the "**initial cash advance**" and the "**line of credit**" is the change in the "**principal limit factor**" resulting from a shift in the "**expected rate**" on the HECM reverse mortgage from 7% to 3%.

The "**principal limit factor**" for "**age of the youngest borrower**"** **of 55** **and the "**expected rate**" of 3% is .484.

The "**principal limit factor**" for "**age of the youngest borrower**"** **of 55** **and the "**expected rate**" of 7% is .257.

The "**initial principal limit**" for a property value of $442,149 and a "**principal limit factor**" of .484 is $214,000 ($442,149 x .484).

The "**initial ****principal limit**" for a property value of $442,149 and a "**principal limit factor**" of .257 is $113,632 ($442,149 x .257).

Here is a flow chart depicting the relationship between "**age of the youngest borrower**" and "**expected rate**" with the "**principal limit factor**" which drives the "**initial ****principal limit**".

Now we need to calculate the "**net principal limit**". The "**net principal limit**" is the "**initial principal limit**" less any "**mandatory obligations.**" The "**mandatory obligations**" would be any existing liens, the upfront MIP, and the other closing costs. Below is a flow chart showing how the "**net principal limit**" is derived.

Now, we need to calculate the "**initial advance**." The "**initial advance**" is typically 10% of the "**initial principal limit**" unless the "**net principal limit**" is **insufficient** to allow for the total amount. If the "**net principal limit**" is less than the "**initial advance**," the "**net principal limit**" will supersede the "**initial advance**" ("**initial principal limit**" multiplied by **10%**), and the "**net principal limit**" will become the "**initial advance**." If the "**net principal limit**" is not only below the "**initial advance**" but is **negative**, then the loan is considered "**short to close**."

In our original analysis, I set the property appraised value to $442,149, the age of the youngest borrower to 55, and the expected interest rate to 7% so that the "principal limit factor" resulted in a 0 "initial cash advance" and a "loan balance" equal to the "principal limit" so that the "line of credit" would be 0 throughout the life of the mortgage. The "line of credit" is the difference between the "principal limit" and the "loan amount."

**In Summary:**

The "**net principal limit**" will determine the **net available liquidity that can be accessed utilizing a reverse mortgage**.

Use the below to determine the "**principal limit factor**" from the HUD tables.

- "
**age of the youngest borrower**" - "
**expected rate**"

Take the "**principal limit factor**" multiplied by the "**maximum claim amount**." (derived from the lessor of the "**initial property value**" or **$1,149,850**) to determine the below:

- "
**initial****principal limit**"

**Subtract **the "**mandatory obligations**" (upfront MIP, other closing costs, and outstanding liens) from the "**initial principal limit**" to determine the below:

- "
**net principal limit**"

If the "**net principal limit**" is above the "**initial advance**," there is liquidity. If it is below the "**initial advance**" but still **positive**, there is some liquidity. If it is **negative**, the loan is "**short to close**," and there is no additional liquidity.

Note: If you want to run some calculations by changing the input, try this calculator, HECM Reverse Mortgage LOC Calculator. This calculator will automatically obtain the "**principal limit factor**" based on the "**age of the youngest borrower**" and the "**expected rate**." It will run all the calculations based on the required input, "**age of the youngest borrower**," "**expected rate**," "**initial property value**," and "**liens payoff**." It is best not to change the input for "**MIP (Upfront Mortgage Ins.)**" = **2%**, "**MIP (Ongoing Mortgage Ins.)**" = **.50%**, and "**Expected Appreciation**" = **4%**. These are relatively fixed.