Expected rates have gone up and down each week over the last several years, yet the principal limits have remained constant. The reason these rate changes have not affected principal limits is because HUD’s principal limit factors (PLFs) top out at 5.06 percent and stay the same for all expected rates equal to, or lower than, that rate. 

However, in the last six months, fixed and variable products with expected rates higher than 5.06 percent are starting to appear. So how do we know what to expect when expected rates change in a higher rate environment? To know the answer, we must first understand HUD’s factor table.

Using HUD’s factor table, we match the youngest borrower’s age with the expected rate on the loan. This results in a factor, or percentage, that determines the principal limit available to the borrower when multiplied against the maximum claim amount. This factor table is broken down into expected rates from 3 to 10 percent in increments of one-eighth. Each one-eighth of a percent has a list of factors for ages 62 through 99. Most factors top out at 90, so everyone 90 and older receives the same factor or principal limit. As expected rates climb higher than 5.06 percent, the factors for each age will start to drop lower. If expected rates were to climb higher than 10.06 percent, the factors and principal limits drop to zero.

Now let’s examine how changes in the expected rate index cause a change in the principal limit. First is the obvious: It is rare for expected rates to be exactly equal to an even one-eighth of a percent, like 5.000, 5.125, 5.250 percent and so on, in HUD’s factor table. So which factor column gets used for 5.56 or 5.57 percent? HUD requires rounding the expected rate to the nearest eighth. For example, 5.56 percent would round to 5.50 percent so we use the 5.50 percent factors, and 5.57 percent is closer to 5.625 percent so we would use the 5.625 percent factors. Although this sounds simple, it can still cause much confusion.

People have asked me, “How come the principal limit went down when the expected rate barely went up?” Or they’ll say, “Sometimes the expected rate has gone down a good amount and the principal limit doesn’t get any better.” The explanation lies in the rounded expected rates. That one basis point, or 1/100 of a percentage increase from 5.56 to 5.57 percent, caused the principal limit to go down because it was rounded to different factor columns. However, that same 5.56 percent expected rate would have to go down 13 basis points, or 13/100, in order to round down to the 5.375 percent factor column, which results in a higher principal limit. The opposite could be true as well. A small adjustment down could result in a higher principal limit and a larger adjustment up could still give you the same principal limit.

The expected rate is also found in two other formulas in a HECM loan. It is used to calculate tenure and term monthly payments, and is also used in the servicing fee set-aside formula. But in these formulas, the expected rate is NOT rounded like it is to determine the principal limit. So how do changes in the expected rate affect these calculations? A higher expected rate actually produces a lower servicing fee set aside, which is good for the borrower, and when using the same amount of funds available for calculating a monthly payment, a higher expected rate produces a higher monthly payment, which is also better for the borrower. To reiterate, you could see a change in the expected rate from one week to the next that would result in the same principal limit, but the tenure payment would still go up or down a little because that formula uses the unrounded expected rate.

So what should you expect when the expected rate changes? You may see possible alterations to the principal limit, since the rate change caused the expected rate to round to a different eighth, therefore putting it into a different factor column. Every time the expected rate moves, you can also expect to see a change in the monthly tenure payment. Also note that if an expected rate increase causes the principal limit to drop, in most cases (but not all), the tenure payment would drop as well because there are fewer funds available for the tenure payment.

I hope this explanation brings a little understanding to the often misunderstood expected rate and assists you when dealing with HECM loans.