Reverse Mortgage Interest Rate Choices
For most of the life of the HECM Reverse Mortgage, the only choice was an adjustable rate. It wasn't long ago that another choices became available. The fixed rate - long a favored choice for regular mortgages - became available for reverse mortgages. At about the same time, a different index was offered for adjustable rate reverse mortgages. In addition to the Treasury index, a LIBOR index was added.
Reverse Mortgage Adjustable Rate
For someone with a regular mortgage, an adjustable rate can be scary. If the rates go up, the payments go up. If the rates go up too much and the payments become more than the borrower can afford, they might find themselves unable to make the payments and could lose their home.
A reverse mortgage is different in that no monthly payments are made so the potential of losing your home because you can't make the payments is not there. Yes, if interest rates rise, you could be accruing more interest on your mortgage. But interest rates can also go down with lower interest accruing on your mortgage. I've seen both happen. I've also seen them go down, then up, then down again.
The adjustable rate is made up of two parts. The base is the index. Some constant financial instrument that the lender can't manipulate and one that is available to the public to watch is chosen.
Technical alert - You may wish to skip this. The most prevalent for the HECM Reverse Mortgage is the Treasury index. One place they can be seen is at the Federal Reserve Statistical Release site. The one year CMT (Constant Maturity Treasury) is used. To find it on this page, scroll down to U. S. Government Securities. Below that you will see Treasury constant maturities. Under Nominal 12 find 1-year. You will see they are posted daily. The rate of the index used to charge interest on this adjustable rate Reverse Mortgage will be the average of the days in the week. Add up the interest rate for each of the days and divide by the number of days. Normally this will be five. If one holiday is in the week, there will be four days with rates. To the right of the daily rates will be the last two full weeks with their average. To the right of that will be the monthly average of the previous month.
The adjustable rate is capped at 10 percentage points above the start rate for the monthly adjustable choice and 5 percentage points above the start rate for the annual adjustable rate. As an example, that means the most a 4% monthly adjustable can go up is 10 more percentage points to 14%. The 5% annual adjustable choice could go up 5 more percentage points to 10%.
Another index is LIBOR. It has only recently come into use on reverse mortgage. It has been used for quite some time on regular mortgages. LIBOR stands for London Inter-Bank Offer Rate. This is the rate banks charge one another for loans between themselves.
A lender who is doing their job will be aware of the difference between using the Treasury or the LIBOR index. At any one time, one or the other may be more advantageous to the client. The good loan originator will explain the value of this choice.
Added to the index will be the margin. For the longest time, the margin was 1.50%. Not long ago, it moved down to 1%. It has since moved to something over 2% at this writing. Lenders usually charge a margin that could be similar to most other lenders but not necessarily the exact same margin. Competition usually keeps them fairly close.
Reverse Mortgage Fixed Rate
A fixed rate has become available in the relatively recent past. Like regular mortgages, they may be slightly different from lender to lender. All that I have seen have some significant differences from the adjustable rate reverse mortgage
The most notable difference is that all of the available money most be taken up front as a lump sum distribution. This compares to the adjustable rate that allows for funds not needed now to be placed in a Line of Credit with interest not charged until used.
Also, like regular mortgages, the interest rate is higher for a fixed rate than for an adjustable rate. This difference is frequently 2-3% more for the fixed rate than the adjustable rate. If the adjustable rate were 4%, the fixed rate would frequently be in the 6-7% neighborhood.
The less money the borrower wishes to take up front compared to how much is required is what can take this from being a possible choice to a poor choice. As an example, if a borrower wanted to take $50,000 up front and the fixed rate choice had $250,000 available, that borrower would have to take all $250,000 up front.
Using the examples from the two paragraphs above, the borrower would be charged $15,000-17,500 in a year for $250,000 for a fixed rate in the 6-7% range. For an adjustable rate of 4% on $50,000, the amount of interest charged in one year would be $2,000. At the maximum capped rate of 14%, the interest charged in one year would be $7,000. Even though the borrower may draw from the line of credit over time and the balance would grow bigger, the fixed rate wouldn't appear to be the best choice.
What if the borrower had a $250,000 existing mortgage that was being paid off with the $250,000 available in a fixed rate mortgage. This is a closer call. While interest rates are below the 6-7% used in the example, the borrower would be paying more than necessary. While interest rates were above the 6-7%, the borrower would be saving money. As an example, while rates were still 4%, the annual interest would be $10,000 vs. the $15,000-17,500 of the fixed rate. When the adjustable rate grew to approach the 6-7% example, the savings would be less with the adjustable. At the maximum capped rate of 14%, the annual interest would be $35,000. While we all remember the late '70's and early '80s when interest rates grew into double digits, that hasn't happened for some time and may never happen again. While difficult to predict the future from the past, reverse mortgage monthly adjustable rates haven't been over 8% for the past 15 years.
However, if you have a large mortgage to pay off that is close to the amount available in a fixed rate reverse mortgage, it is worth looking closer to the pros and cons as they apply to your specific situation.
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