When considering a Home Equity Conversion Mortgage (HECM) quote, more commonly known as a federally-insured reverse mortgage loan, you will likely have questions about interest rates. After all, these rates play a big part in how much money you can qualify for. Unlike reverse mortgage fees, interest rates are not always easy to understand. It is essential however to learn the answers to commonly asked questions in order to choose the reverse mortgage loan that would be the most beneficial for you.
How Do Reverse Mortgage Rates Work?
As with most other loans and credit lines, reverse mortgage interest rates are charged on the funds that you receive from your loan. These charges are calculated daily and added to the loan balance monthly, and can be found on every borrower’s monthly statement.
The unique part about reverse mortgages is that interest payments on your loan are deferred to the end of the life of the loan: they are not paid up-front, out-of-pocket, or monthly. While most loans require monthly minimum payments to repay the loan balance and all associated interest charges over time, reverse mortgages defer all loan and interest repayment to when the loan matures. Reverse mortgage loan maturity events come about if:
- The home is sold
- All of the borrowers either move out of the home or pass away
- The loan goes into default through a borrower’s failure to pay property taxes and homeowner’s insurance, and comply with all of the loan terms
In your research, there is some interest rate jargon that may intimidate you from getting a reverse mortgage, but there is no need to worry. With help from this article and your personal reverse mortgage professional, you can learn everything you need to know. Read on for important insight into reverse mortgage interest rates.
How Are Reverse Mortgage Interest Rates Calculated?
Fixed Interest Rates:
Fixed interest rates are usually decided upon by investors and various government agencies whose job it is to keep these rates stable. As an example, the National Reverse Mortgage Lenders Association (NRMLA) reverse mortgage calculator lists an average HECM fixed rate of 5.060% for the month of December 2016. Actual rates available to borrowers will vary and are dependent on loan factors.
Variable Interest Rates:
Variable rates are different from fixed rates in that they are composed of two parts: an Index and a Margin.
- Index – An index is a standard rate that changes depending on market interest rates. It is not controlled by the lender. The rate charged on your loan can go up or down depending on if the index goes up or down. At the time of writing (December 5, 2016), the variable 1-month LIBOR index is listed at 0.62% and the variable 1-year LIBOR rate at 1.65%. For current listed rates, a recommended resource is Bankrate.com.
- The LIBOR Index (London Interbank Offered Rate) is the rate at which banks borrow money from other banks, and this is the index that variable rate loans are based off of.
- Currently, all HECM reverse mortgage variable rates are LIBOR based. The 1-month and 1-year LIBOR rates are most commonly used.
- Margin– The margin is the interest percentage that is added to the index by the lender. The margin rate is not adjustable, meaning that after loan origination, the margin stays the same throughout the loan term, regardless of what the index may change to.
Fixed Rate Reverse Mortgage Loan
According to a recent HECMCounselors.org training manual on reverse mortgages, these rates have come to be a favorite in the HECM marketplace since 2009, with about 67% of originated reverse mortgage loans having a fixed rate. They are popular with borrowers because they eliminate the risk that their rate will increase. But, this does not necessarily mean that it is the best loan type for you. There are pros and cons to a fixed rate loan:
- Fixed rates are certain to remain the same for the entire loan term, so you are protected if market rates rise.
- Borrowers who choose a fixed rate reverse mortgage must take their funds as a lump sum, as opposed to other disbursement options offered at a variable rate.
- When taking a lump sum, borrowers are restricted to pull only up to 58% of the principal limit of the loan.
Due to these details, fixed rate reverse mortgages are usually best for borrowers who plan to use their reverse mortgage funds all at once, such as to pay off an existing mortgage or other debt, or to make major home repairs or modifications.
Variable Rate Reverse Mortgages
The less popular, but oftentimes the more flexible option, is the variable rate. Just as the fixed rate is “fixed” for the loan period, a variable rate varies throughout the loan period. There are pros and cons to variable rate reverse mortgages:
- They come with more disbursement options then a fixed rate loan. Borrowers may choose between a line of credit, monthly payments, a lump sum, or a combination of the three.
- Interest is only charged on funds that have been withdrawn. This means that, if you have a line of credit that you rarely use, you will only be charged interest on the amount withdrawn.
- Unused lines of credit may also grow with time, allowing the borrower even more flexibility in the amount available for them to borrow.
- Greater risk of your interest rate rising quickly and drastically.
In general, variable rates are best for borrowers who plan to use their reverse mortgage funds over time, or in rare instances. In this way, borrowers may use it to add to their existing fixed income every month, to supplement their other retirement accounts, or as a stand by account so money is readily available in the case of an emergency.
How Often Does a Variable Rate Change?
All variable rates are subject to reset to the market-based index rate at a predetermined frequency. How often the rate on your variable rate loan will change depends on the frequency you choose. Here are your frequency options:
- Yearly-Variable – As the name suggests, a yearly variable rate changes to the market based index once per year. It has these characteristics:
- Offers protection against steep and rapid rate changes.
- Offers lower principle limits.
- Rate changes may be no more or less than 2% at each yearly adjustment.
- The potential changes in interest rate over the life of the loan are typically capped at a 5%.
- Yearly variable rates are preferred by those borrowers who anticipate sharp or frequent increases in rates over the coming years.
- Monthly-Variable – As the more common offer from lenders, a monthly variable has the following particular characteristics:
- Typically the lower available rate.
- May change more often and more dramatically over the life of the loan.
- The potential changes in interest rate over the life of the loan are typically capped at a 10%.
- The monthly cap on changes is also 10%, meaning that it is possible for the monthly variable rate to change as drastically as 10% in a single month. However, this would mean the underlying index rate has changed this quickly and dramatically, which is unlikely.
- Because monthly-variable rates are the lower available rate initially, and because of the potential for growth of the line of credit option available with the monthly-variable, borrowers who want to maximize their available funds after loan closing prefer it over the yearly-variable option.
Other Interest Rate Terms
Initial Interest Rate (IIR)
This is related to variable rate loans also known as the note rate. This is the rate that is used to calculate interest through the life of the loan, and it will be the borrower’s interest rate for the first month or year of the loan. The reason for the short term is because the rate will only be in effect for the first LIBOR index rate period. When the lender uses the LIBOR, the IIR will be based on the 1-month LIBOR. The 1 year LIBOR is also possible but not as common.
Expected Interest Rate (EIR)
This may apply to both variable and fixed rate loans. The Expected Interest Rate is what the lender estimates the average rate will be over the life of the loan. For a variable rate loan, it is based on a 10-year index such as the 10-year Treasury rate. For a fixed-rate HECM, the Expected Interest Rate is the exact same as the Initial Interest Rate because the rate will not change over the loan term. The reason for the long-term index is because it is an attempted prediction of the rates over the loan’s life. The EIR never changes during the life of the loan. There are a few reasons that the EIR is used:
- To determine principal limits
- To calculate the service fee set aside
- To calculate monthly disbursement option amounts
Also known as the Total Loan Rate, this is the rate at which the balance of your HECM reverse mortgage loan grows. It is the sum of two charges:
- An annual Mortgage Insurance Premium (MIP) of 0.5%
- The current interest rates being charged (the note rate)
For borrowers who choose the line of credit disbursement option, it is good to note that the credit line grows at the same rate that the loan balance does.
How Do Interest Rates Affect Me?
There are a few reasons why choosing the best rate for your situation is important:
- A lower rate will lead to less interest charges over the loan’s life, and will thus directly affect how much equity could be left at the end of the loan.
- A lower Expected Interest Rate (EIR) + a lower margin = a higher principal lending limit, which translates into more funds available to you.
Since there are no monthly mortgage payments, reverse mortgage rate increases won’t make the loan unaffordable to you. When compared to traditional forward mortgages, the reverse mortgage loan holds an advantage in the sense that there is no threat of an unexpected mortgage payment increase due to inflated market rates.
There are also a few other factors that interact with your interest rates that determine how much money is available to you from a reverse mortgage:
- Your age
- The amount of your remaining mortgage balance
- Your home’s appraised value
- A financial assessment of your ability to pay property taxes and homeowner’s insurance
A solid combination of older age, lower mortgage balance, higher appraised home value, and lower interest rates will help garner you the most funds possible.
What Will My Interest Rate Be?
Your interest rate depends on a culmination of a few factors:
- Whether you are planning on getting a HECM reverse mortgage or a HECM for Purchase
- Your age
- Your home’s value
- Your property zip code
- Any existing mortgage balance or liens
- Number of expected years in the house
- Your life expectancy
- The disbursement option chosen