Have you been thinking about a reverse mortgage but worried about inflation and rising interest rates? I recently had a borrower tell me that he was considering one but felt that he may have missed his opportunity before rates started to increase due to recent Fed rate hikes and inflation.
He stated that he probably would not benefit now, with all the uncertainty of the future and based on everything that was going on in the economy, (inflation, interest rates, etc.) he just did not think a reverse mortgage made sense for him. I told him that the loan was a personal decision for each borrower and that it needed to make sense for each person and their circumstances.
With inflation currently at 8.5% and interest rates on the rise, now might actually be the best time to consider a reverse mortgage line of credit!
HOW CAN INFLATION AND HIGHER RATES MAKE IT AN OPPORTUNE TIME TO TAKE A REVERSE MORTGAGE?…
1. HIGHEST PROPERTY VALUES IN YEARS
Property values are currently at the highest level in most areas than they have ever been. Those values are one of the factors that determine how much money a borrower will receive with their reverse mortgage loan.
With all the pressure the housing values will soon be under due to rising rates (there have been as many as 6 or more additional rate hikes reportedly planned by the Fed for later this year), property values may soon begin to decline.
It’s true that rates have increased somewhat already, but they are still near the floor rate for the HUD HECM line of credit program. So currently they have not deeply impacted borrowers’ borrowing ability.
2. HIGHER FUTURE RATES = INCREASED LINE OF CREDIT GROWTH RATE
Next, we discussed the effect of future rate hikes for borrowers who have reverse mortgages. The line of credit growth rate is determined by the current interest rate plus the MIP renewal rate and is applied to the unused line of credit.
Simply put, if the rates increase and you still have a large line available to you that you have not yet borrowed, you actually are helped by the increase in rates because your line of credit available grows at a greater rate on the unused portion of the line.
If the rate increases to 5% and you haven’t taken the funds yet, you are not accruing interest but your line of credit available to you is growing at 5 1/2% (5% plus ½% MIP accrual on the unused line). If the rates come back down later, you keep the additional funds available in your line of credit.
If you never use them you never accrue interest on them, but if you ever need them they are there for you.
3. UNLIKE A TRADITIONAL LINE OF CREDIT (HELOC) – HECM LINE OF CREDIT CANNOT BE FROZEN
Another thing to keep in mind with a reverse mortgage is that unlike a Home Equity Line of Credit (HELOC), you have guaranteed access to the line of credit for as long as there are funds in your line.
You sustain the terms of the program. Unlike the HELOC, you do not have to worry about a bank freezing your line because they are afraid your property value has gone down, your income is not the same, or they just don’t want to do those loans anymore.
And if you don’t think that can happen, talk to anyone who had their line frozen or closed sometime between 2009 and 2012. If they are like me, it happened when they were never late on their loan, they may not have had any or much balance owed on the line and it might have happened just when they needed it most.
That cannot happen with a reverse mortgage.
As long as you live in the home, pay your taxes, insurance and any other property charges on time, maintain the home in a reasonable manner and adhere to the terms of the loan, you will always have access to your funds.
In fact, if the lender doesn’t pay you on time under a reverse mortgage, you are entitled to a late charge from them and your loan is backed by HUD.
HELOC vs Reverse Mortgage Product Comparison
Compare Features Traditional Home Equity Line of Credit (HELOC) Home Equity Conversion Mortgage (HECM) Proprietary Reverse Mortgage
Borrower Minimum Age 18 62 55
Line of Credit Term 10 Years Lifetime 10 Years
May Be Frozen Yes* No* Yes*
Line of Credit Growth Rate No For Life 7 Years
$0 Monthly Payment Option No Yes Yes
Income Requirements Yes Limited Limited
Credit Score 680+ Any Any
Reserves 2-6 Months PITI Any Any
Low/No Closing Costs No No Yes
Fixed Interest Rate No No No
Common Index Prime Rate Treasury Treasury
**All line of credit programs may be frozen if you fail to maintain taxes and insurance, or leave your home as your primary residence. If you enter bankruptcy, courts will not allow you to incur new debt while in BK proceedings and therefore your line of credit during this time could also be frozen.
4. INVESTMENT PROTECTION
We are not licensed financial advisors and we would always direct you to discuss all financial decisions with your financial planners before making any decisions but we would encourage you to discuss the benefits and pitfalls of selling your investments in down markets and rising rate markets should the need arise.
A reverse mortgage can give you access to borrowed funds that you can choose to repay at any time without penalty or on which you can choose to make no repayments for as long as you live in your home.
Unlike other sources of funds, with a reverse mortgage you do not lock yourself into losses by selling investments during down markets and you can choose how much of your line to access and if you want to repay them early or make no mortgage payments and let the home repay the loan when it is sold.
You don’t deplete your investment assets nor do you put yourself in a bind paying payments on loans which can have a double negative effect in a down market if you need funds. Again, we would always recommend you discuss your circumstances with your trusted financial advisor, but many of the borrowers who come to us do so at the urging of their financial experts for just this reason.
WHY NOW IS THE BEST TIME FOR A REVERSE MORTGAGE
Only you can determine if a reverse mortgage is right for you. But values will likely not be higher for a long time to come and if history is any indication, there are signs that they may begin to erode with the coming rate increases.
As rates increase, that would also lower the amount of money borrowers would receive under the reverse mortgage programs for future loans. Those two factors combined might just make now the best time for a very long time to come for many borrowers to act.
I would never suggest that borrowers close a loan with the intent of refinancing the loan or only if the loan could be refinanced in the future. But there is always the option to refinance if the future lending and rate conditions are such that a refinance of the loan would benefit the borrower with better terms and more funds.
This means that if values and rates are such that in the future the borrower could get better loan terms with a refinance. Borrowers who do not choose to take full advantage of the current market values and rates, before any additional upward pressure on rates or downward pressure on values occurs, may never get the opportunity to utilize all their current equity at today’s interest rates. And they would certainly not be able to take advantage of the increased credit line growth during higher interest rate periods if they chose not to open the loan.
The bottom line is, if you are thinking about a reverse mortgage, now may be the best time in your life to get the most possible proceeds and then benefit from higher credit line growths after you close your loan. No one knows exactly what the future will do or when.
We are already seeing signs of a slowing real estate market, and we have seen rates increasing which have already changed the proceeds available in some cases, so we certainly have a clear indication of the current trend.
If you have not considered a reverse mortgage and would not consider one, then I would never try to convince you to get one. However, if you are considering one, I would reassure you that now is still a great time and advise you to act as quickly as you are comfortable. If you have any questions at all please don’t hesitate to contact us.
What’s the difference between a bank HELOC and a HECM line of credit?
A bank Home Equity Line of Credit (HELOC) is a line of credit secured by your home that a bank controls and can freeze or eliminate at any time (subject to the terms of the security instruments). This means that if the Bank decides to change the terms by lowering the line available or close it entirely, the banks can do so at any time with the only provision being they must honor the terms of the Note and Deed on any outstanding funds.
There is usually a draw period during which time the payment may be for interest only, followed by the repayment period during which time the payment can increase as much as 200 – 300% and the loan balance must be repaid. Even during the draw period when the payments may be interest only, payments must be made. Then later when most senior borrowers’ incomes are lower, the payments can be considerably higher. A Home Equity Conversion Mortgage is also known as a reverse mortgage. Borrowers are not required to pay a monthly mortgage payment on a reverse mortgage but can choose to do so at any time, in any amount without penalty.
Borrowers are guaranteed to have access to their full loan amount for as long as they still have funds available and the lender cannot simply change their mind and decide not to offer the program any longer. The loan is not due and payable until the borrower no longer lives in the home or does not pay their taxes and insurance in a timely manner so it is important that borrowers pay their taxes and insurance in a timely manner but then as long as they do and live in the home, they can continue to live in the home and access all their funds without having to pay a mortgage payment.
How does the reverse mortgage line of credit growth rate work?
When you have remaining funds left in your line of credit on a reverse mortgage, that line of credit increases by a percentage equal to the interest rate of the loan plus the mortgage insurance premium (MIP) renewal rate (currently .5%). So if your loan interest rate is 3% and your MIP is .5%, your line of credit grows on the unused funds at a rate of 3.5%. This is not interest you are earning as these funds are not in a bank account in your name.
But since you are not accruing interest on them either because you have not borrowed them but you could have, the money you would have accrued in interest had you borrowed the money is added to the line of credit and made available to you to borrow later if you want or need it. For a borrower with a $200,000 line of credit that is not being used, this can really add up in just a few years. At the end of one year, instead of having $200,000 available, the borrower would have a line of credit of approximately $207,000 available.
If the rates do not change, the next year that line of credit would increase to more than $214,200 and it will continue to grow. Again, it is not interest being paid to you and if you do take any money from the line, you would begin to accrue interest you owe on the money you draw but if you were able to wait for several years before you had to start drawing funds you would be able to experience a very nice increase in the funds available to you.
How do interest rates affect reverse mortgages?
Interest rates obviously determine the amount of money you or your estate will owe. The higher the rates, the more money you would owe if you choose not to make any payments and live in the home payment free which is the whole idea of having a reverse mortgage for most people. However, a reverse mortgage is affected by interest rates in other ways as well.
The amount of the funds you receive with a reverse mortgage is determined by the youngest borrower’s age, the property value or the HUD lending limit (whichever is less) and the interest rate on the Expected Rate. The expected rate is a longer term rate than the rate you will even use to get your loan and will no doubt be higher than the rate at which you even close your loan or at which you accrue interest but HUD uses the 10 year index to determine the amount of money you will receive under the program.
HUD established a “Floor Rate” of 3% and any Expected Rate at or below this rate at which borrowers are able to close their loan receives the maximum available under the reverse mortgage for the borrower’s circumstances (age, property value, etc.). However, when rates begin to rise above 3%, the amount of money the borrower receives under the program begins to fall. So, every incremental increase over 3% will lower the proceeds the borrower(s) will receive in their loan.
When is the best time to take a reverse mortgage?
The absolute best time to take a reverse mortgage is when the property value is the highest and the interest rates are at or below 3% and the loan terms are the best that HUD will allow. When will all that be? That can be anyone’s guess but the last time people waited for the rates and HUD lending limits to improve, HUD changed their parameters by dropping the floor from 5% to 3% and also lowered the Principal Limit Factors (the amount of money allowed to each borrower as a percentage of their homes by age).
The moral of the story is that any time can be a good time. If the rates are heading up and you do not get the most money available, you can always look at a refinance at some point in the future if the parameters then are better for your circumstances but if you continue to wait and they never come back to where you felt they should be, you missed your opportunity. If you feel that you are “too young” now and you can do better by waiting a few years (older borrower, get more money in their loans than do younger borrowers), do the math with the credit line growth and see how much the line would grow during the time you think the additional age would help.
Most of the time, the credit line growth if the line is left untouched adds more money to the availability of the line than the added funds due to the additional year(s) of age. And once you have your loan, as long as you live in the property and continue to pay your taxes and insurance, your loan is secure whereas if your income drops or if you have difficulties with payment of taxes, insurance or mortgage payments due to future income interruptions, you are not in danger of qualification at that time.
How will inflation affect reverse mortgages?
It is difficult to say exactly how inflation may affect future reverse mortgages. It may require an adjustment to qualification methods. What HUD deems appropriate income to qualify now may be deemed too little during inflationary times. Obviously higher interest rates will give borrowers much less on their Principal Limits (loan amounts).
Every incremental increase over 3% (the HUD floor rate) means there is less money available to the borrowers under the program. We wrote an article about how higher rates can affect borrowers. The Article shows that with an increase in rates of 1.5% (which is not a huge increase), a 62-year-old borrower would receive a decrease of 8.5% of their expected loan proceeds.
On a reverse mortgage of $300,000, that is $25,500 less available to the borrowers! There has been talk of interest rate hikes of 2% or more which on a $600,000 home could be over $67,000 less available to the homeowner on a reverse mortgage. This is why waiting for the “right time” can be a bad idea, especially when rates are headed upward.
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