What Rising Interest Rates in 2018 Mean for Reverse Mortgage Borrowers
Interest rate increases impact reverse mortgage borrowers differently from how they impact forward mortgage borrowers. While gains in short-term rates have a minimal effect on the amount of loan proceeds reverse mortgage borrowers may be eligible to receive, hikes in longer-term rates can significantly reduce their borrowing power over time.
Much of the difference has to do with how rates are calculated on reverse mortgages. The vast majority of reverse mortgages are Home Equity Conversion Mortgages (HECMs), which are insured by the Federal Housing Administration. These loan products allow homeowners age 62 and older to convert a portion of their home equity into tax-free loan proceeds, which they can choose to spend however they want.
When reverse mortgage lenders calculate the amount of loan proceeds that borrowers may be eligible to receive (also known as the Principal Limit), they use what is called the Expected Interest Rate. These longer-term interest rates are tied to a 10-year index which can go up or down depending on market interest rates.
Rate swings impact borrowing amounts
The Department of Housing and Urban Development (HUD), which regulates the HECM reverse mortgage program, maintains a “floor” rate of about 5%. Essentially, if rates stay at roughly 5% or below, the borrower receives the maximum amount of loan proceeds available to them under the HECM program.
But depending on how much long-term rates rise or fall above HUD’s “floor,” borrowers could be eligible to receive more loan proceeds from a reverse mortgage at lower expected rates compared to when rates rise.
For example, a 62-year-old homeowner with a property appraised at $300,000 would have a Principal Limit of $157,200 available to him/her at a 5% expected rate. But if this rate grew by a single percentage point to 6%, this amount decreases to $118,500 for the same homeowner. At a 7% rate, the amount drops even further to $93,600.
This means that even a small 1% increase in long-term rates could result in at least a 20% reduction in the amount of loan proceeds available to a borrower, equating to tens of thousands of dollars LESS of home equity borrowers can access as rates rise.
As a rule under the HECM program, older borrowers receive more loan proceeds compared to younger borrowers. An 80-year-old reverse mortgage borrower will be able to tap into a larger share of their home equity than someone who is age 62. But even so, older borrowers will see their proceeds diminish as rates increase.
For instance, an 80-year-old borrower with a $300,000 home may be able to receive $197,100 at an expected rate of 5%. But when this rate increases to 6%, the available amount falls to $161,700. In this scenario, the difference between the rate increases results in a Principal Limit reduction of approximately 18%.
Implications for rising rates
Remember, long-term reverse mortgage interest rates are tied to an index which changes with the market. While rates have remained below the 5% threshold for several years now, there is the potential that rates could increase in the future.
What this means for reverse mortgage borrowers is that not only will rising rates impact the amount of loan proceeds they might be eligible to receive, but rising rates will also affect the ability of lenders to quote loan amounts to prospective borrowers, since longer-term rates change each week.
But with rates continuing to hover at historically low levels, the current interest rate environment is still ripe for homeowners to tap into their home equity with a reverse mortgage—but it won’t last forever.