Reverse Mortgage Rates & Why They Matter
You may have heard that changes are coming to the Federal Housing Administration-insured reverse mortgage program, the Home Equity Conversion Mortgage program. The agency announced in late august that it would be making several changes to HECM loans that will impact borrowers- both in terms of how much they will pay to get a reverse mortgage, and also how much they’ll be able to borrow.
One of the big changes is that the amount you will be able to borrow with a HECM loan depends largely on current interest rates.
How your loan amount is determined
All HECM reverse mortgages use a specific table provided by the Department of Housing and Urban Development to determine loan amounts for borrowers. This amount is called the “principal limit.” The principal limit depends mainly on three factors: the borrower’s age, the home value, and current interest rates.
From home to home and borrower to borrower, every loan amount will be different. After October 1, the percentage of home equity that borrowers can access will range from around 27% to 75%. Generally speaking, older borrowers can access a greater percentage of home equity than their younger counterparts.
Why interest rates matter
The amount of home equity you can borrow is tied directly to the interest rate available at the time you get your reverse mortgage. Just like in the “forward” market, your interest rate determines the amount of interest you’ll pay. But in the reverse mortgage market, it also determines the amount you can borrow.
Under the changes that were recently announced, the amount that a 62 year old can borrow at an expected interest rate of 3% will be almost twice as much as what he or she can borrow at an expected interest rate of 8%, for example. (The expected rate is the estimated average interest rate over the life of the loan. For fixed rate loans, the expected rate is the same as the initial interest rate when the loan closes.)
For a 92-year-old borrower, the amount he or she can borrow when the expected rate is 3% is about 25% more than that borrower would be able to access when the expected rate is 8%.
Where interest rates are going
No one knows exactly what will happen to interest rates, but they have been historically low in recent years following the Great Recession. While there is no hard and fast rule, in general, when rates rise, reverse mortgage borrowers can borrow less. For those considering a reverse mortgage today, under the new rules, it makes sense to do the math on this so that you can achieve the optimum borrowing power available to you based on your age and home value.
The total interest rate charged to your outstanding loan balance is the Margin + Index + Monthly Mortgage Insurance of .50%
* Fixed Rate APR ran with $250,000 loan amount including .50% Mortgage Insurance Premium and standard 3rd party closing costs.
** Tenure or Line of Credit Plan: Assume the youngest borrower was 72 years old when you opened your Plan and you had an outstanding balance of $10,000 at the beginning of the Draw Period with an initial rate of 8.37%. If you took no other advances or payments and the rate increased as rapidly as possible so that the rate was 10.37% in the second year, 12.37% in the third year and 13.37% (5.0% above an assumed initial rate of 8.37%. (The maximum Annual Percentage Rate) in the fourth year and remained at the maximum rate, the minimum payment that would be due at the end of 13 years (based on the life expectancy of the youngest borrower) would be $51,517.55.
Choosing Fixed-Rate Vs Adjustable
You can choose a fixed rate or an adjustable rate and fixed rates sound great, but they are what is called a “closed end instrument” and require the borrower to take the entire loan at the very beginning of the transaction. For borrowers who are paying off an existing mortgage and need all their funds to pay off the current loan, this is no problem.
For a borrower who has no current lien on their property or a very small one, this would mean that they would be forced to take the entire eligible mortgage amount on the day the loan funds. This might give a borrower $200,000, $300,000 or more in cash from the very first day that they do not need at the time and on which they are accruing interest. This can also have an adverse effect on some seniors with needs-based programs. (Medicaid: Seniors on Medicaid and some other needs-based programs would impact their eligibility by having the sudden addition of the liquid assets)
A borrower who is planning on using only a portion of their funds monthly need not pay interest on the entire amount from the very start, eroding the equity unnecessarily fast. An adjustable rate will accrue interest at a much lower rate at today’s rates, but has a 10% cap and can go much higher if rates rise in the future.
However, the adjustable rate programs do allow you more flexibility in how you can receive your funds. First option would be a cash lump sum. This is not advised on the adjustable product as a cash lump sum request is usually associated with fixed interest rates, however it is available. Second option would be a line of credit. The Reverse Mortgage line of credit is not the same as a "Home equity Lines of Credit or (HELOC) that you can get at your local bank. The Reverse Mortgage line of credit grows in available on the unused portion and cannot be frozen or lowered arbitrarily as the banks can and have done recently on the HELOC's.
Third option is a monthly payment option which can be set over a specific period of time and then cease or as a "tenure" which would be a monthly payment guaranteed for life. Fourthly, a homeowner could choose any combination of the three options listed previously.
The adjustable rates are currently much more flexible to meet borrowers’ needs. One of the things that can determine the amount for which borrowers will ultimately qualify is the rate at which the loan accrues interest. When the margins on the adjustable rates were lower and the fixed rate was higher, the adjustable rates gave borrowers more money in their pockets in the form of eligibility. Now, most borrowers who run the numbers receive more money on the fixed rate program.
This is extremely important to know if you are trying to get as much as possible to pay off an existing lien. It also means that the higher the margin, the less money the borrower will receive and the faster interest on the loan will accrue. So the thing to look for in a reverse mortgage here is definitely the rate on a fixed rate or the margin on an adjustable rate that is being quoted.
About Libor Index
LIBOR stands for "London Inter-Bank Offered Rate." It is based on rates that contributor banks in London offer each other for inter-bank deposits. In October of 2007, the U.S. Federal Housing Administration (FHA) ruled in favor of insuring ARM loans based on the one-year LIBOR index.
At the same time, HUD also ruled to allow the one-month LIBOR to be used for the purpose of calculating adjustments to interest rates for monthly adjusting Home Equity Conversion Mortgage (HECM). Below is a chart of LIBOR rates for the last 10 years.
LIBOR loans normally have lower margin rates than CMT (constant maturity of U.S. treasuries). This is particularly helpful to senior borrowers due to the fact that the CMT margin became increasingly less desirable when selling the loans in the secondary markets and the change helped insure the availability of the market for ongoing lending.
If you had an annual adjustable rate in January 2001 with a 2.50% margin your fully indexed note rate would have been 7.67% (+.50% MIP) for a total interest charge to your outstanding loan balance of 8.17%.
Note: That same reverse mortgage in 2001 with an open line of credit would have grown in availability by that same rate of 8.92% - Example: $200k Line of credit would grow in availability by $1,486.66 which then compounds month after month, year after year. Be sure to read more about this important line of credit growth rate.
Where we are now:
History of Adjustable VS Fixed Rates
Below you will find the history of the Libor and National Fixed Rate Averages since 2008. We have prepared this illustration to better help your decision when choosing your interest rate option. Be aware these are only the indexes themselves and do not include the lenders margin + .50% Monthly Insurance Rate.