The interest rate that you pay on your reverse mortgage is important for two reasons – first, it determines how much you pay for the money that you borrow, and second, it determines how much you’re allowed to borrow. The lower the interest rate, the more home equity you’re allowed to cash out. Keep in mind that, in addition to the interest rate charged by your lender, you’ll also pay a monthly insurance charge of 1.5 percent of the loan balance each year. That amount is included in the loan’s APR when you get your reverse mortgage disclosures.
Fixed or Adjustable?
For HECM products, fixed rates are available only if you choose the lump sum distribution – that is, taking your entire loan balance when you close your loan. If you’re using that sum to pay off the mortgage on your home, freeing you from mortgage payments, to pay off more expensive debt, or to buy a new home, it makes sense to choose that option. However, when you take the entire balance upfront, you pay interest on that entire balance, and your monthly mortgage insurance is also based on that amount. It may not make sense to pay these charges for money that you aren’t ready to use. In addition, you could render yourself ineligible for supplemental security income (SSI), Medicaid or other benefits if you retain a large sum of money on your accounts.
Adjustable HECM rates apply if you choose monthly payments or a line of credit when you take your reverse mortgage proceeds. Just as in traditional “forward” mortgages, HECM adjustable rates consist of several parts:
- Index – a published financial index such as the 1-month LIBOR. You can find the value of the index online on many financial sites.
- Margin – this represents the lender’s income on the loan. It is expressed as a percentage that is added to the index.
- Fully-indexed rate – this is the total of the index plus the margin. It’s the rate you pay, subject to any rate caps or floors that apply. If, for example, the 1-month LIBOR is at .25 percent, and the lender’s margin is 2.25 percent, your fully-indexed rate is 2.50 percent.
- Rate caps – these limit the amount that your loan can adjust upward. Using the example above, if that loan has a seven percent lifetime cap, and the LIBOR index rose from .25 percent to eight percent, giving you a fully-indexed rate of 10.25 percent, your rate would only go to seven percent.
- Rate floors – these limit how low your rate can go. So, if the 1-month LIBOR is at .25 percent, the lender’s margin is 2.25 percent, but you have a rate floor of four percent, your rate won’t drop lower than four percent.
You can see why it’s so important to understand what makes up a reverse mortgage rate when you compare loans. In general, lower indexes, lower margins, lower caps and lower floors give you the best deal on your reverse mortgage. These factors can be much more important than the starting interest rate, particularly if the start rate is only good for a short time.