Looking into reverse mortgages, you will quickly learn that there are three interest rate options available:
1. Fixed Rate
2. Monthly Adjustable
3. Annually Adjustable
The fixed rate option is only for people who need to take all the money in one lump sum at closing (to pay off an existing mortgage for example).
If you want to set up a line of credit or monthly payment option, (where the lender pays you every month), you have to choose one of the adjust-able rate
options.
Which option is best? The monthly adjustable rate or the annually adjustable option?
Before we get too deep into this discussion, I do need to point out that interest rate changes on reverse mortgages affect you differently than on a forward
mortgage.
If your interest rate changes on a forward mortgage, your payment changes along with it.
With a reverse mortgage increases or decreases in the interest rate do not affect you directly.
Since you do not make payments based on the rate as you do with a regular “forward” mortgage, changes in the rate simply cause the loan balance to grow
at a faster or slower pace.
Both adjustable rates have their pros and cons:
The annually adjustable rate has more favorable caps. An interest rate cap is a maximum the interest rate can rise over a given time period.
For example, the annual cap on the annually ad-justable rate is 2% above the start rate. This means that if your rate starts out at 3.5% the most it can
go up to in any 12 month period is 5.5% (3.5% + 2% = 5.5%).
The lifetime cap on the annually adjustable pro-gram is 5% above the start rate. Going back to the 3.5% start rate, the high-est your rate could ever go
is 8.5% (3.5% + 5%=8.5%). But since the
annual cap is just 2%, it would take 3 years for your rate to get to 8.5%.
One thing to keep in mid though is that these caps also apply when the rate is coming down. If the rate drops 3% this year, your rate would only drop by
a maximum of 2% and it could take up to 12 months for it to take effect.
There is no annual rate cap on the monthly adjustable program. If the rate goes up by 3% over the course of the year, your rate will also go up 3% and
since it changes monthly, any increase (or decrease), takes affect immediately.
The 5% lifetime cap is the same on the monthly adjustable program as it is on the annual program.
The actual rate that you are charged on the monthly program is typically 0.5% to 0.75% less than on the annual program.
Usually, when the rates are low and expected to rise, (like now), most people are more comfort-able with the annually adjusted rate.
When the rates are higher and expected to come down, that is when the monthly adjustable rate would be more beneficial because there is no annual change
limit and the change (a lower rate), would take effect immediately.
