Reverse Mortgage loans offer a choice of fixed or adjustable interest rates. There
are pros and cons to both choices but the adjustable rate offers homeowners much more flexibility.
I’ve compared the two choices in past articles but since most people go with the adjustable rate, I thought it might be interesting to do more of a deep
dive into how the adjustable interest rate works on reverse mortgages.
If you choose to take an adjustable rate loan, you then have to choose whether to go with an annually adjustable or monthly adjustable rate. The monthly
adjustable rate is adjusted monthly and has a lifetime cap on the interest rate of 5.0%. This means that the interest rate cannot change by more that
5.0 percentage points higher or lower than the start rate.
For example if your starting interest rate is 3.75% your rate cannot increase by more than 5.0 percentage points (8.75%).
There is no annual cap with the monthly adjustable rate. Theoretically, this means your interest rate can change by 5 percentage points in one month.
The annually adjustable rate is adjusted once per year and has a cap of 2.0% per year and 5.0% lifetime. For example, if your annually adjustable rate
starts at 4.0%, the most it can change after the first year is by 2.0 percentage points (6.0%). The start rate on the annually adjustable rate is typically
about 0.25% higher than the monthly adjustable program.
The most it can change over the life of the loan is 5.0 percentage points. If you start at 4.0%, the highest the rate can ever go is to 9.0% (5 percentage
points higher than the start).
Every adjustable rate is “tied” to an index. The index is what the rate follows. If the index increases, the rate you are charged will also increase.
The index for both the monthly and annually adjustable rate reverse mortgages is the London Interbank Offered Rate (LIBOR). The LIBOR is the interest rate
that banks pay to borrow money in the London money markets. The rate is calculated with a survey that is sent to the banks that trade and do business
in the London Money Markets.
Because London is home to the largest money market in the world, banks who do business internationally tend to trade and borrow money from one another
in the London money markets. This is why the LIBOR is the most widely used index in the world and is considered the most accurate measurement of a
bank’s cost of money
The 1-Year LIBOR closely tracks the Fed Funds Rate, which is the interest rate that banks pay to borrow overnight funds from other banks in the US. The
Fed Funds rate is controlled by the Federal Reserve. Therefore, the LIBOR is likely to change whenever the Fed changes or is getting ready to change
the Fed Funds rate.
Because the Fed has been threatening to raise rates most of the year, the 1-Year LIBOR has increased by .373 since January of 2016.