Interest Rate – Fixed or Variable rate?
You have a choice of either a fixed or variable interest rate. It really depends on your specific situation as to which rate is best for you. Here are the facts of how each choice works:
The interest on a fixed rate reverse mortgage is fixed for the entire life of the loan. It never changes. That is the up side. However, this option also has a couple of down sides:
- The fixed interest rate option requires you to take all the money from the loan at the time of the closing. This means that you cannot receive the money as a monthly payment or a line of credit. There are also limits on the amount of money you can receive within the first 12 months of the loan that can restrict the amount of funds you actually receive at closing.
- A fixed interest rate is typically higher than the adjustable rate option. Also, if the interest rates drop, the only way to lower your rate is by refinancing the loan.
Before we dive too deep into the discussion of adjustable interest rates, I want to remind you that interest rate changes on reverse mortgages affect you differently than they do on a traditional forward mortgage or home equity line of credit (HELOC).
If the rate on your forward mortgage or HELOC changes, it causes your payment to change (up or down). This can have a serious impact on your monthly budget (especially if your payment increases!). However, when the interest rate changes on your HECM loan, it does NOT affect you directly. This rate change does affect the amount of interest you are charged,* but since there is no principal or interest payment required for reverse mortgages, there is no impact to your monthly budget.
You should keep this in mind when weighing the pros and cons of interest rate options.
Annually Adjustable Variable Rate
With the annually adjusted variable rate option, the interest rate can change one time per year. The maximum annual rate change can be no more than 2.00% up or down. This is called the annual cap. The maximum the rate can change over the life of the loan is 5.00% up or down. This is known as the lifetime cap.
Monthly Adjustable Variable Rate
With the monthly adjusted variable rate option, the interest rate can change every month. The maximum it can change is by 5.00% on any given change. This is the monthly cap as well as the lifetime cap.
The biggest difference between the fixed or variable rate is how you receive the funds.
With the formula FHA uses, the government basically dictates to the lender how much can be borrowed with a reverse mortgage. The lender is required to make that full amount available to you. However, you do not necessarily have to take it all…unless you chose the fixed rate. The adjustable rate can provide you with more flexibility.
With the fixed rate, you must take whatever amount is available to you in one lump sum.** This option works great if you have a big mortgage that you need to pay off and plan to take most of the money anyway. But if you own your home free and clear, or don’t need a lot of money upfront, the fixed rate option may not be in your best interest.
The HECM reverse mortgage program restricts the amount of upfront funds that you are allowed to draw out at closing to 60% of the “principal limit” during the first 12 months of the loan unless the funds are being used to pay off an existing mortgage or lien on the home. In this case, you can draw enough to pay off the mortgage or lien, plus up to 10% of the principal limit, or up to the maximum principal limit, whichever is less. Any remaining funds will be available as a line of credit or monthly payment after 12 months from the date of closing.
With the variable rate, you have a choice of how you receive the money. You have five different pay-out options:
- Line of Credit
The available money is placed into a credit line that you can draw on whenever you wish, up to the credit limit. You are only charged interest on the amount of money you have actually used.
- Lump Sum
Just like the fixed rate, you take all the money that is available to you, (within the 60% cap limits, but any amount left over can be left in the line of credit and are available 12 months after the closing).
- Tenure Payment
This is where all the money that is available is paid out in equal monthly payments for as long as either homeowner lives in the home.***
- Term Payment
All the money that is available to you is paid out in equal monthly payments over a set period of months or years. At the end of this “term”, the payments will stop. However, you can continue to live in the home.***
- Combination of any of the above options
You can take an immediate cash advance at the closing of any amount (up to the 60% limit), and either place the rest of the money in a line of credit, receive it as a monthly payment, or a combination of both.
*If you elect to set up a reverse mortgage line of credit plan, increases in the rate can actually have a net benefit for you because the line of credit has a growth rate attached to it that increases or decreases along with the rate that you are charged on the balance owed.
**If a fixed rate is chosen, the maximum cash at closing is restricted to 60% of the principal limit or enough to pay off an existing mortgage or lien, plus up to 10% of the principal limit, or up to the maximum principal limit, whichever is less. No line of credit or monthly payment is allowed. Any remaining available funds will be forfeited.
*** The above payment plans assume all homeowners are at least 62 years old at the time of the reverse mortgage application. Any existing line of credit or monthly payments will be frozen and unavailable if a younger, non-borrowing spouse, (NBS) is still living in the home when the older borrower passes away.