With the April 1st elimination of the FHA Home Equity Conversion Mortgage (HECM) Standard Fixed Rate, the Adjustable Rate will once again be the most common choice of reverse mortgage borrowers. While adjustable rates mortgages have gotten a bad rap they should be understood and considered with reverse mortgages. Let me educate you.
A mortgage just like any other mortgage, the reverse mortgage offers special terms for senior home owners 62 and older. Advantages for seniors, are with the reverse mortgage there are no income or credit score requirements to impact the interest rate and no monthly mortgage payment requirements. The non-recourse loan is due and payable when the home is no longer the primary residence of the borrower(s) or on their 150th birthday.
To understand the programs and interest rate options, first you need to know how the loan amount is determined. With the reverse mortgage the Principal Limit or maximum loan amount at the time of origination is determined by the home appraised value or FHA’s Lending Limit ($625,500 through 2013), the age of the borrower (the older one is the more they can receive), and the Expected Interest Rate of the program chosen. The Expected Interest Rate is only used to determine the loan amount it is not necessarily the same as the interest rate on the loan.
The funds available can be received in a lump sum, monthly payments, a line of credit, or a combination of these. The monthly payments can be structured as one needs or as tenure payments (for life) as long as the home is the primary residence of at least one of the borrowers. Funds in the line of credit grow so more funds can be available in the future.
Prior to 2008 the only reverse mortgage option was an adjustable rate. In 2008 HUD introduced the HECM Fixed Rate. And in October 2010 the HECM Saver was introduced which reduces the up-front Mortgage Insurance Premium (MIP) but also has a lower Principal Limit or loan amount; generally the HECM Saver has a higher interest rate as well. The HECM Saver is available as an adjustable rate option and a fixed rate option. The programs that have the full up-front 2% FHA MIP are called Standard, and are available in the adjustable and fixed rate programs (through April 1, 2013 when the Fixed Standard will be eliminated).
The Fixed rate is often a favorite option however with the reverse mortgage it requires that all the funds be drawn in a lump sum at closing which isn’t the best option for everyone’s situation.
The bad rap on adjustable rates occurred with conventional mortgages because when the interest went higher so did the monthly mortgage payments. And this impacted many who couldn’t afford the higher monthly mortgage payments. Let’s look at why the reverse mortgage is different and should be considered as a viable option for senior homeowners.
- Because monthly mortgage payments are not required with the reverse mortgage, having the rate change doesn’t impact one’s monthly payment and/or cash flow.
- The Adjustable Interest Rate is the option that offers receiving funds as monthly payments, a line of credit, lump sum or a combination of these.
- Having more flexibility with how the funds are drawn is beneficial to borrowers. If you don’t have a need for all the funds up-front then leaving them in a line of credit, which has a growth rate, or structuring monthly payments to your needs are more favorable options.
- The growth rate on the unused portion in the line of credit is determined by the current interest rate on the loan plus 1.25. For example if the current rate is 2.5%, the growth rate will be 3.75%. If/when the interest on the loan increases so does the growth rate on the line of credit, meaning even more funds become available to the borrower over time.
- Because it is a loan against the property, not considered income, if one is receiving or will receive Medicaid (Medical Assistance in Minnesota) in the future, the adjustable rate is also more favorable, allowing you to draw funds as needed rather than as a lump sum which could impact receiving Medicaid.
- Taking funds as periodic payments means interest and the on-going MIP is accruing on the loan balance at a slower pace vs taking funds as a lump sum, especially when there isn’t a need or better use for lump sum funds.
- Monthly mortgage payments are not required however you have the option of making payments. When the payment is made it reduces the loan balance and with the adjustable rate it is applied to the line of credit and available for future draws.
- The adjustable rate is low right now, and yes, it can adjust and be higher in the future, however it only impacts the amount due when the loan is due and payable. And there is a cap of 10 points higher than the initial interest rate at closing. For example, if the interest rate at closing is 2.5%, the cap is 12.5%.
- What we don’t know is when the rates will increase or how high they will increase but with the lower rates now, even if the rates do increase substantially the interest expense over the life of the loan will be tempered by the current low interest rates.
- And even if the reverse mortgage interest rate does go up, as a non-recourse loan when the loan is due and payable if the loan balance is higher than the home can be sold for, the borrower or the estate will not need to come up with the difference. If the home can be sold for more than the loan balance due, the equity goes to the borrower or their estate.
With an understanding you can see why the reverse mortgage, even with an adjustable rate, can be favorable to senior homeowners.
The HECM Saver is available in the adjustable rate and will remain an option with the fixed rate. So if you really want a fixed rate you will still have the option, just remember less funds will be available and the interest rate is likely to be higher.
When considering a reverse mortgage review all the options, Adjustable Standard, Adjustable Saver or Fixed Saver, and decide which is best for your situation.
©2013 Beth Paterson, Beth’s Reverse Mortgage Blog, 651-762-9648
This material may be re-posted provided it is re-posted in its entirety without modifications and includes the contact information, copyright information and the following link: http://wp.me/p4EUZQ-CD
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