A reverse mortgage can be an attractive prospect for people looking to utilize the equity in their home and convert into regular income. Unlike a regular mortgage, where borrowers have to make monthly payments to the lender, a reverse mortgage is an arrangement where the lender pays the borrowers.
Practically, the sum obtained by the borrower after reverse mortgaging the estate can be considered as an advance payment on the equity in it. Also, the amount received by the borrowers is usually tax-free.
However, homeowners should know the snags that come with this mortgage, which includes the interest rate that is typically on the higher side. But this particular loan is especially appropriate for homeowners who do not wish to disperse their sprawling home and move to a smaller dwelling.
In some cases, it also suits the purpose of the owners are unable or don’t want to continue with the regular loan payments. As the upfront costs and rates of an RM can be an issue, the owners should be ready to reduce the size of their home, as these can be deducted from the sum being paid to them.
Again, the borrowers don’t have to pay back the sum they receive from the lenders as long as they continue to live in the mortgaged estate. The property would pay for itself, as it would be eventually sold by the lender on their demise, or plan to move out for good. Before deciding to go for a reverse mortgage, the details on interest rates can help applicants bag the right deal.
Reverse Mortgage Rates are broadly classified into two categories, namely the Adjustable rate programs and the Fixed rate programs, which function in different ways.
1. The Adjustable Rate Reverse Mortgage
This is the category of RM that is opted by majority of homeowners across the country. The probable reason for the popularity could be the increased flexibility it offers. Borrowers opting for adjustable rate mortgages not only have more options when it comes to choosing the rate but can also utilize the money they receive from the mortgage in many different ways.
The adjustable programs, which have been around for much longer than the fixed rate programs, offer two types of rate components.
The first is the index rate, which is based either on CMT index – the United States Treasury Rate (CMT) or its alternative – the LIBOR (London Inter-Bank Offered Rate).
The margin of the loan is the second component. The total interest is figured out by adding the index rate and the margin rate together. In addition, there are index rates to choose from and include the monthly rate and the annual LIBOR rate.
The flexibility offered by the adjustable rate reverse mortgages allows the borrowers to choose their loan proceeds either a line of credit or as a lump sum amount. Borrowers can even ask the lender to pay the amount in installments, either on a monthly or a quarterly basis.
They can even make a combination of the given options. For instance, a part of the proceeds can be received upfront, while the remaining amount can be opted as an installment or a line of credit.
The unique feature about this mortgage is that the rate at the beginning of the loan changes after a given period, but has certain constraints. The adjustable rate of the annually adjusted HECM loans, for instance, cannot rise beyond a certain cap amount, which is itself based on the initial rate.
As mandated by the Federal Housing Administration (FHA), these HECMs cannot be adjusted to go more than two percentage points per year and are not allowed to go beyond five total percentage points over the life of the loan.
The mandatory cap is designed to protect the borrowers from the impact of a financial situation that leads to a rapidly increasing rate, which could occur during the life of the loan.
2. The Fixed Rate Reverse Mortgage
In this version of the reverse mortgage, the rate remains fixed for life. As simple as its sound, the fixed interest rate programs are easier to comprehend, though with minor differences in how they work. Also, this version of reverse mortgage is inflexible as compared to an adjustable rate, as it’s always a “closed-end” loan, which means, the proceeds from the loan can only be paid to borrowers as a lump sum.
The non-availability of the line-of-credit and the monthly payment feature is preferred by homeowners is some specific cases where they may need the whole amount at once. Some lenders use discounts and credits to lure homeowners to opt for fixed rate programs, which could help them save some precious dollars on various types of fees involved. (See Volume I for details). Moreover, the different fixed rate reverse mortgage programs can vary in terms of rates as well as the discounts and credits.
As it’s evident, a primary difference between the fixed and the adjustable rate reverse mortgage is the interest rate, which remains fixed for life in the former’s case, where as in the latter’s scenario, they change after a given period. Also, the latter allows the borrowers to receive the money from the loan in various ways, whereas in the fixed rate, the borrowers have to receive the whole amount as a lump sum.
Having a basic knowledge of the reverse mortgage rates and programs can be really helpful for applicants when selecting the interest rate program that works best for them.
As it can be observed, a mortgage loan with lower rates and margins would be suitable for a homeowner who is concerned about the loan balance, while higher margins and rates could be well suited for borrowers who are keen to max out on the available money that can be received through a reverse mortgage.