Getty
The Federal Reserve has cut interest rates to historic lows, and reverse mortgage borrowers and their families want to know how that really affects them. Borrowers age 62 and over or family members of borrowers age 62 and over need to understand how these rates affect reverse mortgages and the options reverse mortgage borrowers choose.
How do lower rates help me with the reverse mortgage I want to get?
Reverse mortgages are home loans. Just like any other home loan, the lower the rate of interest accrual, the less interest you must repay when you (or your heirs) repay the loan. But this is not the only benefit of a lower rate.
There are a few important rates to consider when shopping for a HUD home equity conversion mortgage (HECM). The U.S. Department of Housing and Urban Development uses a start rate that determines the interest you will accrue, at least in the beginning period on the adjustable-rate loan, and something called the effective rate. In the case of the effective rate, the rate is used as part of the formula to determine the amount of money you can borrow, but you never accrue interest at this rate. Knowing what each of these rates are, what the HUD floor is and how that affects your loan in conjunction with your goals will help you decide which loan option is best for you.
What is an effective rate?
If you have a fixed-rate loan, the effective rate is the same as the accrual or initial rate. However, if you have an adjustable-rate loan, HUD uses a different index to determine the amount of money you can borrow and to run the comparisons. Because most of the loans closed now are on the adjustable-rate line of credit and the effective rate is not the start rate, people don’t pay attention to it. The initial rate may be based on the 1-year Libor index plus a margin (e.g., 1.5%), but the effective rate is based on the 10-year Libor index plus your margin. And since the longer index is higher, the effective rate will also be higher.
Why should this affect you if you don’t accrue interest at this rate? Because one of the components that HUD uses to determine how much money borrowers can borrow is the interest rate based on the effective rate. If your effective rate is above the HUD floor, the amount of money you can receive under the program is less.
What is the HUD floor?
The floor rate is the rate at which borrowers receive the maximum amount of money. Rates above the floor begin to lower proceeds to the borrower. In 2018, HUD lowered the interest rate floor from 5% to 3%. This means that all borrowers with effective rates over 3% now are receiving less money. The difference can be quite substantial based on the change in the floor, as many borrowers did receive thousands less when the change first took effect.
At the time, interest rates were also rising and all program rates were above the HUD floor, and as a result, the industry saw several new jumbo reverse mortgage options surface. Most borrowers are now able to obtain adjustable-rate loans below the HUD floor, making the HUD loan amount the maximum available for their age group and property value due to recent rate decreases. The effective rate is the same as the note rate for fixed-rate loans; those rates were, and still are, over 3%. Borrowers opting for the fixed-rate loans receive less money on the HECM program than a borrower on the adjustable-rate program with all other factors being the same (age, value, location).
How else am I affected by the lower rates then?
How you may be ultimately affected also depends on your goals. When there is more room in the rates to deliver different margins to borrowers, there is also different flexibility available to the lender. You may remember when lenders were advertising “no borrower-paid closing costs,” but then they just went away. That is partly due to the secondary market value of the loans but also due to the lowering of the floor rate.
If lenders have to deliver the lowest possible margin just to maximize the benefits to the borrower, then the loan is not worth as much to lenders so there is not as much income available from the origination of the loan to pay fees on behalf of the borrower. When the rates decrease as much as they have lately, it starts to give lenders the opportunity to work with borrowers again to give them more options on rates and fees. Now is an excellent time to compare different options to see what lenders can do with the lower rates.
But which is best, lower rates or lower fees?
Do you want to pass on the most equity to your heirs? Then perhaps you want the lowest margin available to accrue the least amount of interest. Do you think you might downsize in the next five years? Perhaps the lowest upfront fees would be a better option. If you need all the funds upfront to pay off your existing loan, you might go either way. If you need all the money possible, a higher margin and lower fees work best. If you want to minimize interest accrual over a long period of time, compare the amortization schedules for both options to see which works better for you. If you have no heirs or plans to move and you just want the highest payout possible, look at the higher margin with lender credits to pay some or all the loan costs. The higher margin will also give you a higher growth rate on funds left on the line of credit.
The reverse mortgage is all about you, the borrower. It is not meant to be the best loan for the lender, it is meant to be the last loan most borrowers will ever need. Lower rates are great, but they can also help in other ways besides just the lowest interest rate on the note based on all options. Be sure you get the loan that best suits your overall needs and goals.