Understanding Reverse Mortgage Interest Rates
May 1, 2019 | By Alaya Linton
When you’re looking for a reverse mortgage, it’s easy to take shortcuts while shopping. After all, you’re not making payments — so why does it matter what the interest rate is?
But the reality is that interest rate matters quite a bit. Reverse mortgage interest rates have a considerable impact on how much you’ll be able to borrow and how far the proceeds of the loan will stretch.
In this article, we will cover:
- What is a reverse mortgage?
- Why does the interest rate matter on a reverse mortgage?
- The two types of reverse mortgage interest rates
- How to get a better reverse mortgage interest rate
What is a reverse mortgage?
A reverse mortgage is a type of loan that allows a homeowner to borrow money using the value of their home as collateral. Instead of requiring monthly payments, reverse mortgages are not due until the borrower stops living in the home.
Borrowers can choose to receive their money in a lump sum, through monthly payments, or in a line of credit. The overall loan balance grows over time as interest accrues, and typically gets paid back by selling the home when the owner no longer needs it.
To qualify for a reverse mortgage, you must be at least 62 years old and have either paid off your home or have a significant amount of equity built up. Equity refers to the value of the home minus the remaining mortgage balance. The amount you can borrow is dictated primarily by the amount of equity you have.
Borrowers are still responsible for paying property taxes and homeowners insurance, and must also keep up with home maintenance and repairs. Many homeowners turn to reverse mortgages as an option to cover these costs and other living expenses as they near and enter retirement.
There are three types of reverse mortgages.
- Home Equity Conversion Mortgage (HECM): This is the most common type of reverse mortgage. They are offered by private lenders and are insured by the Federal Housing Administration (FHA). The limit for HECMs in 2019 is $726,525.
- Proprietary: Some lenders offer their own reverse mortgage programs. These loans are not insured by the government and come with lender-specific limitations and guidelines.
- Single-purpose: These loans are provided by some state and local governments and nonprofit agencies. Typically, they are for smaller amounts than the other types of reverse mortgages and are used for a specific purpose (e.g., making a house wheelchair accessible).
The information in the remainder of this article applies to HECMs. For details on proprietary or single-purpose reverse mortgages, please contact a lender directly.
Why does the interest rate matter on a reverse mortgage?
It would be a mistake to ignore the interest rate when shopping for a reverse mortgage, since it is a major factor that affects the borrowing limit that you’ll qualify for. In general, the lower the interest rate, the more you can borrow. The higher the interest rate, the less you’ll be able to borrow.
Why? Because you’re not making payments, interest and fees are continually added to the loan balance as the loan ages. Those fees get compounded, meaning each month, interest and fees are charged on top of the interest and fees that were previously charged. This increases your loan balance and decreases the amount of equity you have in your home.
Lenders don’t want your final loan balance to be more than the house is worth. If interest rates are higher, they’ll lend you less money.
This also becomes a factor when the loan needs to be repaid: either when you sell the home, choose to move, or pass away. The more you must pay in interest and fees, the less you receive from the sale. And if your heirs want to keep the home after you pass, they will need to pay off the loan balance or 95% of the home’s appraised value (whichever is less).
The two types of reverse mortgage interest rates
Reverse mortgage interest rates can be fixed or adjustable. The type of interest rate you choose determines your payout options. Of course, each rate type and payout option has pros and cons.
Fixed-rate reverse mortgages offer the borrower a lump sum of cash and predictable interest rates. While rates on adjustable-rate reverse mortgage can fluctuate, they tend to be lower than fixed rates and offer more flexibility in how the borrower receives their money.
Scott Withiam, housing counseling supervisor at American Consumer Credit Counseling, said in the past, consumers tended to gravitate towards fixed-rate reverse mortgages. However, in recent history, the rate difference between the two has narrowed, and more reverse mortgage borrowers are looking at adjustable rates.
Fixed-rate reverse mortgages
With a fixed rate, borrowers have one payment option: the Single Disbursement Lump Sum. Borrowers who choose a fixed-rate reverse mortgage receive the total amount of the loan immediately, and the interest rate charged stays steady for the life of the loan.
- You get all the money from the loan right away.
- The interest rate is not subject to market fluctuations, giving you stability.
- You’re more likely to retain some of your home’s equity.
- You’ll be able to borrow less money overall. Typically, you can only borrow 60% to 70% of the allowed principal limit based on your equity.
- You risk running out of money.
- Fees and interest costs are higher because they are based on the entire loan amount.
- You can’t take advantage of a drop in interest rates.
- You might affect your ability to qualify for benefits that are income- and asset-sensitive.
- You’ll likely pay higher rates than with adjustable-rate reverse mortgages.
Adjustable-rate reverse mortgages
Interest rates are generally lower on adjustable-rate reverse mortgages because the borrower assumes a higher risk than with a fixed rate. Additionally, there are multiple payout options and other advantages.
One major advantage of these reverse mortgages is the ability to borrow more than you would with a fixed-rate, lump sum payment. The government has limits on how much you can borrow during the first year of a reverse mortgage. If you take a lump sum, you’re stuck at that limit. If you’re taking out an adjustable-rate reverse mortgage with either a line of credit or monthly payment feature, you can also borrow to your true maximum.
With monthly payouts, you can choose to receive scheduled monthly payments for either a predetermined amount of time or for as long as you or your co-borrower remain in the home. Borrowers also have the option of combining a line of credit with monthly payouts.
- You have more money available than with the fixed-rate option.
- You benefit from a predictable monthly income.
- You pay interest and fees only on the amount of money withdrawn.
- You take on more risk. The amount you borrow can decrease considerably if interest rates go up.
Line of credit
With this payout option, you’ll withdraw funds as needed in the amount you choose, up to the total principal limit.
- You withdraw only what you need when you need it.
- You pay interest and fees only on the amount you use.
- You have more money available than with the fixed-rate option.
- The unused portion of the credit limit will continue to grow.
- Equity in the home is not used as quickly.
- You take on more risk. The interest rate is subject to market fluctuations, and if the rate increases significantly, your available money decreases.
How to get a better reverse mortgage interest rate
While no one can truly know where interest rates will go, there are a few ways you can make sure you are getting the lowest rate possible.
Only borrow what you need
Consider carefully how much of the equity in your home you want to borrow. You’ll be charged an initial mortgage insurance premium of 2% of the loan amount and then pay annual premiums of 0.5% of the outstanding balance. Limiting the amount you borrow to what you need will keep the overall costs of the loan down.
Borrowers should shop around and compare lenders the same way you would with a traditional mortgage. “Shop for two reasons,” Withiam said. “One, for price; and two, for the [lender] who’s giving you the most information, you trust the most, and you feel the most comfortable with.”
He said consumers should compare the terms offered by multiple lenders and use those comparisons to negotiate.
Pay attention to the margin
For adjustable-rate reverse mortgages, specifically look at the lender’s margin. The margin is the amount of percentage points the lender adds to the market index they use to arrive at your total interest rate.
Generally, the lower the margin, the lower your rate, but Withiam said borrowers should beware when comparing margins. “A lower margin might mean something else in the lending product offsets it,” he said.
Consider how the rate will adjust
When choosing an adjustable-rate mortgage, Withiam said borrowers should also consider when the interest rate will adjust: annually or monthly. A rate that adjusts monthly will be lower but is subject to more volatility as rates change. “Generally speaking, the lower the rate, the higher the risk,” he said.
The bottom line
“A lot of borrowers who come in for reverse mortgage counseling see it as their only option and aren’t interested in alternatives,” Withiam told LendingTree. But he said consumers should consider reverse mortgages as an option, not as a single solution.
Reverse mortgages can be costly. “So, be realistic about [your] situation and short- and long-term goals,” Withiam advised. “Familiarize yourself with the options. Know your goals, what you’re looking to do, and which product fits you the best.”