Once you decide to move forward with a reverse mortgage, you will be faced with the decision of choosing a fixed rate or an adjustable rate loan. There are some significant differences between the two choices, so it’s a good idea to read further. Most people’s instinct is to lean towards the fixed rate product, but we think it should be the other way around.
Pros and Cons of Fixed Rate Reverse Mortgages
Fixed rate reverse mortgages have the benefit of being just that, a fixed interest rate for the life of the loan. Most lenders only offer one fixed rate option. It is lump sum product, meaning the loan is fully drawn at closing. For those with free and clear homes, or those with very limited debt against their home, the loan is limited to a partial draw of 60% of the loan amount. That means you are leaving 40% of the potential loan proceeds on the table. There’s a lot of downside in doing this if you plan to keep the loan for ten or more years.
Here’s an example of this scenario:
Jane Doe has a home valued at $200,000, and she qualifies for a reverse mortgage loan of $100,000. Since she owns her home free and clear, she is limited to drawing 60% of the loan amount in the first year (a new rule instituted by HUD in September 2013). That means her lump sum payout will be $60,000 minus the financed closing costs. The remaining $40,000 will not be able to be borrowed because the fixed rate requires a lump sum draw at closing.
The fixed rate, single lump sum option is good for those with significant existing mortgage balances (80% or more of the reverse mortgage loan amount) and those using a reverse mortgage to purchase a home (full access to 100% of the loan amount).
There is one more fixed rate option, and it’s a multiple draw loan that is only offered by one lender. There is a major catch with this product though, you must have 50% or more of the loan amount in “mandatory obligations”. Mandatory obligations are defined as financed closing costs, federal debt, mortgages or lines of credit using the home as collateral, and any funds set-aside for repairs (not known at the time of application). If you meet the minimum mandatory obligation requirement, then you will be able to borrow the amount of mandatory obligations plus ten percent in cash at closing. The remaining funds are available twelve months from the closing date (lump sum, line of credit, monthly, etc). This is a great option, but it will only fit a limited percentage of those interested in reverse mortgages.
The Benefits of Adjustable Rate Reverse Mortgages
Now that you have a grasp of the pros and cons of fixed rate reverse mortgages, we want to touch on the different adjustable rate loan options. The key benefit of an adjustable rate reverse mortgage is that there are no lump sum requirements. Due to the fact that interest and mortgage insurance do not accrue until the money is borrowed, it is highly beneficial to borrow money only as you need it. That’s the advantage to doing a line of credit or electing one of the monthly payment options.
Adjustable rate reverse mortgages can vary significantly from one lender to the next. Most base the interest rate on the London Interbank Offered Rate (LIBOR) plus an index that can range from 2%-3.5%. In the recent past there was only a monthly adjustable rate, and now there is also an annually adjustable rate. There was also only one type of cap on the interest rate and that was a lifetime cap of 10% above where it starts. Now you can get an adjustable rate loan with a 2% annual cap and a 5% lifetime cap. That’s a lot less interest rate risk!
When you take into consideration the interest rate caps and the lack of a monthly payment, adjustable rate reverse mortgages should be less anxiety inducing. Due to the September 2013 rules that limit the funds available in the first year, most applicants will be best served by an adjustable rate. Give us a call today if you would like to discuss any of these loan options.