How Reverse Mortgage Interest Rates Are Calculated

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How Reverse Mortgage Interest Rates Are Calculated

Although you may be concerned about the fees on a Reverse Mortgage, the highest cost associated with this product is interest. The good news is that the interest payments are added on to the principal of the loan, and no payments are due until the borrower leaves the property on which the Reverse Mortgage has been placed. Best of all, the amount due on a Reverse Mortgage will never exceed the value of the property at the time the Reverse Mortgage ends.

Method of Calculating Interest Rates

Interest rates for a Reverse Mortgage float on a base of an established benchmark interest rate index and adjust periodically within maximum allowed adjustments and within interest rate caps.
The table below shows how the HECM Reverse Mortgage loan program calculates interest.
Index Base Rate: The Index Base Rate is the interest rate of the publicly published financial index upon which the Fully Indexed Rate is based. These rates fluctuate over time.
Margin: The margin is the lenders’ profit margin above the value of the publicly published financial index. The interest rate margin is bounded by maximums and minimums, but varies company by company. The above figure is an average.
MIP Margin: In addition to the upfront fee, all HECM Reverse Mortgages involve an annual margin applied towards premiums for federam Mortgage Insurance. As of February of 2013, this margin is 1.25%.
Periodic Rate Adjustments: Periodic Rate Adjustments refers to the periodic adjustment to the Fully Indexed rate. It applies only to Adjustable Rate Reverse Mortgage programs.
Interest Rate Caps: Interest Rate Caps are a preset maximum Margin used to calculate the maximum Fully Indexed Rate of the reverse mortgage loan. The loan may or may not reach this maximum depending on the change in Index Base Rate.
Initial Fully Indexed Rate: This is the actual interest rate charged at the beginning of the loan, calculated by adding Index Base Rate + Margin = Fully Indexed Rate.
Maximum Fully Indexed Rate: This is the maximum actual interest rate that could be charged, calculated by adding Index Base Rate + Margin + Maximum Periodic Rate Adjustments = Maximum Fully Indexed Rate. Fully Indexed Rates will likely go up and down over the life of the loan and may or may not reach the Maximum Fully Indexed Rate allowed under the program’s interest rate cap. Depending on whether you select an annually or monthly-adjusting interest rate, the cap on your interest rate will be different.
The maximum fully indexed interest rates and interest payments can be a considerable drawback for Reverse Mortgage borrowers. However, Reverse Mortgages have a significant advantage. Interest payments are added on to the principal of the loan (with no payments due until the borrower leaves the property) and the amount due on a Reverse Mortgage will never exceed the value of the property, even if the property decreases in value over the lifetime of the loan.

Comparing Reverse Mortgages to Home Equity Loans and More

A Reverse Home Mortgage is not the only way to cash in on your home in retirement. Other ways of getting money out of your home include:
  • Downsizing
  • Home Equity Loans
    • Cash-out Mortgage Refinancing with either fixed rates or adjustable rates (refinancing your first mortgage)
    • Second Mortgages
    • Home Equity Line of Credit
The initial interest rates on most home equity loan products are slightly lower than those charged by Reverse Mortgage loan products.
While home equity interest rates can be lower than those charged on Reverse Mortgages, the primary disadvantage of home equity loans is that you will have to make loan payments and if the rate is variable, those payments can increase dramatically if interest rates go up. This is often difficult for retirees living on a fixed income. It is also possible to default on a home equity loan and lose your home.

Comparing Downsizing to a Reverse Mortgage

Downsizing can be the most economically efficient way of securing money from your home in retirement. However, the costs of moving are impossible to generalize and declining home values or a soft real estate market may make your home difficult to sell.
Nonetheless, it might be worth your while to consider how much you might be able to sell your house for and how much less you could buy another house for. If considering downsizing, you will also want to factor in the costs of using a realtor to sell your existing house and buy a new house and moving costs as well as the emotional attachment you have to your existing home.

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