Comparing Fixed Rate and Adjustable Rate Reverse Mortgages

ajustabel rate reverse mortgage or fixed rate reverseAdjustable Rate Reverse Mortgages Explained

Adjustable rate reverse mortgages (also referred to as variable rate reverse mortgages) offer much more product flexibility than fixed rate loans for the simple fact that fixed loans require that the borrower take all the available proceeds in a one-time lump sum draw at closing, while adjustable rate loans allow for several draw options with the loan proceeds.

The options available with the adjustable loan include a lump sum draw, a line of credit that can be used as needed that allows for the unused portion to grow over time, a monthly payment for a specific term or for life, or a combination of all of the aforementioned.

There can be several benefits or pitfalls to choosing the adjustable reverse mortgage. Whether or not it’s a good choice for you relies heavily on your specific situation, which leads to everyone’s question, “is a variable rate reverse mortgage the right choice for me? To answer that question, let’s first look at who it’s not right for.

Homeowners, who require a draw of most or all of the monies available to them under the reverse mortgage program, would be better suited to choose the fixed rate option. The only choice the borrower has with the fixed rate is a lump sum payment. It will also provide the security of knowing exactly what the interest rate will be for the life of the loan.

However, many homeowners would like a little more flexibility in their reverse mortgage and may want to explore the adjustable rate. One nice feature about the adjustable rate is that you only accrue interest on the money borrowed. For example, you take $25,000 at closing and put the rest in a line of credit you would only be accruing interest on the $25,000 plus closing costs, fees and accrued interest.

If you don’t have a desire to take a lump sum, know that you don’t need a large sum of money in the near future, prefer monthly payments, like the idea of a line of credit and are not concerned about the potential of rising rates, then you may be a good candidate for the adjustable.

The adjustable rate can adjust monthly based on the index plus the margin. The index currently used is the LIBOR rate. This simply is the rate at which banks lend to each other. The LIBOR is used for all adjustable Home Equity Conversion Mortgages (HECM) and will be the same from lender to lender. To this index, the margin is added to get the actual accrual rate.

Different lenders may offer different margins. When shopping for a reverse loan, the margin is a very important piece of the rate pie. For example, one lender offering a margin of 2.25% and another offering a margin of 2.5% will show the same principal limit amount on the comparison page (based on today’s rates). Because of this, borrowers often fail to see the rate difference of 0.25%.

The difference of 0.25% may not seem like much, but over time that will cause the loan balance to grow at a faster rate, which reduces the equity in the estate quicker.

The last important item to know is the interest rate cap. The adjustable reverse mortgage loans have a life cap of 10%. This means that the rate will never go more than 10% above the start rate. As an example, the LIBOR today is 0.248%. Assume a margin of 2.25%. The start rate on the loan will be 2.498% (index plus margin). The life cap would be 12.498% (2.498% + 10%).

Historically, over the past 10 years, the highest the 1 month LIBOR has been was 5.497% in August 2007. The fully indexed rate would have been 7.747%, assuming a 2.25% margin. The chart below shows the history of the 1 Month LIBOR since 1989. The LIBOR rate is charted in blue. The red line represents the LIBOR plus a margin of 2.25%.

What it all boils down to is making sure you educate yourself through the process. The loan originator you choose to work with should provide several comparisons for many different situations to aid in your decision. Education is king. Be sure that your loan officer presents a fair representation of all available programs and doesn’t steer you to the program they want to sell, but helps to guide you to the program that is right for you based on your needs.

Here’s a quiz for you. A 75 year old borrower owes $20,000 on a home valued $250,000. She would like to pay off her mortgage and receive $500 per month for the remainder of her life. She also has no immediate need for additional money. Which is the better choice, fixed or variable? In this situation, she would pay off $20,000, receive $500 per month and she would also have a line of credit for over $75,000. The adjustable would appear to be the best option. Ultimately it will be the borrower’s decision to make. Many borrowers are afraid of variable rates and may opt to take a one-time lump sum fixed rate for the security of knowing exactly what the rate will be. This decision is one that should be explored with friends, family, a financial advisor or someone trusted to help navigate the complexities of the decision.

If you have any other questions about a fixed rate loan vs a variable loan, or are interested in learning more, don’t hesitate to contact us or call 1-888-888-4834.