How Interest Rates Affect a Reverse Mortgage

Many seniors spend decades paying down their mortgages and building equity in their homes. But when they reach retirement, they may find that money would be more useful as a source of income than being stuck in their homes. That’s where reverse mortgages come in—they allow seniors 62 or older to borrow against their home equity without having to pay it off as long as they live in their homes.

Reverse mortgages can be an excellent financial tool for older homeowners, but they come with some unique characteristics and features. Learn more about these loans, including how interest rates will affect your reverse mortgage.

How Reverse Mortgage Lenders Calculate Interest Rates

Like other forms of financing, reverse mortgage lenders charge interest on these loans, which is rolled into the cost of the loan and repaid with the principal loan balance. Your interest rate depends on a variety of factors, including the type of reverse mortgage, your age, your home’s value, your life expectancy, and your disbursement option.

Each reverse mortgage has a “principal limit,” which is the total amount the borrower can receive with the loan. The principal limit is based on several factors, including the home value, the borrower’s age, and the interest rate.

How Your Interest Rate Affects Your Reverse Mortgage

Generally speaking, the higher a borrower’s expected interest rate, the lower their principal limit. This happens because a higher interest rate increases the total loan costs. And as costs eat up more of the equity, there’s less available for the borrower to receive as a principal amount.

In the case of a fixed-rate reverse mortgage, it’s easy to determine what the rate will be for the entirety of the loan, because the rate doesn’t change.

But for an adjustable-rate reverse mortgage, the lender must calculate an expected interest rate (EIR), which is used to calculate the principal limit. The EIR uses the initial interest rate to estimate the loan rate in the future.

Fixed vs. Variable Interest Rates

Reverse mortgages can have either fixed or variable interest rates. With a fixed interest rate, the rate is set at the time the loan is originated, and it doesn’t change for the lifetime of the loan. Variable rates, on the other hand, can change over time. Additionally, there are other key differences between fixed and variable rates as it relates to reverse mortgages.

Distribution Options

One of the key differences between a fixed-rate and variable-rate reverse mortgage is the distribution options available. With a fixed interest rate, borrowers have only one option: a lump-sum distribution. Rather than receive their loan proceeds over time, they receive them in a single payment when they borrow.

Borrowers who opt for a variable-rate reverse mortgage have considerably more options, including:

• Term monthly payment: With a term monthly payment, borrowers will receive fixed monthly payments for a specific number of years.
• Tenure monthly payment: With a tenure monthly payment, borrowers will receive fixed monthly payments as long as they’re in the home and don’t exceed their principal limit.
• Line of credit: This option allows borrowers to access funds only when they need them. They can withdraw all the money at once, or take some and leave the rest for the future.
• Monthly payment and line of credit hybrid: Borrowers can opt to receive monthly payments—either the term or tenure option—paired with a line of credit to access when they need it.

Long-Term Interest Charges

Over the long term, a fixed-rate reverse mortgage generally results in higher interest charges. You receive all the money right away, meaning interest begins to accrue immediately. But with monthly payouts or lines of credit, interest only accrues on the amount that’s actually been received by the borrower. As a result, the total interest cost is lower.

Protection Against Rate Increases

Fixed interest rates are set at the time the loan is originated and don’t change over the life of the loan. As a result, fixed-rate loans offer protection from future rate increases.

Variable-rate loans, on the other hand, fluctuate based on an index rate. If market interest rates rise in the future, so will the rates on reverse mortgages. This could result in borrowers having to repay more than they anticipated later on.

Access to More Funds in the Future

The principal limit for a reverse mortgage is generally set at the time the loan is originated. For a variable-rate loan, the principal limit can increase over time, giving borrowers access to more money. But the principal limit on a fixed-rate loan won’t increase. The lump sum the borrower received at the beginning of the loan term is the most they can receive.

Interest Rate Changes With Variable Reverse Mortgages

Variable rates can change over time as market interest rates change. Rates are based on two key factors:

• Index: Each variable-rate loan is tied to a particular rate index, such as U.S. Treasury rates or the London Inter-Bank Offered Rate (LIBOR).
• Margin: Each lender adds an additional percentage to the index rate, known as the margin. The margin generally stays the same for the entire loan term.

As the interest-rate market changes, so does the rate on variable-rate loans. A reverse mortgage can have either yearly-variable or monthly-variable rates. A yearly-variable rate can change annually, while a monthly-variable rate can change each month.

No matter how often the rate on a variable-rate reverse mortgage can change, there’s generally a cap on how much it can increase, both in a single change and over the life of the loan.

How To Pay Interest on Reverse Mortgages

A key feature of reverse mortgages is the borrower doesn’t have to repay the loan as long as they remain in the home. This could occur if the borrower moves out, sells the home, or if they pass away. The amount that must be repaid is based on the principal balance, fees that were charged during the loan term, and the interest that accrued.

In some cases, borrowers may choose to pay interest on the loan even while they live in the home to reduce the amount they’ll owe when they leave the home.

How To Pay Off a Reverse Mortgage Without Losing Your Home

In most cases, a reverse mortgage is paid off with the sale proceeds of the home when the borrower moves out or they pass away. There are some protections in place, including a non-recourse clause that prevents borrowers or their heirs from having to repay more than the value of the home when it’s sold.

Unfortunately, because reverse mortgages are usually paid off with the sale of the home, homeowners often aren’t able to get out of the loan or leave it to their heirs when they die. The only way to keep the home is to find another way to repay the loan.

Frequently Asked Questions (FAQs)

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