Fixed Vs Adjustable Rates
Can I get a fixed rate with a reverse mortgage?
Many consumers and finance experts alike believe that all reverse mortgages have adjustable interest rates. Up until a few years ago this was true. As demand for better reverse mortgage products grew fixed rate reverse mortgage options became available.
Many wonder what kind of a difference having a fixed vs. variable rate mortgage makes on a reverse mortgage since there are no mortgage payments due on the loan. The argument is made that because you never make a payment, it doesn’t matter what type of interest rate you have. This argument however is only partially true. In the current market adjustable rate reverse mortgages often carry lower loan size limits than its fixed rate counterparts. The reason for this is the lender assumes the adjustable interest rate on the mortgage is carried at its “fully indexed rate” which is currently higher than the fixed rate. So how do the adjustable rate mortgages work?
An adjustable rate mortgage, regardless of mortgage type, is based on two factors. The first is called the index, the second the margin. The index is simply an average of some type of finance market, such as the T-Bill or the prime interest rate. Another common index used in mortgages is the LIBOR index- similar to the US T-Bill, however it’s based on the London Interbank Offered Rate. These indexes adjust daily, however mortgage rates are typically based on an average rate of a period of time. The T-Bill is usually averaged over a 1 year period, and the Libor over a 6 month period. FHA backed reverse mortgages are based on the T-Bill index. This index can be looked up online via numerous sources such as the Wall Street Journal or Bloomberg.
The margin is an amount that is added to the index. The margin varies from loan to loan but is commonly set at 2.75% - 3.25% over the index rate. As a result, if the T-Bill index is at 3.5% and the margin is at 2.75% the fully indexed interest rate would be 6.25%, derived by adding the index and the margin. If the current fixed interest rate is lower than the adjustable fully indexed rate you will qualify for a larger loan size upfront on the fixed rate. If the fixed rate is high at the time you take out your reverse mortgage you may qualify for a larger loan size on an adjustable rate.
Many ask what the start rate or teaser rate on the loan refers to. This term points to the interest rate your loan is set at when you first take the mortgage out. On adjustable rates this rate is often lower than the fully indexed rate and remains lower for a period of time. With reverse mortgages that period of time is usually 1 year. After the year is up, the lender adjusts the interest rate in accordance with the current index and adds the margin to it. That rate is then charged for the next year, and then it resets again using the same calculation.
Finally, adjustable rates have some safeguards in place. These safeguards are called caps- which is basically a maximum amount the interest rate can adjust during a period of time. The cap on a mortgage has two parts to it. One is the yearly cap- the most the interest rate can adjust from one year to the next (FHA loans usually have a 1% per year cap) and the 2nd is the lifetime cap- the most the rate can increase from the start of the loan over the lifetime of the loan. FHA usually has a 5% lifetime cap on the interest rate.
As a result, both fixed and adjustable rates are valid mortgage types. Depending on your situation one loan may fit you better than another. However, during the current market we are in fixed rates are at historic lows, so most consumers will find a superior loan size with the fixed rate option. By talking to your reverse mortgage adviser you can get full information on the best option for you.
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