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Reverse Mortgage Options - Fixed Rate or Adjustable Rate
There are two types of reverse mortgages: fixed rate and adjustable rate (ARM). The amount and type of disbursements you receive and the interest rate you pay vary depending on the type of reverse mortgage you select. Each program involves different benefits and risks for borrowers. For example, the mortgage rate on an adjustable rate reverse mortgage can increase but you can usually access more loan proceeds. The interest rate for a fixed rate reverse mortgage never changes but you usually access less proceeds plus your disbursement options are more limited.
The type of reverse mortgage that is right for you depends on your objectives as well as your risk profile and financial situation. Borrowers looking for more certainty are likely to select a fixed rate reverse mortgage while borrowers who have higher appetite for risk are more inclined to choose an adjustable rate reverse mortgage.
Although the choice is personal and depends on many factors, it is important to first understand the program options as well as their similarities and differences. The discussion below outlines how fixed rate and adjustable rate reverse mortgages work and reviews the positives and negatives for each program. Understanding both types of mortgages as well as their advantages and disadvantages is key to selecting the reverse mortgage that is right for you.
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The interest rate for a fixed rate reverse mortgage is set and cannot change over the life of the loan. The rate is determined by the lender and subject to negotiation with the borrower. The interest rate for a reverse mortgage is approximately 1.25% higher than the current market rate for a normal 30 year fixed rate mortgage and higher than the interest rate for an adjustable rate reverse mortgage.
For a fixed rate reverse mortgage there is typically little variation in rates across lenders but borrowers can elect to pay discount points to lower their rate. Additionally, there is usually more variation in closing costs across lenders so borrowers should gather reverse mortgage proposals from at least four lenders to find the loan with the lowest combination of interest rates and fees.
Disbursement Options for a Fixed Rate Reverse Mortgage
With a fixed rate reverse mortgage the borrower receives a one-time disbursement, or lump sum payment, when the loan closes. The disbursement equals approximately 60% or less of the initial principal limit. The initial principal limit, calculated using an FHA formula, varies depending on age and property value and is typically between 50% and 60% of the property value. The amount of money the borrower receives equals the disbursement amount minus the principal balance on any existing mortgages on the property and closing costs.
The borrower does not receive any additional disbursements following the initial disbursement with a fixed rate reverse mortgage. The borrower does not receive any monthly disbursements and does have access to their remaining property equity through a reverse mortgage line of credit. The principal balance of the mortgage grows over time depending on the interest rate. The lower the rate, the slower the principal balance of grows.
The chart below outlines the positives and negatives of a fixed rate reverse mortgage:
With an adjustable rate reverse mortgage, the interest rate can change and possibly increase over the life of the loan. The higher the interest rate, the faster the principal balance grows so an adjustable rate reverse mortgage exposes the borrower to more risk than a fixed rate loan. The borrower can choose between a mortgage that adjusts on a monthly basis or on an annual basis, with the annual adjustable rate reverse mortgage being the most popular.
The interest rate for an adjustable rate reverse mortgage is comprised of two components: the margin and the index. To calculate the interest rate, you add the margin to the index. For example, if the the margin is 2.500% and the index is 1.000%, the interest rate for your reverse mortgage is 3.500%.
The margin is a set interest rate amount that does not change over the term of the reverse mortgage. The margin is typically 2.0% - 3.0%. The margin is determined by the lender and subject to negotiation with the borrower.
The index is an underlying interest rate that can change over time. Reverse mortgages obtained prior to June 2020 usually use LIBOR as the index while reverse mortgages after June 2020 typically use the 30 day average SOFR (Secured Overnight Financing Rate). Simply put, SOFR and LIBOR represent the interest rate that banks charge each other to borrow money and change based on movements in the economy. The values for SOFR and LIBOR fluctuate but are the same for all banks.
LIBOR is being eliminated after 2021 and most LIBOR-based reverse mortgages will transition to SOFR. We recommend that you review your reverse mortgage documents to learn how your rate is calculated when LIBOR is not published.
The interest rate for an adjustable rate reverse mortgage is re-calculated on a monthly or annual basis for the entirety of the loan and changes with any fluctuations in the index. If the index increases, your interest rate increases and the loan balance increases faster over time because you are adding more interest expense to the loan. The interest rate for an adjustable rate reverse mortgage also has a life cap which limits how much it can increase over the term of the mortgage. The typical life cap for an adjustable rate reverse mortgage is 5.0% which means the interest rate over the life of the loan cannot exceed the initial rate by more than 5.0%.
Disbursement Options for an Adjustable Rate Reverse Mortgage
The maximum amount of proceeds the borrower is able to receive at closing with an adjustable rate reverse mortgage is equal to or greater than a fixed rate reverse mortgage (depending on the borrower's age), plus the borrower has more options for how and when they take disbursements over the life of the loan. Additionally, with an adjustable rate reverse mortgage, the borrower is able to borrow more over the life of the loan as compared to a fixed rate reverse mortgage.
With the adjustable rate option the borrower receives an upfront disbursement when the mortgage closes and is able to take additional disbursements after waiting a year. The maximum upfront disbursement equals approximately 60% or less of the initial principal limit. The borrower has to wait twelve months after the mortgage closes to be able to access the remaining available loan proceeds, up to the initial principal limit, either through another lump sum disbursement, monthly disbursements or through a line of credit.
The table below outlines the multiple disbursement options for how and when borrowers access the proceeds from an adjustable rate reverse mortgage.
It is important to highlight that different lenders offer different reverse mortgage programs and not all lenders offer programs that allow borrowers to draw down the proceeds from their reverse mortgage as described above. Be sure to consult multiple lenders to understand the programs they offer so you can find the reverse mortgage and disbursement strategy that are right for you.
The chart below outlines the advantages and disadvantages of an adjustable rate reverse mortgage:
Sources
“Are there different types of reverse mortgages?” CFPB. Consumer Financial Protection Bureau, August 30 2019. Web.
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