How rising interest rates may affect reverse mortgages
People who have financed real estate or obtained reverse mortgages over the past decade have benefitted from long-term historically low-interest rates. The prolonged low-rate environment has helped lower the cost of buying a home and enabled reverse mortgage borrowers to access a higher percentage of their home’s equity.
Interest rates have been so low for so long, however, that the conventional wisdom is rates have to increase at some point. If/when that occurs, what will be the impact on people who either have a reverse mortgage in place or have delayed getting one?
If you’re considering a reverse mortgage…
For those who are in the market for a reverse mortgage but haven’t pulled the trigger, higher interest rates will reduce the amount of money one can borrow.
The amount available to a reverse mortgage borrower is based on three factors: the borrower’s age, the amount of equity in the home, and the expected interest rate.
As its name implies, the expected interest rate is what the lender anticipates the rate averaging over the life of the reverse mortgage. The bank will arrive at that rate based on the average yield for U.S. Treasury securities adjusted to a constant maturity of 10 years, or the 10-year rate on the London Interbank Offered Rate (LIBOR) Index.
The expected rate is just a projection. The actual interest you pay when the loan becomes due will be based on actual interest rate movements during the loan. But the expected rate helps determine how much of your home’s equity you can borrow.
Here’s an example of how an increase in market interest rates could impact the amount you can borrow from a reverse mortgage:
If your home is valued at $275,000, then you can access as much as $144,000 (a maximum of $81,000 in the first year) from a reverse mortgage provided the interest rate was under 5 percent.
If the rate increases to 5.25 percent, your reverse mortgage funds drop to $135,000, with a first-year lump sum availability of $78,000.
At 5.625 percent, the reverse mortgage on the same house has a principal limit of $122,000, with a first-year lump sum maximum of $68,000.
How increasing rates impact an existing reverse mortgage
If you already have a reverse mortgage, the impact of rising interest rates will depend largely on whether you have a fixed-rate or variable-rate loan.
If your loan has a fixed rate, it won’t change regardless of what happens to market rates. Fixed rates remain the same for the life of the loan.
If you’re contemplating getting a fixed-rate reverse mortgage to avoid the consequence of rising interest rates, there is one major downside: You can only receive the proceeds in a lump sum. No other payment options, such as a line of credit or monthly payment, are available with a fixed-rate loan.
Also, reverse mortgage rules state that borrowers can only claim 60 percent of the loan’s principal amount in the first year, unless they are using it to pay off the existing mortgage balance. So a borrower may forfeit 40 percent of the loaned amount just to get a fixed interest rate.
Therefore, experts typically advise that borrowers use a fixed-rate reverse mortgage only in circumstances where a large lump sum is needed, such as paying off the existing mortgage or other debt, or making major repairs to the home.
If you have a reverse mortgage with a variable rate loan, then an increase in market rates will not have an immediate impact. It won’t reduce the monthly payment you receive or the line of credit that’s been established. But higher rates over the course of the loan will result in a higher repayment amount than if rates had remained steady or declined.
Increasing interest rates have one potential benefit for reverse mortgage holders. If you have a reverse mortgage line of credit, then your total line of credit will increase the more market rates increase.
Once the initial line of credit is determined, it grows automatically at the variable rate that takes into account the movement of the LIBOR index. The higher the LIBOR moves, the higher the growth rate on the line of credit.