One thing most people looking for reverse mortgage loans are keen on is the interest rate being offered. In any case, it is the interest rate that determines how much money you qualify for.
Contrary to reverse mortgage fees, understanding how interest rates work may prove to be a challenge. However, if you are considering applying for a reverse mortgage loan, then it is imperative to understand how the interest rates work.
How Reverse Mortgage Rates Work
Similar to what happens in most credit facilities, reverse mortgage interest rates are applied to the money that you get from the loan.
The interest rates are calculated on a daily basis and later included on the monthly loan balance. You can always view the details of the charges from your monthly statement.
It is also important to note that interest rates for reverse mortgage loans often get differed until the maturity time of the loan. The lender won’t demand upfront or monthly payments.
When can a reverse mortgage loan be considered mature?
- When the house or home is sold
- When the borrower passes away or moves out of the house
- When the loan has defaulted as a result of the borrower failing to pay homeowner’s insurance, property tax or comply with the terms of the loan
How reverse mortgage loans are calculated
Fixed interest rates
Fixed rates are normally set by investors and different government agencies. They are the ones charged with the responsibility of maintaining the stability of interest rates in the market.
For instance, the National Reserve Mortgage Lenders Association (NRMLA) in 2016 used a reverse mortgage calculator to set the average HECM fixed rate at 5.060%.
Variable interest rates
Variable interest rates differ from fixed rates in the sense that they are categorized into margin and index.
An index is a standard rate that is bound to change based on the market forces. It is not controlled by the institution lending the money. The interest rate charged on your reverse mortgage loan will increase or decrease depending on the direction taken by the index.
Margin refers to the interest percentage added on top of the index by the lending institution. The margin rate cannot be adjusted. This means that after the interest rate of a loan has been calculated, the rate remains the same until the maturity of the loan.
Choosing between fixed and adjustable rates
There’s not much difference when it comes to choosing between fixed and adjustable rates – and even if there’s any, it not significant.
What you need to understand is that reverse mortgage loans are “closed-end instruments”. This means that a borrower is supposed to take the entire loan and its terms at the beginning.
If you are paying for paying off an existing loan and require funds to clear the current loan, then this won’t be a problem.
However, for a borrower who has doesn’t have or has a very small lien on the property, it means that they will have to take the whole mortgage amount they qualify for when the funds are ready.
How often do variable interest rates change?
All variable rates are bound to adjust in order to conform to the market-based interest rates. The changes usually happen on a pre-determined frequency and will depend on how often you want them to happen.
Below are the common frequency options:
Yearly variable – just like the name suggests, happens once in a year. It has the following characteristics:
- Provides lower principle limits
- Guards against steep and spontaneous interest rates
- Rate changes are capped at 2% at every yearly adjustment. It cannot be more or less than two percent.
- All rate changes throughout the lifetime of a loan are capped at 5%
This is the most popular or commonly used variable by lenders. It has the fowling features:
- It is normally the lowest available rate
- It can change rapidly and several times in the course of the loan repayment period
- The total number of times the interest rate can change through the lifespan of the loan is capped at 10%
- There’s a possibility of the interest rate being adjusted to ten percent in one month
Other terms of interest
Expected Interest rate (EIR)
EIR is what a lender estimates will be the interest rate throughout the lifespan of a loan. This can apply to either fixed or variable interest loans. If it is a variable rate loan, the rate will be calculated on a 10-year fixed index.
For the case of a fixed rate loan, the EIR will be similar to the initial interest rate- since there will be no adjustments over the lifespan of the loan.
Below are some reasons why EIR is normally used:
- To calculate principle limits
- To calculate service fee separately
- To determine exact loan amounts to be disbursed monthly
Initial Interest Rate (IIR)
IIR It is the rate that lenders use to calculate the interest throughout the entire lifespan of a loan. It is also the interest rate that a borrower will be charged as the loans begins.
Compounding rate is also called the Total Loan Rate. It is the rate through which your reverse mortgage loan grows in. Compounding rate is generally the total sum of two of the following charges:
- The Annual Mortgage Insurance Premium – 0.5%
- Current interest rates are also known as the note rate
In a nutshell, there are different factors that come into play when calculating reverse mortgage loan rates. The most important thing is to ensure that you understand these factors – to assist you to make the right decision.