A reverse mortgage can be a good way to create an additional income stream without being required to make mortgage payments. Once you get approved for a loan, you have several payment options including a lump sum payment, a payment plan, or a line of credit. The interest rate you pay on the reverse mortgage varies by lender.
As of November 2022, the lowest fixed interest rate on a reverse mortgage is 6.68% (7.68% APR), up from 4.81% as of April 2022. The lowest adjustable interest rate on a reverse mortgage is 6.865% with a margin of 2.125, up from 3.52% in April 2022. The interest rate is wrapped into the loan and repaid with the principal mortgage balance.
Reverse mortgage interest rates
Reverse mortgages can charge either fixed or variable interest rates. The fixed interest rate does not change throughout the loan term, and it provides protection from sudden changes in mortgage rates. On the other hand, the adjustable interest rate is a variable interest rate, where the interest rate remains constant for a certain period, after which the rate adjusts based on the current market rate.
While the interest on a reverse mortgage will accrue continuously during the term of the loan, the interest payment is deferred until a future date when the homeowner sells the home, moves out, or dies. If you are married, and the spouse is listed as a co-borrower or is eligible to borrow, they can remain in the home even after the spouse dies or moves to a nursing home.
How reverse mortgage interest rates are calculated
Interest rates on reverse mortgages are charged on the loan amount you receive from the lender. You can see the total interest added to your loan balance on your monthly mortgage statement.
When you get approved for a reverse mortgage, you will find the initial interest rate on your mortgage documents. If you choose an adjustable-rate loan, the mortgage company will use this initial interest rate to determine your future interest rate. You will pay the initial interest rate during the first index rate period, which could be a month, quarter, or year.
Typically, the adjustable interest rate is calculated by summing up the index rate and the margin set by the lender. The index used is the London Interbank Offered Rate (LIBOR). For example, if the index is 2.81% and the margin is 3.00%, the adjustable interest rate will be 5.81%. If the index increases, the interest rate will also increase. However, the margin stays the same, and it does not change during the life of the loan.
If you have a fixed-rate reverse mortgage, the interest rate stays the same for the duration of the loan, and this means you are protected even if market rates increase. A fixed-rate mortgage allows for predictability since you can estimate the amount of interest you will pay during the loan term. The actual interest rate varies across lenders, but they are not indexed to market interest rates. To determine the best available fixed interest rate, you should compare quotes from several mortgage lenders.
Choosing Fixed Rate vs. Adjustable Reverse mortgage
The interest rate you pay on a reverse mortgage loan can affect the amount you receive in loan proceeds. A higher interest rate on the reverse mortgage can lower the loan proceeds you receive from the mortgage company.
Here are the two options you have:
Reverse mortgage fixed rate
If you are taking a reverse mortgage to buy a retirement home or pay off the outstanding balance on your existing mortgage, you might find the fixed-rate mortgage appealing. The fixed interest rate remains constant throughout the loan's lifetime, but you must take a single lump sum disbursement at closing. For example, if you qualify to take a fixed-rate reverse mortgage of $300,000, you will receive these funds at closing.
However, the fixed-rate reverse mortgage can affect your eligibility for other needs-based financial assistance programs. For example, if you receive Medicaid or Supplemental Security Income (SSI), the sudden addition of liquid assets could make you ineligible to collect further benefits. Additionally, even though the loan interest is predictable, it does not mean you will pay a lower interest rate than reverse mortgage adjustable rates.
Reverse mortgage adjustable rate
Generally, adjustable interest rates are often lower than fixed-rate reverse mortgages, and they allow more payment options for loan proceeds. While fixed-rate reverse mortgages allow only a single lump sum disbursement, an adjustable reverse mortgage offers several payment options, including single lump sum disbursement, line of credit, payment plan, or a combination of these options.
During the term of the loan, the lender will adjust your interest rate by adding the index and the margin. The interest rate may be adjustable monthly or annually. If the lender adjusts the interest rate every 12 months, it will take the 12-month LIBOR index value and add it to the margin. The margin remains fixed during the term of the loan, but you can negotiate the lender's margin at the time of application.
Other Reverse Mortgage Charges
Apart from interest, there are other fees that you should consider when applying for a reverse mortgage. Some of the fees that you may be required to pay include:
Mortgage Insurance Premiums (MIP)
These charges are unique to Home Equity Conversion Mortgage (HECM), which is federally insured. Borrowers pay an initial charge of 2% of the maximum claim at closing, but the rate reduces to 0.5% of the loan balance in subsequent years. If you take a proprietary or single-purpose reverse mortgage, you won't require to pay MIPs.
Origination fee
This is the upfront fee that lenders charge to initiate the loan, and it may be deducted from the proceeds of the loan payable to you at closing. The US Department of Housing and Urban Development caps these fees at $6,000.
Closing costs
These costs represent the third-party services that must be undertaken before the reverse mortgage application is finalized. It may include appraisal fees, title searches, state, local, and federal mortgage taxes, credit checks, and insurance. The lender may also charge a monthly fee on the mortgage.