How Does Interest Work with a Reverse Mortgage?
All loans come with interest attached. This is how the lender makes a profit on the loan. The interest you pay is their return for loaning you the money. You should be familiar with the concept from your current home mortgage. However, there are some important differences to note with the way interest works on a reverse mortgage.
Perhaps the single most important thing to realize is that interest with reverse mortgages is not calculated the way it is with other home loans. In fact, it’s calculated the way it is with credit cards, meaning that the amount you owe will increase quickly because of compounding interest. That can be bad news for your heirs if they intend to pay off the mortgage after you move out or pass away, but if you intend to allow the lender to sell your home at the end of the loan, then this may not be a deal breaker. Let’s look at a brief outline of how this works:
You’re approved for the reverse mortgage and complete the closing process.
You receive your funds and spend them as you like.
You never need to worry about making a payment on the new mortgage if you do not want to.
However, each month that passes, interest and mortgage insurance premiums are added to your loan balance.
The interest and insurance premiums compound, meaning that because they are added to the balance, they affect the amount of interest the next month.
Over time, your loan balance grows larger and larger because interest and insurance premiums are being added to it, but the larger balance also increases the amount of interest insurance premiums you’re charged subsequently.
Note that this applies only to HECM reverse mortgages backed by the FHA. Proprietary reverse mortgages available through private lenders may have very different costs.
What Reverse Mortgage Terms Are Available?
In the world of lending, the word “term” means lifespan. A 30-year mortgage has a term of 30 years. A 15-year mortgage has a term of 15 years. What sorts of terms are available with reverse mortgages?
First, understand that there’s no such thing as a lifespan when it comes to reverse mortgages. They last as long as you (and/or your spouse or partner) remain in the home. This could be a few years, or it could be 50 years. There is no end date specified the way there is with regular mortgages.
With that being said, you do need to consider the structure of your loan. Specifically, you need to think about whether you want a fixed rate loan or an adjustable rate loan. What’s the difference?
Fixed-Rate Reverse Mortgages
A fixed rate mortgage (FRM) is exactly what it sounds like. You’re offered a specific interest rate at the beginning of the loan, and it is locked in. It never changes over the life of the loan, no matter what happens with the national rate.
The most important thing to consider here, beyond the rate that you’re given by your lender, is the fact that taking a fixed rate loan means you will receive the funds for your mortgage as a single lump sum. You cannot take them as monthly payments or as a line of credit (or as a combination).
Adjustable-Rate Reverse Mortgages
An adjustable rate mortgage (ARM) differs from a fixed rate loan in that the interest rate you’re charged can change over time. With an adjustable rate reverse mortgage, you’ll find two varieties – loans that can adjust once per year, and loans that can adjust monthly. That differs greatly from conventional ARMs, which have strict limitations on how often they can adjust over the life of the loan.
Going with an ARM could mean paying more in interest, but it could also mean paying less, depending on what the index rate does and the margin added to the loan by the lender. However, it also gives you the ability to receive your funds in a number of different ways, including tenure, term, a line of credit, and modified tenure and term combinations.
What Will Your Reverse Mortgage Interest Rate Be?
The only way to determine what your interest rate will be is to discuss your loan with a lender. However, there are many factors that go into determining what your interest rate will be. These include many of the same factors that apply to determining your maximum principal amount. The factors to know include the following:
The type of HECM mortgage you’re interested in (reverse or for purchase)
The value of your home
Your age (or the youngest borrower on the loan)
The zip code in which you live
The amount still owed on your current mortgage, if any
The amount owed on any other liens on the home
How long you expect to remain in the home
Your actual life expectancy
The method of disbursement you choose