A reader caught me off guard the other day by saying that
she had counted 28 articles on adjustable rate mortgages on
my web site, but all of them pertained to standard
mortgages. Not one applied to reverse mortgages, and she
wondered whether that was because the issues were exactly
the same? I winced at that, because the issues are not the
same – not even close.
The consequences of a rate change, however, are very
On standard mortgages, a rate change is almost always
accompanied by a change in the required payment. The new
payment is the amount that will pay off the mortgage over
the period remaining of the term specified in the contract.
If it is a 30-year mortgage with the first rate adjustment
after 5 years, for example, the new payment is calculated
over 25 years.
On a HECM reverse mortgage, in contrast, there is no
required payment. Interest is added to the loan balance,
which grows over time. A change in the interest rate,
therefore, results in a larger or smaller rate of increase
in that balance but no payment is due until the borrower
dies or moves out of the house permanently. At that point,
the entire balance is due.
The reasons for selecting an adjustable rather than a fixed
rate are also different.
On a standard mortgage, few borrowers opt for an
adjustable-rate because of fears that they will still have
their mortgage when the initial rate period ends, and that a
rate increase at that time will increase their required
payment. Many seniors considering a reverse mortgage bring
along a negative mindset from their experience with (or what
they have heard about) adjustable rates on standard
mortgages. Some begin the process by expressing a strong
preference for a fixed-rate reverse mortgage, which may or
may not meet their needs.
The rationale for preferring fixed rates on standard
mortgages, which is to avoid the risk of a payment increase,
has no applicability to reverse mortgages, which have no
required payment. The benefit of the fixed rate on a reverse
mortgage is only that the borrower knows in advance exactly
how fast the debt secured by his home will grow. The
downside is that the
fixed-rate HECM offers only one way to draw funds, which is
to take a lump sum at closing.
The fixed rate HECM reverse mortgage is primarily for seniors who plan to use all or most of their borrowing power right away. Their intent is to pay off an existing mortgage, buy a house, purchase a single-premium annuity, or transact for some other purpose that requires a large and immediate payment.
The fixed-rate HECM does not allow the borrower to reserve any borrowing power for future use. Once it is closed, no more funds can be drawn. The only way the senior can draw more funds is to refinance the HECM into a new HECM, but for that to work, either the value of the home would have to rise appreciably, or regulations that cap draw amounts would have to be relaxed.
The adjustable rate HECM allows seniors to draw funds at
closing, and also to draw funds after the closing. Such
borrowers are able to plan for their future in a way that
those who take a fixed-rate cannot.
Adjustable rate borrowers can draw a fixed monthly payment
for a specified period, or for as a long as they reside in
the house; they can draw cash irregularly as needed; and
they can let their borrowing power sit as an unused credit
line indefinitely. The unused line grows month by month at
the same rate as their debt, so that the longer they wait
before drawing on the line, the larger is the line.
addition, seniors can combine these draw options, taking
some cash at closing, some as a monthly payment, and some as
irregular draws on a credit line. Further, they can adjust
their options in the future as their needs change. For
example, they can use their unused credit line to purchase a
monthly payment at any time, or they can do the opposite,
converting their monthly payment into a credit line.
In sum, where the fixed-rate HECM may be helpful in resolving an immediate financial problem, the adjustable rate HECM can be an integral part of a long-range retirement plan.