While there are a variety of differences that set reverse mortgages apart from conventional mortgages, some distinctions are more subtle than others and play unique roles.
The dual interest rates associated with Home Equity Conversion Mortgages (HECM) are an example of one of these distinctions, according to Jack Guttentag, writing in a column published by Inman News.
Guttentag writes in the column:
The expected rate is used to calculate the amount the senior can draw under the different options. Seniors can draw cash, take a credit line, or receive monthly payments for life or for a specified term. The higher the expected rate, the smaller the amount obtainable under any of these options.
Now is a good time to take a HECM because the probability that expected rates will decline from current levels is very low, while the probability that they will rise within the next few years, perhaps steeply, is very high. The current expected rate is only slightly above the low point of 3.81 percent, reached in July 2012, but it is far below the highest levels reached in earlier years. In July 2000, it was 9.6 percent.
The second interest rate on a HECM is the accrual rate, which is the rate used to calculate the interest due the investor every month, exactly the same as on a standard mortgage. The only difference is that on a standard mortgage the borrower must pay the interest due every month, whereas on a HECM the interest is added to the loan balance.
The accrual rate on a HECM can be fixed or adjustable, but the fixed rate is available only on transactions in which the borrower draws the maximum amount allowable in cash. Borrowers who want a credit line or a monthly payment plan must accept an adjustable rate.
Since interest on a HECM is not paid but is added to the balance, the accrual rate determines how fast borrowers’ debts will grow, writes Guttentag.
There is also another unique feature accrual rates play on reverse mortgages, notes Guttentag. Because the unused portion of a HECM credit line grows at the same rate as the borrower’s debt, future increases in the accrual rate will result in faster growth in unused credit lines.
Written by Jason Oliva