Fixed vs. Adjustable Interest Rates on Reverse Mortgages
Key Takeaways
- Fixed-rate reverse mortgages require you to take all your cash as a single lump sum.
- Adjustable-rate loans allow you to use the Line of Credit and monthly payment options.
- Adjustable rates feature strict lifetime caps to protect you from hyperinflation.
In the traditional mortgage world, getting a 30-year fixed-rate loan is considered the safest and smartest financial move. When seniors apply for a reverse mortgage, they naturally demand a fixed rate.
They are often shocked when their loan officer strongly advises them to take an Adjustable Rate Mortgage (ARM). In the reverse mortgage universe, the rules are completely inverted.
The Limitation of the Fixed Rate
You can get a fixed-rate reverse mortgage, but it comes with a massive, deal-breaking restriction imposed by the FHA:
If you choose a fixed rate, you must take 100% of your available cash as a single lump sum at closing.
You are not allowed to have a Line of Credit. You are not allowed to receive monthly Tenure checks. The bank wires you all the cash on Day 1, and you immediately begin accruing compounding interest on the entire massive balance. For 90% of seniors, this is a terrible financial strategy that drains their equity rapidly.
The Freedom of the Adjustable Rate
If you want the safety of the Line of Credit, or the guaranteed income of the monthly Tenure plan, the FHA forces you to accept an Adjustable Rate.
Because the bank does not know when you will draw the money (you might draw $5,000 today and $20,000 ten years from now), they cannot lock in a fixed cost of capital. They must tie your interest rate to the current market index.
If national interest rates go up, the compounding interest on your loan balance will grow faster. If national rates drop, your interest rate drops with them.
The Safety Caps
Seniors who remember the 18% interest rates of the 1980s are terrified of adjustable rates. To protect borrowers, the FHA enforces strict Lifetime Caps.
When you sign the loan, the contract dictates the absolute maximum interest rate the loan can ever reach. Typically, an annually adjusting HECM has a lifetime cap of 5.00% above your starting rate. If you start at 6.00%, the absolute worst-case scenario is that your rate eventually maxes out at 11.00%, even if national interest rates hit 20%.
For most borrowers, the massive equity preservation of the Line of Credit vastly outweighs the risk of the adjustable rate.