Based on research from leading reverse mortgage professionals Harlan Accola and Dan Hultquist
This article does not constitute tax or financial advice. Please consult a tax and/or financial advisor regarding your specific situation.
It’s easy to lose focus on interest rates when you’re shopping for a reverse mortgage loan.
After all, the interest rate won’t affect your monthly payment because you won’t have to make one (though you will need to pay taxes and insurance and maintain the home).
Reverse loans don’t require monthly payments, as the full balance comes due when the last borrower dies or leaves the home.
But reverse mortgage interest rates are still a big deal and should factor into your borrowing decision. Your rate will make a huge difference when the balance comes due and you or your heirs must decide what to do with the home.
What is a reverse mortgage?
Reverse mortgage loans aren’t all that complicated. But they are different from the traditional, or “forward,” mortgage loans with which most homeowners are familiar.
With a traditional mortgage you build equity, gradually, by making monthly payments. With a reverse mortgage, you can receive money by borrowing against the equity you’ve spent years building in your home.
Only homeowners 62 and older are eligible for reverse mortgages. The most common type of reverse mortgage (and what we’re referring to in this article) is a home equity conversion mortgage (HECM). HECMs are insured by the Federal Housing Administration (FHA), which is part of the U.S. Department of Housing and Urban Development (HUD).
Reverse home loans resemble the home equity loan or home equity line of credit (HELOC) you might get to consolidate debt or renovate your house. The difference is, reverse mortgages do not require ongoing monthly payments. You do, however, have to pay taxes and insurance and maintain the home’s upkeep and repairs.
Instead, the loan balance becomes due when the last borrower moves, sells the home, or passes away.
You can make payments, if you want, and doing so can keep your reverse loan balance from growing larger.
But you don’t have to. And that can be really helpful if you’re on a fixed income and need access to more money each month.
A valuable source of retirement income
The combination of receiving payments from your home equity and not owing a monthly mortgage payment can be a game-changer for your retirement. Since you’ll only need to pay taxes and insurance, plus any costs related to maintenance and upkeep, you can have more cash on hand for other expenses.
Even if you’re not retired yet, a reverse mortgage can significantly boost your retirement finances. Money received from a reverse mortgage does not count as taxable income, and you may be able to hold off on taking withdrawals from your investment accounts — which do count as taxable income — by relying on reverse funds instead.
Of course, everyone’s situation is unique and you should work with your financial advisor to determine whether a reverse mortgage fits into your retirement financial plans.
How do reverse mortgage interest rates work?
Your home equity makes a reverse mortgage possible because the home serves as collateral and you can borrow against the equity you’ve built. You can access the equity as a lump sum, a line of credit, monthly cash advances, or a combination of cash advances and a line of credit.
But even though you’re receiving money, a reverse mortgage is still a loan. And loans come with costs.
Reverse mortgage costs
For a reverse loan, the costs come in the form of upfront closing costs, servicing fees, FHA mortgage insurance premiums (MIP), and — of course — interest.
Right now, we’re still in a relatively low interest rate environment. And if you plan to remain in your home for the rest of your life, you may not be as concerned with your reverse mortgage interest rate as you would with a traditional mortgage or home equity loan.
You’re not obligated to make a monthly mortgage payment, so you don’t have to worry about whether you can manage that cost. The only ongoing housing costs you’ll have will be taxes, insurance, and any necessary maintenance and repairs on the home.
But it’s still important to consider your interest rate, especially if there’s a chance you’ll want to sell the home and move elsewhere at some point in your retirement or you intend for your children to inherit the property and keep it in the family.
Although you won’t owe a payment until the last borrower leaves the home, interest will accrue throughout the life of the loan. When the balance comes due, you or your heirs will need to pay off the loan — whether that’s through the sale of the home, cash, or by refinancing to a forward mortgage.
Even if you know your heirs plan to sell the home when they inherit it, consider this. The higher the loan balance, the less money they’ll get to keep from the sale. They have to pay off your reverse mortgage lender before they get access to any of the profits.
That’s why it’s important to compare interest rates from at least three reputable reverse mortgage lenders and understand exactly how the interest will be charged.
How does interest accrue on a reverse mortgage?
When and how interest accrues on your reverse mortgage depends in part on how you receive the funds.
If you receive your entire loan balance all at once, your lender will add the annual interest charges to your balance in monthly installments. Each month your outstanding balance would grow a little larger if you choose not to make payments (again, you can make payments on a reverse mortgage, but you don’t have to. You just need to pay your property taxes and homeowners insurance and keep up with property maintenance).
Line of credit
You can also set up a reverse mortgage line of credit and draw funds from it as needed. In this case, you’d pay interest only on the amount used.
Another option is to receive monthly cash advances combined with a line of credit. You’ll want to discuss the terms of any of these plans with your reverse mortgage lender. The lump sum option may come with a fixed interest rate, so you don’t have to worry about the interest increasing substantially over time.
However, a lump sum disbursement may actually give you access to a lower amount than a line of credit or monthly advances. And although the rate on a line of credit may be variable — meaning it can go up over time — you may save money by not drawing on the funds until you absolutely need them.
This is why it’s critical to talk with your financial advisor and get quotes from several lenders. There are many options for how to best leverage a reverse mortgage, and the right one for you will depend on your finances, goals, age, and the amount of equity you have in the home.
Whichever way you choose to receive the funds, though, shopping around for a competitive interest rate and making payments (if you can) can help keep your final loan balance in check for you and your heirs.
How can I get the best interest rate on a reverse mortgage?
To get the best reverse mortgage interest rate, shop around. Getting a few quotes will give you a sense of what a reasonable rate looks like based on your circumstances, and if you get an outlier — either very high or low — you can ask the lender more detailed questions about the rate.
Some interest rate factors are beyond your control, such as your age, location, the appraised value of the home, and current market rates.
So it’s important to control the factors you can influence, including shopping around and making an informed decision about how to structure your loan proceeds.
What types of reverse mortgage interest rates are there?
Reverse mortgage loans can come with different types of interest rates. The type of rate you choose will affect your long-term borrowing costs.
Fixed-rate reverse mortgages have the same interest rate throughout the life of the loan. This means you’d be insulated from future rate increases, but you won’t save money if rates drop significantly, as they did in 2020.
Typically, you’d get a fixed-rate reverse mortgage if you opt for a lump sum disbursement of the loan proceeds.
If you need to access a lot of equity all at once — to renovate your existing home for aging in place, for example — the fixed-rate, lump sum option may be the way to go. Or, if you never want to wonder, “Is my interest rate getting uncomfortably high?”, a fixed rate can bring peace of mind.
Adjustable interest rate reverse mortgages have variable interest rates, which means your rate can change monthly or annually (either up or down).
If you choose to take a line of credit from your reverse mortgage, you’ll have an adjustable rate loan. Interest will not be charged until you draw on the line of credit, and you have the option of paying it down whenever you choose.
As with the lump sum option, you don’t have to pay on the line of credit. But if you want to keep drawing funds out, you can make payments to give yourself that flexibility.
Market conditions can cause your rate to rise, making your loan balance grow more quickly. However, there are caps on the amount of interest a lender can charge. Be sure to ask your reverse mortgage lender about whether your interest rate adjusts monthly or annually and what the relevant caps are.
A few reverse mortgage interest rate terms to know
As you shop around for rates, you’ll probably see these reverse mortgage-specific terms. Here’s what they mean:
- Initial interest rate (IRR): This is your rate during the first month of an adjustable-rate reverse loan. It matters because it’s the basis for future rate fluctuations. This won’t apply if you’re getting a fixed rate.
- Expected interest rate (EIR): Your ERR anticipates your variable rate loan’s reverse mortgage rate in 10 years, using your IRR as a starting point. If you’re getting a fixed rate, your EIR will be the same as your IRR.
- Compounding rate: This rate combines your loan’s interest rate with the ongoing cost of your mortgage insurance premiums to measure your balance’s growth over time. (FHA mortgage insurance premiums add 0.5% of your loan amount each year and 2% upfront.)
Reverse mortgage interest rate FAQs
Reverse mortgage interest rates change frequently. According to the U.S. Department of Housing and Urban Development, average rates in mid-2021 are slightly lower than reverse mortgage interest rates in 2020.
With a reverse mortgage, interest charges and fees accumulate on your principal balance, which means your home equity decreases over time. You can offset these costs by making payments, but you are not obligated to.
Monthly reverse mortgage payments are optional; the full loan balance comes due when the last borrower dies or moves out of the home.
Even though you don’t have to make a monthly mortgage payment, you will need to continue paying your property taxes and homeowners insurance premiums. You’ll also have to keep up with regular maintenance and repairs on the property.
Closing costs are typically 2-5% of the loan, but exact amounts depend on your particular situation. HECMs include a 2% upfront mortgage insurance fee, and lenders can charge an origination fee, though HUD caps the latter at $6,000. Closing costs also include appraisal fees, legal fees, and other expenses.
Reverse mortgage interest rates may seem like secondary thoughts since you don’t have to worry about managing monthly payments on the principal and interest, and only need to stay current with your taxes, insurance, and maintenance.
But interest rates significantly impact the total loan balance you and your heirs will need to pay off when you leave the home.
Working with a financial advisor will help you determine the best course of action when it comes to your reverse mortgage and making sure it enhances your financial security and what you leave to your family.
Fairway is not affiliated with any government agencies. These materials are not from HUD or FHA and were not approved by HUD or a government agency. Reverse mortgage borrowers are required to obtain an eligibility certificate by receiving counseling sessions with a HUD-approved agency. The youngest borrower must be at least 62 years old. Monthly reverse mortgage advances may affect eligibility for some other programs. This is not an offer to enter into an agreement. Not all customers will qualify. Information, rates and programs are subject to change without notice. All products are subject to credit and property approval. Other restrictions and limitations may apply. Equal Housing Opportunity.