For homeowners over the age of 62 who find themselves short on ready money, a Home Equity Conversion Mortgage (HECM), also called a reverse mortgage, can seem like a very accommodating proposition. This type of mortgage, however, is quite different from a standard mortgage. It is important to understand how these reverse mortgages and their rates work so that you can get the most out of your home’s equity.
Features of a Reverse Mortgage
Unlike a standard mortgage, a reverse mortgage provides funds based primarily on the borrower’s age and the equity of their home. They are only available to senior citizens who hold small mortgages or else own their homes outright, but there are few restrictions on how the money can be spent. This makes the reverse mortgage an ideal way to supplement a fixed income, pay off an outstanding loan or other debt, or improve the value of a home.One of the most conspicuous features of the reverse mortgage is when the loan must be repaid and interest comes due. Like standard mortgages, interest on principal is added monthly to the loan balance. Unlike interest on a standard mortgage, however, the borrower does not make a monthly payment. Instead, the loan along with all the interest accrued are deferred until the end of the loan’s life. This occurs when the borrower dies, sells the house and/or permanently moves out, or if property taxes and insurance are not paid.Between the ease of obtaining money through a reverse mortgage and the “out of sight, out of mind” nature of the costs, these loans can become something of a pitfall. It is important to understand how interest accrues on the different types of reverse mortgages so that you can get the greatest value out of your home’s equity.
Fixed Rate HECMs
As the name implies, the interest rates on these mortgages will never vary; once established, your rate will remain rock steady for the life of the loan. This has been the preferred type of reverse mortgage since about 2009, thanks to the fact that their rates are steady regardless of market volatility.The downside (compared to variable rate mortgages) is that the money must be taken as a lump sum, and there are certain restrictions on the amount of principal you’re able to receive. If you’re not paying off a mandatory debt, such as a home mortgage, then you can only receive 60 percent of principal.
Variable Rate HECMs
Once again, as suggested by the name, the interest rates of these reverse mortgages vary over time. These rates are made up of two components: the index and the margin. The index is a standard rate that changes based on market activity; the margin is an interest percentage that the lender adds onto the index. Unlike the index, the margin does not vary over the life of the loan.Taking out a variable-rate reverse mortgage puts you at great financial vulnerability, as the interest rates may rise suddenly and dramatically. However, there are ways to protect yourself from risk with these mortgages, based on how you plan to take your payouts.These payouts are much more flexible than in a fixed-rate reverse mortgage. You will have the option of using your home’s equity as a line of credit, receiving a monthly sum, taking a lump sum or any combination of the three. Interest will only be charged on funds that have been withdrawn, so by carefully budgeting how much money you take out on the loan, you will be able to mitigate the costs of an interest rate explosion. This type of reverse mortgage is ideal for supplementing a fixed income or keeping money available in the event of an emergency without making yourself overly vulnerable to hikes in interest rates.Obviously, these different types of HECMs are meant for very different purposes. By knowing the structures of these types of mortgages and by defining your goals for the money you’ll be borrowing, you can have financial peace of mind in the years when you need it the most.