The most common and important discussion I have with my clients is regarding the payment plan and interest rate option. Someone I’ve been talking with over the past 2 years announced she was ready to do the reverse mortgage and wants the most money she can get. She stated very emphatically that she wanted the fixed rate with a lump sum draw. So I suggested we talk further and I started asking questions.
How long do you intend to stay in your home? She felt five years was the maximum time she would live there as the home is large and property maintenance is demanding. She had tried to sell her home but the market was too poor and she didn’t want to ‘give away’ the home that was the result of built up equity in all the homes she and her husband (now deceased) had bought and sold over their lifetime together. She had a mortgage to pay off that amounted to about one-half of the reverse mortgage proceeds. The lump sum she would have to draw with the fixed rate option would just be put into the bank earning less than one percent interest, where she would be accruing interest and mortgage insurance over 6% on the reverse mortgage loan.
I suggested we look at the variable rate option because she could keep the extra funds in the line of credit which would not be charged interest until she took draws. In addition, the available money in the line of credit grows at the same rate of interest plus mortgage insurance as charged on the balance, currently 3.77%. And if rates increase, she would benefit from more growth in her line of credit. She said she was terrified of variable rates as she heard people have lost their homes because of mortgages where rates went up and they could no longer afford the payment. I pointed out that since no payments are required, you don’t have the same risk as forward loans. Of course, higher interest rates cause the loan balance to increase more rapidly and she would owe more at the end (when she leaves the home permanently or sells). On the other hand, her line of credit would increase more. She liked that idea because that increasing available line of credit is a hedge against the home dropping in value. Even if the home value was less than the line of credit in the future, she could still take all of the money out. It’s not like a conventional HELOC where the lender can cancel the credit line at any time. Also, since she expected to be in the home for no more than five years, the risk of high interest rates is lower.
Then we compared amortization schedules between the fixed rate with the lump sum draw and the variable rate where she just drew the amount of the mortgage and upfront fees that were financed. It wasn’t too many years before the fixed rate balance was twice that of the variable rate, even using a higher rate than today’s rate on the variable option.
In many cases the fixed rate lump sum is best, especially if you expect to stay in your home for a long time or the rest of your life and if you have a large mortgage to pay off. You will find the upfront costs are typically lower with the fixed rate option also.
Knowing your goals, what is important to you and understanding the programs in depth helps you choose the best option for your needs. Let’s have a conversation!