It’s a crazy world out there right now. Entire nations locked down, people confined to their homes, the stock market crashing (then rebounding), businesses shut down, and unemployment rising. If there’s one silver lining in all of the craziness, it’s falling mortgage rates. According to the Freddie Mac Primary Mortgage Market Survey, average 30-year fixed interest rates fell from 3.72% on January 2, 2020 to 3.23% on April 30, 2020. Not surprisingly, this has sparked a massive refinance boom in the traditional “forward” mortgage industry.
The reverse mortgage industry has seen a significant rate drop as well. Yes, this means interest costs on reverse mortgages are lower now than they were a handful of months ago. However, lower rates also provide some other benefits that may pleasantly surprise many reverse mortgage applicants. But before I explain what these benefits are, I need to first explain some important basics about how a reverse mortgage works.
How HECM proceeds are calculated
The most popular reverse mortgage in America today is the home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders). The HECM is FHA-insured and enables homeowners 62 or older to convert a portion of their home’s value into cash without giving up ownership of the home or taking on a mortgage payment. This is the reverse mortgage product we’re focused on here at MyHECM.com.
The total amount of proceeds available through a HECM is called the principal limit. The principal limit is calculated by multiplying the maximum claim amount (the home value for most borrowers) by a principal limit factor published in FHA’s principal limit factor tables. The lender determines the proper principal limit factor to use based on the age of the youngest borrower (or non borrowing spouse) and the current expected interest rate.
To see how this works, let’s check out an example. Let’s assume the appropriate principal limit factor based on age and expected interest rate is 0.50. Let’s also assume the home value is $300,000. Because the home value is less than the FHA lending limit, the maximum claim amount equals $300,000 as well. To determine the principal limit, we simply multiply the maximum claim amount by the principal limit factor:
0.50 (PL factor) * $300,000 (MCA) = $150,000 (PL)
As you can see, the principal limit factor is essentially a loan-to-value of sorts. It establishes the portion of the maximum claim amount available to the borrower as proceeds. In this case, the principal limit is $150,000. This is the total gross proceeds available before paying off existing mortgages, closing costs, etc.
So, why does all this matter? Because the principal limit is heavily impacted by prevailing interest rates. When interest rates decrease, expected interest rates decrease as well. When expected interest rates decrease, principal limit factors increase. This means reverse mortgage borrowers tend to qualify for a larger percentage of their home’s value as interest rates fall.
The expected interest rate is calculated based on the 10-Year LIBOR Swap, which has fallen from 1.8% in January 2020 to 0.62% at the end of April 2020. Because the swap rate has fallen, expected interest rates have fallen as well. Our HECM calculators were assuming an expected interest rate of about 4.05% in January. Today, our expected interest rate is under 3.00%. This means the principal limit factors used for our calculations today are significantly higher than they were in January.
Check out the chart, which shows principal limit factors for expected interest rates of 4.125% and 3.00%. You’ll notice that the principal limit factors are significantly higher today (the 3.00% column) than they were at the beginning of the year (the 4.125% column). A 65-year old applying for a reverse mortgage today would get about 12% more than what would have been available in January. For a 74-year old, proceeds are about 10% higher now than they were at the beginning of the year.
Folks, it’s obvious the rate bonanza in the “forward” mortgage world has also benefited reverse mortgage applicants. Lower interest rates means reverse mortgages are accruing less interest. Even better, lower rates means reverse mortgages are offering substantially more money than what was available just a few months ago.
Here’s something else you may not be aware of: when rates fall, lenders often have more leeway to reduce your net closing costs as well. If you plan to apply for a reverse mortgage soon, be sure to ask your lender what they can do to reduce your closing costs.
The bottom line
If you’ve been considering a reverse mortgage, now is as good a time as any. Rates have fallen substantially since the beginning of the year. Interest costs are down and proceeds are up – significantly. If you’ve been on the fence about getting a reverse mortgage, now might be the time to pull the trigger and get it done.