January 30, 2016 by HECM Pro
There are two main FHA-insured reverse mortgage products, the fixed-rate HECM and the variable-rate HECM. The fixed-rate HECM is generally the less popular of the two because it isn’t as flexible and customizable as the variable-rate HECM, but it is still a great reverse mortgage option for many people. It comes with the security and predictability of an interest rate that never changes, but the rate is usually higher than the start rate of a comparable variable-rate HECM.
How It Works
Unlike the variable-rate program, which allows for the loan proceeds to be distributed as a monthly payment, line of credit (LOC), lump sum, or some combination of all three, the fixed-rate program only allows for lump sum. In other words, all of the money you qualify for must be taken at closing whether you need the cash right now or not. And again, there’s no option for an additional line of credit or monthly payment plan as with the variable-rate program.
The 60% Utilization Rule
A downside to the fixed-rate HECM is that it can sometimes offer far less cash than the variable-rate HECM. This isn’t always the case, but if you have a low mortgage balance or the home is free and clear, the variable-rate HECM probably will give you more money overall. If you have a high mortgage balance, both programs may offer about the same amount of money.
The reason the fixed-rate program sometimes offers far less money is the 60% utilization rule. If your mandatory obligations (all mortgage payoffs, closing costs, property charges due, etc.) are less than 60% of the principal limit (the total amount of money qualified for), you’ll receive the difference between the mandatory obligations and 60% of the principal limit in cash at closing as a lump sum payment – and that’s all you’ll receive. No more money will be available.
For example, if the principal limit is $100,000 and the mandatory obligations add up to $40,000 (40% of the principal limit), that means you have another $20,000 available before you hit 60% of the principal limit ($60,000). Under the fixed-rate program, you’ll receive the additional $20,000 as a lump sum payment, then the loan will be locked down and no more cash will be available.
If your mandatory obligations are more than 60% of the principal limit, you’ll be given an additional 10% of the principal limit at closing up to a maximum loan amount equal to the principal limit. For example, if the principal limit is $100,000 and your total mandatory obligations are $70,000 (70% of the principal limit), you can draw out an additional $10,000 (10% of the principal limit) at closing because you’re over the 60% of principal limit threshold.
As another example, let’s assume your mandatory obligations are really high and total $95,000 (95% of the principal limit). In this case, there wouldn’t be enough room to pull out another 10% of the principal limit because only 5% is available. You would receive the additional $5,000 up to the principal limit, then the loan would be locked down and no other cash would be available.
The bottom line is this: If your mandatory obligations are really low, such as in cases where you have little or no mortgage balance, it’s a good bet the fixed-rate program will offer you a lot less money. If your mandatory obligations are higher and exceed 60% of the principal limit, it’s possible that the fixed-rate could offer the same amount of money as the variable-rate program.
Regardless of whether you go fixed or variable, keep in mind that you always remain the owner of your home and you will never be asked to make a payment on the reverse mortgage or pay it back for as long as at least one borrower (or non-borrowing spouse) is permanently living in the home. Your responsibility is to simply keep up with the required property charges (property taxes, homeowner’s insurance, HOA dues, etc.).
When to Go Fixed-Rate
The variable-rate HECM tends to offer more money overall for most people, but there are some scenarios where the fixed-rate HECM can make more sense:
- You owe a lot on your home. If you have a high mortgage balance, the fixed-rate program likely will pay out the same or slightly more than the variable-rate program, so you might as well take the added security and predictability of the fixed-rate.
- The idea of a variable rate keeps you up night. Remember that the reverse mortgage never requires a payment, so there’s no payment to go up if rates go up. However, if the idea of a variable rate keeps you up at night, then fixed might be better.
Work With a Good Professional
If you’re not certain which option makes the most sense, be sure to talk to a qualified reverse mortgage professional with a reputable company. A knowledgeable professional can run options under both the fixed- and variable-rate HECM programs to see which one better achieves your financial goals.