1/1/2021 UPDATE: In 2021, the reverse mortgage industry will be transitioning to the CMT index instead of the LIBOR. The LIBOR is to be phased out across all financial markets by the end of 2021.
The variable-rate HECM is the most popular product in today’s reverse mortgage marketplace. It’s more flexible and customizable than it’s fixed-rate counterpart and will often offer more cash as well.
It comes with a variable interest rate that can move around over time, but only within certain limits. If the idea of a variable rate makes you nervous, keep in mind that the reverse mortgage never requires a monthly payment. Even if your interest rate goes up in the future, your required payment will always be zero.
How It Works
Unlike the fixed-rate HECM, which offers only a lump sum payout option, the variable-rate HECM can be structured many different ways based on your financial circumstances and goals:
- Lump sum: All loan proceeds are paid at closing in one lump sum payment.
- Tenure: Receive a set payment every month for the rest of your life, regardless of how long you live.
- Term: Receive a set payment for a set period of time.
- Line of Credit: Loan proceeds are made available as a line of credit that you can tap as needed. Whatever you have available in the line of credit will automatically accrue growth and grow larger over time.
- Modified Tenure: A combination of a line of credit and tenure payments.
- Modified Term: Set payments for a set period of time and a line of credit.
If all of these options seem a little overwhelming, be sure to talk with a qualified reverse mortgage professional with a reputable company. A good professional can help structure the options that make the most sense based on your financial goals.
The 60% Rule
Though the variable-rate HECM offers more money than the fixed-rate HECM for most people, not all of the funds are necessarily available right off the bat. FHA implemented a new rule a few years ago that limits how much of the proceeds you can access in the first 12 months. The idea was slow down reverse mortgage borrowers who would otherwise burn through the available money quickly.
The way the rule works is this: of the available pool of cash you qualify for (called the principal limit), only 60% of that number will be available within the first year, whether you opt for a monthly payment plan, line of credit, lump sum, or some combination of all of those. The remainder of the principal limit will automatically be made available to you at the one-year anniversary of the reverse mortgage.
If you’re paying off an existing mortgage balance and the new loan amount is already above 60% of the principal limit, you’ll be allowed to access another 10% of the principal limit in the first year (up to the principal limit itself). Any remainder of the principal limit will come available at the 1-year mark.
If you want to get an estimate of how the 60% rule might apply to you, be sure to check out the reverse mortgage calculator.
When to Go Variable-Rate
Because the variable-rate HECM is much more customizable and often offers a lot more money, it’s a good bet it will make more sense for most people. The following are the scenarios where the variable-rate HECM probably makes more sense:
- You definitely want a payment plan and/or line of credit. The fixed-rate HECM only offers a lump sum payment, so if you want to go with a payment plan or line of credit, the variable-rate HECM is the better option.
- You have a low mortgage balance or the home is free and clear. The variable-rate HECM will likely offer far more cash if you owe little to nothing on the home.
- You don’t want to take out all of the proceeds right now. The fixed-rate program requires that whatever you qualify for must be taken as a lump sum at closing. If that’s not your preference, the variable program makes more sense.
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.).
Variable-Rate HECM Products
Unlike the fixed-rate HECM, which comes in only one “flavor”, the variable-rate HECM comes in two flavors: the 1-Month LIBOR and the 1-Year LIBOR Cap 5. The only difference between the two programs is how the interest rate is structured and managed over the life of the loan. Both programs offer the exact same amount of money and customization options.
- 1-Month LIBOR: The interest rate is based on the 1-Month LIBOR index and starts off lower than the 1-Year LIBOR Cap 5, but it can adjust on a monthly basis up to a lifetime cap of 10% above the start rate.
- 1-Year LIBOR Cap 5: The interest rate is based on the 1-Year LIBOR index and starts off a little higher (though usually not as high as the fixed-rate HECM), and it can only adjust on a yearly basis up to a lifetime cap of 5% above the start rate.
The 1-Year LIBOR Cap 5 is probably the more popular option these days because it’s more stable and has the much lower lifetime cap, but the compromise is that the interest rate starts off a little higher, which means you’re accruing interest on your loan balance a little faster at the start of the loan. However, because the lifetime cap is so much lower, it will better protect you against much higher interest costs if rates rise significantly in the future.
Nervous About a Variable Rate?
Many people have very deep reservations about taking on a variable-rate reverse mortgage because they’re so used to hearing horror stories about variable-rate forward mortgages. The concern is valid, but keep in mind that no payment is ever required on a reverse mortgage. Even if rates go up in the future on your reverse mortgage, your payment will remain exactly as it started: $0.
Work With a Good Professional
If you’re not certain where a fixed- or variable-rate 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 HECM programs to see which one better achieves your financial goals.