Caps

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What are reverse mortgage caps?

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.

Caps are limits placed on the initial interest rate (IIR) of the variable-rate HECM reverse mortgage to regulate how much the interest rate can increase between rate adjustments and over the life of the loan. Caps allow the IIR (the actual note rate) to increase, but only within certain limits at each change and over the lifetime of the reverse mortgage.

The variable-rate HECM is the most popular HECM in today’s marketplace. It’s more versatile and flexible than it’s fixed-rate counterpart. Yes, the fixed-rate HECM comes with the security of a fixed interest rate for the life of the loan, but it only offers the lump sum payout option. The fixed-rate HECM commonly offers less cash than the variable-rate HECM as well.

The variable-rate HECM generally comes in two flavors, the 1-Month LIBOR and the 1-Year LIBOR. Both loan products offer the exact same options for distribution of proceeds (lump sum, line of credit, term income, tenure income, modified term, modified tenure, etc.) and the same benefit amount. The differences between the two are in how the initial interest rate and caps are structured:

  • 1-Year LIBOR Cap 5: The IIR likely will start off higher than the 1-Month LIBOR, but can only increase once per year a maximum of 2% above the start rate and has a lifetime rate cap of 5% above the start rate.
  • 1-Month LIBOR: The IIR will likely start off lower than the 1-Year LIBOR Cap 5, but it can adjust monthly a maximum of 10% above the start rate up to a lifetime cap of 10% of the start rate.

Though the IIR starts off a little higher, the 1-Year LIBOR Cap 5 is the more popular of the two options in today’s reverse mortgage marketplace. Borrowers seem to like the added the protection that comes with the lifetime cap of 5% above the start rate.

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