Expected interest rate, EIR

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What is an expected interest rate or EIR?The expected interest rate, or EIR, is an interest rate value used to calculate the amount of proceeds initially available to a HECM reverse mortgage borrower.

It’s important to understand that the EIR is used for calculation purposes only. It is not the actual interest rate on a reverse mortgage (though it can sometimes match the interest rate). The initial interest rate, or IIR, is the actual interest rate at which interest accrues on an annual basis.

How EIR impacts proceeds

The EIR and age of the youngest borrower (or non-borrowing spouse) is used to look up a principal limit factor in a table published by FHA. The principal limit factor is then multiplied by the maximum claim amount (equal to the appraised value for most borrowers) to determine the principal limit, which is total initial amount of proceeds available to the borrower.

As an example, let’s assume the maximum claim amount is $300,000 and the PL factor is 0.50 based on the youngest borrower’s age and the expected interest rate. The principal limit is calculated as follows:

$300,000 (maximum claim amount) * 0.50 (PL factor) = $150,000 (principal limit)

The borrower in this example has $150,000 of gross proceeds that can be used to pay off closing costs and existing mortgages. Any remaining proceeds can then be allocated to line of credit, lump sum, term/tenure income, or some combination of all of these options.

Both the EIR and IIR are disclosed on your loan documents. Again, it’s important to understand that interest accrues at the rate specified by the IIR, not the EIR. Again, the EIR is only used to calculate the initial amount of proceeds.

EIR is essentially an assumption about where interest rates are likely to be in future years. If rates are higher, then interest accrues faster on the reverse mortgage balance, which increases the risk the loan balance will exceed the value of the home. This means that FHA will have to settle part of the loan if the home isn’t worth enough to cover the entire balance (the HECM is a non-recourse loan). Obviously, FHA can’t settle too many claims against the mortgage insurance fund or it quickly becomes insolvent. Because of this, PL factors tend to decrease as EIR increases. In other words, reverse mortgage borrowers tend to qualify for less money if the expectation (expressed via EIR) is that rates will be significantly higher in the future.

To see how various EIRs can impact proceeds, let’s look at a few different PL factor/EIR combinations for an 80-year old borrower. This is based on the principal limit factors table published in August, 2014.

The following example is based on an EIR of 5.00%:

  • Maximum Claim Amount: $300,000
  • Age: 80
  • EIR: 5.00%
  • PL Factor: 0.776
  • Principal Limit: $232,800 (0.776 * $300,000)

Now, let’s assume rates are on the rise and the expected interest rate hits 7.00%:

  • Maximum Claim Amount: $300,000
  • Age: 80
  • EIR: 7.00%
  • PL Factor: 0.674
  • Principal Limit: $202,200 (0.674 * $300,000)

As you can see, a increase of 2% in the EIR results in a reduction of over $30,000 in reverse mortgage proceeds. This is why reverse mortgages are a particularly lucrative option for seniors when interest rates are historically low.

Because the expected interest rate impacts proceeds, lenders offer an expected interest rate lock that begins when you sign your loan application.

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About Mike Roberts

Mike Roberts is the founder of MyHECM.com, an author, and a highly experienced veteran of the mortgage industry. When he's not working, he enjoys spending time with his family, skiing, camping, traveling, or reading a good book. Roberts is the author of The Reverse Mortgage Revealed: An Industry Insider’s Guide to the Reverse Mortgage, which is available on Amazon.