Reverse Mortgage Glossary
Initial Interest Rate (IIR)
The initial interest rate (IIR) is the actual note rate on a HECM reverse mortgage. Interest accrues onto the loan balance (assuming the borrower doesn’t make payments) at an annual rate equal to the IIR.
The IIR on the variable-rate HECM can change over time based on the underlying index. The fixed-rate HECM has an IIR that never changes for the life of the loan.
Note that IIR is different than EIR, which is used solely to calculate how much money you can receive from a reverse mortgage. IIR and EIR are usually different numbers on the variable-rate HECM and equal to one another on the fixed-rate HECM.
You’ll see both EIR and IIR on the loan documents and disclosures from your lender, so it’s important to realize that interest accrues at the rate specified by IIR. Again, EIR is only used to calculate the amount of money you can receive from the reverse mortgage.
How Interest Accrues
It’s important to understand that interest accrues on a HECM reverse mortgage at an annual rate based on the loan balance. For example, if the IIR is 4% and the loan balance starts at $100,000, then the interest accrued for the first year (assuming the borrower makes no payments or additional withdrawals) will be $4,000 and the loan balance at the end of the first year will be $104,000. Assuming no rate changes, payments, or additional withdrawals, the loan balance will grow to $108,160 at the end of the second year and $112,486 the third year.
As you can see, the loan balance isn’t growing by just $4,000 per year in this example. Because any unpaid interest that accrues onto the loan balance is considered a loan advance, interest can accrue on top of interest over time. This can cause the reverse mortgage balance to grow relatively quickly in the later years of the loan if the borrower has had it for a long time.
Some commentators might consider this one of the disadvantages of a reverse mortgage, but it’s really just a consequence of how the program is designed and how the investors who lend the money want to be compensated. Remember, monthly payments aren’t required, so it’s possible that a lender will have to wait decades before collecting even a dollar’s worth of interest. That’s a long time to wait for a return on your investment.
Having said that, it’s also important to understand that the HECM is designed to preserve equity as well. It’s not a healthy loan program if it uses equity quickly because that would increase the risk of the loan balance growing larger than the value of the home, which could make the HECM program insolvent.
Remember, you, your heirs, and your estate are not on the hook for the shortage if the home isn’t worth enough to settle the entire loan balance. A HECM reverse mortgage is a non-recourse loan. Any shortage has to be settled up by the FHA mortgage insurance fund. Obviously, FHA needs to limit the hits to the insurance fund or the whole program would go belly up.
Only take out money from the reverse mortgage if you absolutely need it. It doesn’t make sense to pull out a large amount of money you don’t really need because you’ll accrue interest on a larger balance.
If there’s extra money available that you don’t need right now, go with the variable-rate HECM and leave it stored in the line of credit. The money in the line of credit is accessible at any time and you’re not accruing interest on it until you use it.