The margin is the portion of the initial interest rate that is charged by the lender. The margin basically is the lender’s profit from interest on the loan.
The margin is an important part of the reverse mortgage because it impacts how much you qualify for and the interest rate you’re charged on the money you borrow. The margin also impacts the growth rate of the line of credit payout option.
How the margin impacts proceeds
The margin is used to set the expected interest rate, which is used (along with age and home value) to calculate the principal limit. The principal limit is the total pool of cash available from a reverse mortgage.
The expected interest rate has a significant impact on the amount of proceeds available. If the expected interest rate increases, proceeds will typically decrease. If the expected interest rate decreases, then proceeds will typically increase. Expected interest rate and principal limit have an inverse relationship.
The expected interest rate is calculated by adding together the margin and an index value set by the financial markets. Because the margin is used to calculate the expected interest rate, the margin impacts the amount of money available from a reverse mortgage.
Note that the expected interest rate is used only to calculate proceeds; it’s not the actual note rate on the loan (though it can match the note rate). The initial interest rate is the actual note rate at which interest accrues on an annual basis.
The initial and expected rates for a variable-rate HECM are commonly different numbers. For the fixed-rate HECM, however, the initial and expected rates are typically the same.
The impact to initial interest rate
The margin is also used to calculate the initial interest rate (the actual note rate) for a HECM reverse mortgage. The margin is added to an index to create the fully-indexed initial interest rate. For example, if the index is 0.50% and the margin is 2.50%, the fully-indexed initial interest rate is 3.0%. As you can see, the margin has an impact on how much interest you’re charged on the money you borrow from a HECM reverse mortgage.
Again, note that the initial and expected interest rates for variable-rate HECM are often different numbers. The initial interest rate or a variable-rate HECM will also likely change over time, which means interest accruals will change as well. The margin will never change, but movements in the index will cause the initial interest rate to change.
The most commonly used indices for the variable-rate HECM are the 1-Month LIBOR and the 1-Year LIBOR.
The initial and expected rates for a fixed-rate HECM are typically the same number and will never change over time.
The impact to line of credit growth rate
The reverse mortgage line of credit growth rate is the annual rate of increase applied to the variable-rate HECM line of credit. The growth rate is calculated by adding the initial interest rate (IIR) to the annual MIP rate. For example, if the initial interest rate is 4.50% and the MIP rate is 0.50%, the growth rate on the available credit line would be 5.00%.
Because the growth rate is determined in part by the initial interest rate, it is also impacted by the margin. A higher margin will increase the growth rate on your line of credit, but at the potential expenses of proceeds. Remember, a higher margin means a higher expected interest rate, which can reduce proceeds. A lower margin may increase proceeds at closing (by reducing the expected interest rate), but it will mean slower growth on the line of credit.
Note that the line of credit payout option is only offered via the variable-rate HECM, which also offers the lump sum, term, and tenure payout options. The fixed-rate HECM offers just the lump sum payout option.
The lender doesn’t have control over the index, but it does have control over the margin. You may be able to negotiate for a lower margin, which lowers the initial interest rate and reduces interest costs over the life of the loan. However, again, note that the growth rate on the line of credit is tied directly to the initial interest rate. A lower initial interest rate will also reduce the growth accrued on the line of credit.