September 6, 2011 in Mortgages

Dear Dr. Don,
I am getting a reverse mortgage on my home. The interest rate I am being charged is 5.06 percent, but the annual percentage rate, or APR, is 6.31 percent because of the mortgage insurance. How are these rates determined? Is there any relationship to current mortgage rates or London Interbank Offered Rate, or Libor? This is a fixed rate and a jumbo mortgage based on home value of $1 million.
— Priscilla Percentage

Dear Priscilla,
A lot of seniors will turn to reverse mortgages to augment their incomes in retirement. Despite a million-dollar home value, the amount you may borrow in a home equity conversion mortgage, or reverse mortgage, is derived from the lower of the appraised value, sales price or the Federal Housing Administration’s limit of $625,500 on home equity conversion mortgages. Without government action, that limit will fall to $417,000 in December. I’m assuming you’re using the FHA program because private financing has all but dried up in the reverse mortgage market.

You have a lot of choices in how you structure your reverse mortgage. You can structure it as a conventional 30-year fixed-rate mortgage; an adjustable-rate mortgage, or ARM, with annual interest rate resets; or an ARM with monthly interest rate resets. Lenders may not change annually adjusted reverse mortgages by more than 2 percentage points per year and not by more than 5 total percentage points over the life of the loan. The FHA does not require interest rate caps on monthly adjusted reverse mortgages.

You also have choices in how you receive the money from a reverse mortgage. You can get the money as a lump sum, take out the money as needed or receive a regular payment, such as an annuity, or some combination of these options. The benefit of not taking the money all at once is you are only charged interest on the money you’ve received. The interest expense is added to the loan balance on a reverse mortgage, so managing the cash distributions holds down the interest expense.

The interest rate on a conventional 30-year fixed-rate mortgage is based on the yield on the 10-year U.S. Treasury note. As of late August, the yield on that note is paying 2.23 percent and the Bankrate national average for a 30-year fixed rate mortgage is 4.37 percent. This is a record low for the mortgage rate and a near-low for the Treasury note.

Interest rates for ARMs are based on a short-term interest rate. For example, approved interest rates for reverse mortgage ARMs from the Department of Housing and Urban Development are based on one of four types of interest rates — two of them attached to Treasury rates, two based on Libor rates.

The APR captures closing and other costs associated with the mortgage. It allows the borrower to compare rates across lenders. Reverse mortgages are more expensive than conventional mortgages, making the APR quite a bit higher than the stated rate on your loan. In your case, it’s the 5.06 percent that’s used to calculate the monthly payment, not the 6.31 percent APR.

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