Adjustable rate reverse mortgages (also referred to as variable rate reverse mortgages) offer much more product flexibility than fixed rate loans for the simple fact that fixed loans require that the borrower take all the available proceeds in a one-time lump sum draw at closing, while adjustable rate loans allow for several draw options with the loan proceeds.

The options available with the adjustable loan include a lump sum draw, a line of credit that can be used as needed that allows for the unused portion to grow over time, a monthly payment for a specific term or for life, or a combination of all of the aforementioned.

There can be several benefits or pitfalls to choosing the adjustable reverse mortgage. Whether or not it’s a good choice for you relies heavily on your specific situation, which leads to everyone’s question, “is a variable rate reverse mortgage the right choice for me? To answer that question, let’s first look at who it’s not right for.

Homeowners, who require a draw of most or all of the monies available to them under the reverse mortgage program, would be better suited to choose the fixed rate option. The only choice the borrower has with the fixed rate is a lump sum payment. It will also provide the security of knowing exactly what the interest rate will be for the life of the loan.

However, many homeowners would like a little more flexibility in their reverse mortgage and may want to explore the adjustable rate. One nice feature about the adjustable rate is that you only accrue interest on the money borrowed. For example, you take $25,000 at closing and put the rest in a line of credit you would only be accruing interest on the $25,000 plus closing costs, fees and accrued interest.

If you don’t have a desire to take a lump sum, know that you don’t need a large sum of money in the near future, prefer monthly payments, like the idea of a line of credit and are not concerned about the potential of rising rates, then you may be a good candidate for the adjustable.

The adjustable rate can adjust monthly based on the index plus the margin. The index currently used is the LIBOR rate. This simply is the rate at which banks lend to each other. The LIBOR is used for all adjustable Home Equity Conversion Mortgages (HECM) and will be the same from lender to lender. To this index, the margin is added to get the actual accrual rate.

Different lenders may offer different margins. When shopping for a reverse loan, the margin is a very important piece of the rate pie. For example, one lender offering a margin of 2.25% and another offering a margin of 2.5% will show the same principal limit amount on the comparison page (based on today’s rates). Because of this, borrowers often fail to see the rate difference of 0.25%.

The difference of 0.25% may not seem like much, but over time that will cause the loan balance to grow at a faster rate, which reduces the equity in the estate quicker.

The last important item to know is the interest rate cap. The adjustable reverse mortgage loans have a life cap of 10%. This means that the rate will never go more than 10% above the start rate. As an example, the LIBOR today is 0.248%. Assume a margin of 2.25%. The start rate on the loan will be 2.498% (index plus margin). The life cap would be 12.498% (2.498% + 10%).

Historically, over the past 10 years, the highest the 1 month LIBOR has been was 5.497% in August 2007. The fully indexed rate would have been 7.747%, assuming a 2.25% margin. The chart below shows the history of the 1 Month LIBOR since 1989. The LIBOR rate is charted in blue. The red line represents the LIBOR plus a margin of 2.25%.

What it all boils down to is making sure you educate yourself through the process. The loan originator you choose to work with should provide several comparisons for many different situations to aid in your decision. Education is king. Be sure that your loan officer presents a fair representation of all available programs and doesn’t steer you to the program they want to sell, but helps to guide you to the program that is right for you based on your needs.

Here’s a quiz for you. A 75 year old borrower owes $20,000 on a home valued $250,000. She would like to pay off her mortgage and receive $500 per month for the remainder of her life. She also has no immediate need for additional money. Which is the better choice, fixed or variable? In this situation, she would pay off $20,000, receive $500 per month and she would also have a line of credit for over $75,000. The adjustable would appear to be the best option. Ultimately it will be the borrower’s decision to make. Many borrowers are afraid of variable rates and may opt to take a one-time lump sum fixed rate for the security of knowing exactly what the rate will be. This decision is one that should be explored with friends, family, a financial advisor or someone trusted to help navigate the complexities of the decision.

If you have any other questions about a fixed rate loan vs a variable loan, or are interested in learning more, don’t hesitate to contact us or call 1-888-888-4834.

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The Players:

HECM or Home Equity Conversion Mortgage is a Government insured reverse mortgage program that allows senior homeowners aged 62 or older to convert the equity in their homes into cash flow, either by a line of credit, monthly draws, lump sum of cash or a combination of the options. With a HECM, there are no credit or income requirements.

HELOC or Home Equity Line Of Credit is a mortgage that allows the borrower to draw on a line up to a limit approved by the bank. There are no age restrictions; however, this loan does require that the borrower meet certain credit and income requirements.

Round 1: Qualifying For the Loan

HECM: Qualifying is simple. All borrowers on title must be 62 or older. The property should be in good repair, although repairs can be made after closing. The home must be the primary residence. Borrowers must undergo an independent HUD counseling session that lasts about 45 minutes. Currently there is no income or credit qualifying.

HELOC: Qualifying for a HELOC requires an analysis of income, assets and home value. The lender will look at current debt to income to determine if the borrower can afford to make payments on the new loan.

Round 1 goes to HECM reverse mortgage for minimal credit and income qualifying requirements.

Round 2: Cost of Reverse Mortgage vs. HELOC

HECM: The costs involved in a reverse mortgage include an origination fee, an upfront Mortgage Insurance Premium (MIP) and other costs such as title, escrow and appraisal. The maximum origination fee on a HECM is $6,000, however borrowers have the option to choose a rate that may lower these fees. The upfront MIP on the new HECM 0.50% of the maximum claim amount (lesser of the sales price, appraised value, or FHA mortgage limit of $625,500) if less than 60% of available proceeds are used or 2.5% of the max claim amount if more than 60% of available proceeds are used. Other fees vary based on property value and location but are in line with what one would expect on a typical “forward” mortgage.

HELOC: The costs involved with a HELOC are minimal. Typical fees run around $500 and are often times waived. Many HELOCs will have an early closure fee which is designed to recoup any upfront costs the bank may have paid on the borrowers behalf to originate the loan.

Round 2 goes to HELOC for lower costs.

Round 3: Amount of Money That Can be Borrowed

HECM: Proceeds for a reverse mortgage are based on age, property values and existing interest rates. The factor currently ranges between 52.4% loan to value (LTV) for a 62 year old to 75% LTV for a 90 year old when utilizing a 5.0% interest rate. Our reverse mortgage calculator will give more specifics.

HELOC: Most current HELOCs will not lend beyond 80% of the value of the home. However, borrowers will need to qualify using income and debt, so many will not qualify for an LTV that high.

Round 3 is a tie.

Round 4: Loan Terms

HECM: A reverse mortgage has no set “due date.” The loan is payable at a maturity event such as the passing of the last surviving spouse, if the home is sold or if the home is no longer the borrowers primary residence.

HELOC: A HELOC is typically due at the end of 10 years, after which the loan needs to be repaid or refinanced.

Round 4 unanimously goes to HECM.

Round 5: Line of Credit Behavior and Unused Lines

HECM: Both the reverse mortgage and HELOC will only accrue interest on the money drawn or borrowed. Only the reverse mortgage’s line of credit will allow the unused portion to grow at the same rate the borrower is paying on the used portion of the line.  This will give the borrower greater borrowing power.

HELOC: A HELOC can be drawn on and repaid over the life of the loan. The downside is that with the current housing market, many lenders are closing borrower’s lines of credit so they can no longer access the funds that were once available to them. A HECM line will always remain open as long as the homeowner continues to meet the guidelines.

Round 5 goes to HECM for the credit line growth rate and the fact that the line cannot be closed like a HELOC at the banks discretion.

Round 6: Interest

HECM: Reverse mortgages have the option of a fixed rate or an adjustable rate. Only the adjustable rate will allow for a line of credit. The rate is based on the 1 month LIBOR plus a margin. The loan has a life cap of 10% above the start rate. So, for example, if the starting rate is 2.50%, the max the interest rate can go to is 12.50%. Interest paid on a reverse mortgage is only tax deductible the year it’s been paid, which for most people will not be until the loan is paid off. Consult a tax adviser.

HELOC: HELOCs are typically tied to Prime plus a margin. Many have a life cap like the HECM, however not all HELOCs are created equal. Many offer a lower introductory rate, which will increase shortly after closing. Be sure to read the fine print. Some HELOCs may allow interest rates to climb to 18%. Interest paid on a HELOC may or may not be tax deductible. Your CPA will know that answer.

Round 6 goes to HECM due to more specific terms.

Round 7: Required Loan Payments

HECM: A reverse mortgage requires NO monthly mortgage payments until the loan terminates. This is one of the main reasons seniors will choose a HECM over a HELOC. No payments frees up much needed cash for day to day living expenses.

HELOC: Typical HELOCs will require that at minimum an interest only payment be made. Payments will increase as the loan balance increases.

Round 7 goes to HECM for no monthly payments. Both loans require that taxes and insurance be paid.

Round 8: Annual Fees to Keep Account Open and Active

HECM: A reverse mortgage will not charge a fee to keep the loan open.

HELOC: Many HELOCs charge an annual fee to keep the line of credit open.

Round 8 goes to HECM for no additional annual fees

Who won the bout in your eyes? Each individual’s situation is unique and can’t be addressed by blanket statements. In general, the main benefit of a HECM reverse mortgage over a HELOC is that reverse mortgages do not require monthly mortgage payments, while a HELOC does. A reverse mortgage need only be paid back at a maturity event such as the death of the last surviving spouse, if the property is no longer the borrowers primary residence, the borrower fails to pay taxes and insurance and/or fails to maintain the property. With a HELOC, the bank has the right to close the line anytime they choose.

The main advantage of a HELOC is the lower upfront costs. Although, the reverse mortgage has evolved to include the HECM Saver, with reduces upfront Mortgage Insurance Premiums (MIP), lowering the overall cost.

When trying to decide between the two loan types, the first question you should ask yourself is if you have the financial capacity to make monthly payments on a HELOC. If the answer is no, then odds are, you may not even qualify for the loan in the first place. Another important question is how long you plan on staying in your home. A short-term solution may be a HELOC. A HECM may be better for homeowners who plan on staying in their home for longer periods of time.

Ultimately, the decision rests in your hands to determine which loan best meets your needs.

Updated July 16, 2014 to reflect the changes to the new reverse mortgage.

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HUD’s Mortgagee Letter about HECM for Home Purchase

October 20, 2008

MORTGAGEE LETTER 2008-33
TO: ALL APPROVED MORTGAGEES ALL HUD-APPROVED HOUSING COUNSELING AGENCIES

SUBJECT: Home Equity Conversion Mortgage (HECM) for Purchase Program

The Housing and Economic Recovery Act of 2008 (HERA) provides HECM mortgagors with the opportunity to purchase a new principal residence with HECM loan proceeds. Section 2122(a)(9) of HERA amends section 255 of the National Housing Act to authorize the Department of Housing and Urban Development (HUD) to insure HECMs used for the purchase of a 1- to 4-family dwelling unit. Accordingly, eligible mortgagors now have the opportunity to purchase a principal residence with HECM loan proceeds. HECM for purchase transactions, for which the FHA case number is assigned on or after January 1, 2009, must satisfy existing program requirements and the provisions of this Mortgagee Letter.

The Federal Housing Administration (FHA) defines “HECM for Purchase” as a real estate purchase where title to the property is transferred to the HECM mortgagor, which the mortgagor will occupy as a principal residence, and, at the time of closing, the HECM first and second liens will be the only liens against the property. HECM mortgagors must occupy the property within 60 days from the date of closing. Lenders are required to ensure all outstanding or unpaid obligations incurred by the prospective mortgagor, in connection with the HECM transaction, are satisfied at closing.

Eligible Property Types

Only properties where construction is completed, as defined in Mortgagee Letter 2007-06, are eligible for FHA insurance under the HECM for Purchase program. Loan proceeds may be used to satisfy outstanding payment obligations associated with a land contract, contract for deed or other similar purchasing arrangements that will ensure the property, which will be used as collateral for the HECM, meets FHA’s title requirements. Those requirements, as provided in section 255(b)(4) of the National Housing Act and implemented in the HECM regulations at 24 CFR 206.45, provide, in part, that the HECM must be on real estate held in fee simple, or on a leasehold under a lease for not less than 99 years which is renewable, or under a lease having a remaining period of not less than 50 years beyond the date of the 100th birthday of the youngest mortgagor.

Ineligible Property Types

The following property types are ineligible for FHA insurance under the HECM for Purchase program: · Cooperative units; · Newly constructed principal residence where a Certificate of Occupancy or its equivalent has not been issued by the appropriate local authority; · Boarding houses; · Bed and breakfast establishments; · Existing manufactured homes built before June 15, 1976; and · Existing manufactured homes built after June 15, 1976 that fail to conform to the Manufactured Home Construction Safety Standards, as evidenced by affixed certification labels (e.g. data plate and HUD certification label) and/or lack a permanent foundation as required in HUD’s Permanent Foundations for Manufactured Housing Guide.

Property Flipping

Prospective mortgagors should be alert to efforts to coerce them into obtaining a reverse mortgage as part of a purchase contractual obligation, or purchasing a distressed home in need of substantial repairs but being sold at or above market rate.

As such, HECM lenders must take steps to ensure that: a) only current owners of record may sell properties that will be financed using FHA-insured mortgages; b) any resale of a property may not occur 90 or fewer days from the last sale to be eligible for FHA financing; and c) for resales that occur between 91 and 180 days where the new sales price exceeds 100% of the previous sales price, FHA will require additional documentation validating the property’s value. Lenders providing HECM financing for purchase transactions must comply with guidance provided in Mortgagee Letter 2006-14.

Refinancing and Existing Upfront Mortgage Insurance Premium (MIP)

The HECM refinance authority is only applicable when the property that serves as collateral for FHA-insurance remains the same. Therefore, existing HECM mortgagors who participate in a HECM for Purchase transaction are ineligible for a reduction of the upfront MIP and lenders must enter the transaction into FHA Connection as a new HECM.

Monetary Investment

Consistent with existing policy, the maximum claim amount and principal limit will continue to be calculated in accordance HECM regulations at 24 CFR 206.3, HUD Handbook 4235.1 REV-1, and applicable MLs. At closing, HECM mortgagors must provide a monetary investment which will be applied to satisfy the difference between the HECM principal limit and the sales price for the property, plus any HECM loan related fees that are not financed or offset by other allowable FHA funding sources. HECM mortgagors may choose to provide a larger investment amount in order to retain a portion of the available HECM proceeds for future draws.

Required Investment Examples

* Appraised Value/MCA is defined as the maximum claim amount and is used to determine the principal limit which is the lesser of the appraised value or the FHA national mortgage limit. The principal limit is the maximum amount available to the HECM mortgagor.

** Assumes the age of the youngest HECM mortgagor is 67 and a principal limit factor of .665 for a 5% expected average mortgage interest rate.

In each example above, loan fees are deducted from the principal limit of the HECM. However, it is not required that loan fees be deducted from HECM proceeds. The mortgagor may pay loan fees as part of the required monetary investment and use all HECM proceeds toward the purchase transaction.

Funding Sources

HECM mortgagors must use cash on hand or cash from the sale or liquidation of the mortgagor’s assets for the required monetary investment.

Verification of Funding Sources

Lenders will be required to verify the source of all funds prior to closing. A verification of deposit, along with the most recent bank statement, may be used to verify savings and checking accounts. If there is a large increase in an account, or the account was opened recently, the lender must obtain a credible explanation of the source of those funds. Such documentation must be provided in the FHA case binder. Failure to provide the necessary documentation may result in a notice of rejection and delay of endorsement.

Gap Financing

Consistent with existing regulatory requirements at 24 CFR 206.32(a), HECM mortgagors may not obtain a bridge loan (also known as “gap financing”) or engage in other interim financing methods to meet the monetary investment requirement or payment of closing costs needed to complete the purchase transaction. This restriction includes subordinate liens, personal loans, cash withdrawals from credit cards, seller financing and any other lending commitment that cannot be satisfied at closing.

Gap Financing Example

A prospective HECM mortgagor completes the required reverse mortgage counseling and receives an estimate stating the required monetary investment could be $25,000. The prospective HECM mortgagor has $20,000 in liquid assets but is short the remaining $5,000. The prospective HECM mortgagor cannot take $5,000 from a credit card or obtain interim financing in order to deposit the money into their banking account in anticipation of being required to bring this amount to closing. However, the prospective HECM mortgagor may obtain the $5,000 from an allowable FHA funding source.

Enhanced Counseling

HUD-approved housing counseling agencies that have been approved to provide reverse mortgage counseling, must counsel those who anticipate using the HECM for Purchase option on all topics covered in this Mortgagee Letter and other HUD requirements and issuances.

Right of Rescission

The three-day right of rescission period is not applicable to HECM for Purchase transactions. Therefore, all initial advances may be disbursed on the day of closing by the settlement agent. However, FHA encourages lenders to seek their counsel’s opinion to assure compliance with Federal or State laws.

Closing Guidance

Lenders are required to ensure the property, when used as collateral for the HECM, meets the following property requirements:

· Will serve as the principal residence of the HECM mortgagor. · Construction is complete and a certificate of occupancy or its equivalent has been issued. · Any construction loan financing for the property, which will serve as the collateral for the HECM loan, is satisfied and the HECM liens will be in a first and second lien position and, at the time of closing, no other liens against the property exist.

Consistent with existing lending practices, lenders are responsible for determining whether a particular HECM loan is open or closed-end credit. In accordance with 24 CFR 206.43, lenders must comply with the regulatory disclosure requirements.

Sincerely,

Brian D. Montgomery
Assistant Secretary for Housing-
Federal Housing Commissioner

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