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Rising Rates Hit Reverse-Mortgage Payouts

The more rates rise, the less you can borrow

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AARP;(Source: GettyImages(2))

Bruce Simmons helps prospective applicants understand how reverse mortgages work, and has the even temper that comes with 20 years of patiently explaining such a complex topic.

Simmons has been fielding even more questions than usual lately about the intricacies of these complex financial instruments. That’s because of a new complication: rising interest rates.

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“It has caused some anxiety among a lot of people who are new retirees or want to retire,” he says.

Just as they are for homeowners or would-be homeowners with conventional mortgages, higher interest rates are bad news for people who have or are considering reverse mortgages. But not entirely, and not necessarily in the ways they might think.

“If a reverse mortgage can help your situation, it still makes sense for a lot of people,” says Simmons, a reverse-mortgage specialist at American Liberty Mortgage in Denver. “There are so many people who can benefit from this today, even with the rates the way they are.”

How they work

Reverse mortgage loans let people 62 or older use the equity in their homes as a source of income, without having to move out. Whatever they borrow against the principal has to be repaid with interest when they sell the house or die.

Higher interest rates mean that existing reverse-mortgage holders (or their heirs) will owe more as interest rates rise. It also reduces the amount that people considering a reverse mortgage will be allowed borrow against their home equity in the first place.

This so-called “principal limit factor” is based on the borrower’s age and the home’s value, but also on the interest rate. That’s because the rules require that a homeowner can’t owe more than what the house is worth. And the higher the interest, the more he or she will ultimately owe.

“As interest rates rise, the loan balance increases at a faster pace,” Simmons says. So “we’re going to loan them less money to start out with.”

Two years ago, homeowners might have gotten a reverse mortgage worth 50 percent of their home equity. Now, they might get only 35 percent.

For example, Simmons says, the owners of a home valued at $500,000 might once have been able to get a $250,000 reverse mortgage. Now, they would be limited to $175,000.

Interest rates have ballooned from near zero to between 5.25 and 5.5 percent as the Federal Reserve tries to restrain inflation. That’s a 23-year high. The Fed has now raised interest rates 11 times since March 2022.

Interest rates on 30-year fixed-rate mortgages are hovering around 6.8 percent, and reverse mortgages often have even higher rates than that.

Owing more

Even though many reverse mortgages don’t have to be paid off until the house is sold, those higher rates also mean the amount that’s owed will rise more quickly. Almost all reverse mortgages are adjustable, not fixed, and interest rate increases catch up to them within a few months, according to the National Foundation for Credit Counseling, or NFCC — burning through the principal.

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“It might accelerate the growth of the balance and reduce potentially the equity when your heirs go to sell the home, because your balance is going to grow faster,” says Stephanie Moulton, professor and associate dean for faculty and research at The Ohio State University’s John Glenn College of Public Affairs.

“If house values drop, the heirs won’t go upside-down, but if there was going to be a leftover $20,000, that may not be left over anymore.”

On the upside, people who still owe some money on their forward mortgages can use a reverse mortgages to pay off what’s left, ending monthly mortgage payments. 

Homeowners with reverse mortgages also can set up lines of credit to be used when needed. Interest is accrued only on the money that’s withdrawn.

Reverse-mortgage holders also can opt for scheduled disbursements — called “term monthly payments” — to cover other expenses.

“The biggest challenge in retirement is cash flow,” Simmons says. And a reverse mortgage can provide one.

Look at alternatives

As long as the line of credit is untouched, it actually grows at the same rate as the interest on the loan plus half of 1 percent — the amount of the mortgage insurance premium. For people who take that route, rising interest rates are good news.

“If you don’t touch it, each year the amount that you leave in that line of credit goes up a little bit,” Moulton says.

Regardless of the interest rate, reverse mortgages carry significant closing costs, including origination fees, required consumer counseling, a home appraisal and that mortgage insurance premium, though these can all be rolled into the loan.

People who need money for such things as home improvements, and who can afford to make monthly payments, may save money on fees by taking out home-equity loans instead, says Bruce McClary, senior vice president at the NFCC.

“It’s safe to say reverse mortgages have a reputation of being sometimes very fee laden,” McClary says.

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As interest rates rise, demand for houses — and home prices — also fall, meaning reverse mortgage holders or their heirs may ultimately get less when they sell. Prices dipped slightly in the second half of last year, according to Standard & Poor’s, though they rose again this year.

“Some people want to get a reverse mortgage before house values drop,” when lenders could even further reduce what they can borrow, Moulton says.

Whether a reverse mortgage remains a good idea “depends on an individual’s capacity to borrow, the reasons for borrowing and what they’re going to use the money for,” McClary says. “The answers will be different depending on people’s financial circumstances and their goals.”

The NFCC provides contacts for nonprofit agencies that provide reverse-mortgage counseling, he says — impartial information, rather than information from the lender, who is incentivized to help them decide to borrow.

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