Last month the Federal Reserve raised the federal funds rate for the third time in just over a year. There is talk among some economists that they will raise it another two to three more times in 2017.
While the federal funds rate doesn’t have a direct impact on reverse mortgage rates, they tend to follow suit. Reverse mortgages use the London Interbank Offered Rate (LIBOR) as the index. What this means is that as the index increases or decreases, the rate you are charged on your reverse mortgage will go up or down.
If you had a reverse mortgage today, and kept some of the money in a line of credit (LOC), which is an option with this loan, the growth rate for these funds will also change along with any rate change. If you happen to have a lot of money in your reverse mortgage LOC, increasing interest rates can have a very positive impact on how quickly it grows.
Here is how it works: When you take out a reverse mortgage, the amount available is determined by the age of the youngest borrower, the value of the home and the interest rate. The lender has to make all of this money available to you, but you do NOT have to take it all.
If the lender tells you that you have $200,000 available, but you only need $80,000, that leaves $120,000 left over that you don’t need and don’t want to be charged interest on. You can choose to leave that extra money in the form of a line of credit. This LOC comes with a growth rate.
For example, if the interest rate that you are charged on the $80,000 you take out is 4.25%, the rate of growth on the unused line of credit is 1.25% greater, or 5.50%. This means that if you left that $120,000 in the line of credit without drawing any out, in 12 months, it would grow to over $127,000.
Please remember that this growth in the LOC is not free money, nor is it interest that you have to pay taxes on. It simply is increasing the amount that you can borrow in the future. The longer you keep the money in the LOC without using it, the larger the amount will grow.
This program works great for people who may not need a reverse mortgage now, but think they might in the future. Get the loan in place now while the values are high and the interest rates are low. If the rates continue to increase, you will benefit with a larger LOC when you need it.
Having said this, the best way to take advantage of this is to get the loan in place before the rates increase too much. Interest rate increases can have a very negative effect on people who want to get a reverse mortgage but haven’t yet.
As interest rates increase, the amount that you qualify to receive from the reverse mortgage goes down.
I want to keep this as simple as possible. If you wait to get your reverse mortgage in place and the interest rates increase by even just one percent higher than they are now, instead of qualifying for $200,000, as in the scenario earlier, you would only qualify to receive $176,000.
After you take the $80,000, that would only leave you with a line of credit of $96,000.
An interest rate increase of just one percent, all other things being equal, would cost you $24,000. Odds are, that if you wait one year and rates increase, any additional increase in the value of your home and age, will not offset even a small increase in the interest rate.
Here’s another way to think about it, without even considering the line of credit. Let’s say you qualify today to receive $200,000 from a reverse mortgage and you have a current loan against your home for $185,0000. If you get the reverse mortgage today, you can pay off this loan against the home and still have $15,000 left over.
If you wait, and the interest rate increases by just one percent, you would only qualify for $176,000 which isn’t even enough to pay off the loan against the home. You would either have to pay the $9,000 difference or not be able to get the reverse mortgage at all.
This is why, without trying to scare anyone, I think it is much better to learn the facts and figure out if a reverse mortgage is right for you sooner rather than later.
I don’t know if interest rates will continue to increase or not. The stock market could crash tomorrow and the Federal Reserve could panic and lower the rates all over again.
My gut tells me this is not going to happen anytime soon, but there is a reason I don’t have a lot of money in the stock market. I don’t understand it.
What I do understand is reverse mortgages and I answer questions from people every day about how they work. Some decide to go with it and some don’t. I’d be happy to talk with you as well.
Please feel free to call me with any questions at 303-467-7821.