Why do Reverse Mortgages have two rates?

At first glance, seeing two different interest rates with a reverse mortgage can feel confusing. But there’s a practical reason for it and understanding the difference can help you better understand how a reverse mortgage works.

First, a quick clarification. Not all reverse mortgages have two rates. However, that structure exists with the most common type of reverse mortgage: the adjustable-rate Home Equity Conversion Mortgage (HECM).

HECMs are Insured by the Federal Housing Administration (FHA) and regulated by HUD, which sets strict rules on how these loans are calculated, One of those rules requires lenders to use two different interest rates, each with a distinct purpose.

These two rates have names:

• The long-term forecast is called an “EXPECTED RATE”
• The short-term interest rate is called a “NOTE RATE.”

In a nutshell, this requirement exists because it’s risky for the insurer (FHA) to use short-term interest rates to calculate long-term borrowing capacity. Therefore, long-term forecasts are used to determine the borrower’s initial loan proceeds.

Consider an extreme example where long-term interest rates (at loan application) are expected to be 10%. Initial HECM proceeds would be dramatically reduced because interest rates that high could cause the loan balance to exceed the home’s value and FHA would have to cover the deficiency.

LET’S MORE CLEARLY DEFINE EACH RATE:

1. EXPECTED RATES

Lenders primarily use this long-term forecast when calculating HECM proceeds. However, it is also used to calculate property charge set-asides and monthly payouts.

• Calculation: Add the Lender Margin to the weekly average of the 10-year Constant Maturity Treasury (CMT)..
• Timing: The previous week’s average generally becomes effective Tuesdays unless delayed by a federal holiday.
• Impact: When expected rates are higher at origination, borrowers qualify for less principal at closing. Conversely, when expected rates are lower at origination, borrowers are offered more principal.

NOTE: The REVERSE plus RATE TRACKER tracks the movements of the 10-year CMT in real time. This allows a loan originator to properly advise the borrower of pending rate changes and the dollar-impact of that rate change.

2. NOTE RATES

Lenders primarily use this short-term rate to calculate accrued interest and credit-line growth after closing.

• Calculation: Add the Lender Margin to the weekly average of the 1-year Constant Maturity Treasury (CMT) and then round that to the nearest 1/8% (0.125%).
• Timing: After closing, the lender must use the weekly average in effect 30 days prior to a rate change date.
• Impact: When note rates rise after closing, borrowers have faster interest accrual and credit line growth. Conversely, when note rates fall, borrowers have slower interest accrual and credit line growth.

NOTE: The REVERSE plus ANALYZER Pro does not quote note rates. That is something a licensed loan originator will need to do when generating proposals and application packages.

Sources:

• HUD 4000.1 II.B.3.d.
• HUD 4000.1 III.B.1.h.