Content in this reverse mortgage guide has been prepared in straight-forward terms, intended for a general audience. Certain technical details of reverse mortgage or home equity conversion mortgage (HECM) loans are presented here.
Important questions addressed in this article:
- How is the interest rate on my HECM determined?
- How do line of credit variable interest rate HECMs work?
- What happens to my HECM's interest rate now that LIBOR is gone?
Click on the link above to go directly to the information you need or scroll down to read this article in its entirety.
How is the interest rate on my HECM determined?
HECMs actually use two interest rates.
1. Expected interest rate.
This is used to estimate how much money you can get as part of an actuarial equation.
The expected rate on adjustable-rate HECMs may be based on the lender's choice of the 10-year Constant Maturity Treasury (CMT). To this value, a margin of a few percentage points (usually 2, 3 or more) is added, and this becomes the "expected interest rate." This expected rate is used to determine the loan amount available to you and the loan's potential total costs.
For fixed-rate HECMs, the expected interest rate for calculation purposes is the same as the contract interest ("Note") rate.
2. Actual interest rate.
For adjustable-rate HECMs, since market conditions change over time, the expected interest rate used to estimate your borrowing capability and total costs may not be that close to reality as market-based interest rates rise and fall over time. As such, in addition to the expected interest rate, there is also an actual interest rate applied to your loan that governs your accruing interest cost.
Rates for adjustable or variable HECMs work much as those do on regular (forward) adjustable rate mortgages (ARMs) or Equity Lines of Credit. Several constructs are available:
The interest rate for an annually-adjustable HECM may use the 1-year CMT or 30-day average Secured Overnight Financing Rate (SOFR) as an index to govern rate changes.
To either of these choices, the lender will typically add a margin of 2 or 3 percentage points to arrive at the actual interest rate charged for the coming year.
To limit how much these annual interest rates may rise or fall in a given year, annually adjustable HECM interest rates cannot vary by more than 2 percentage points per year, or 5 points over the life of the loan. These limits are called "periodic" and "lifetime" caps.
The initial rate on a monthly-adjustable HECM may use the 1-year CMT or the 1-month CMT as an index. Unlike annually-adjusting HECMs, these generally don't have periodic caps, but do have an interest rate cap of not more than 10 percentage points above the HECM's initial interest rate ("Note rate").
This arrangement is similar to a traditional home equity line of credit, where a cap (such as 8 or 10 percentage points over the starting rate) may be expressed -- or there may be an absolute ceiling detailed instead, where the rate can never rise above a specified level, such as 18 percent.
How your rate is constructed (index, margin, caps) and the rate you are being charged can have an effect on how quickly any available balance may grow over time. For line-of-credit HECMs, this is called the HECM's "compounding rate;" the total "compounding rate" charged on the loan balance equals the current interest rate charged on the loan + 0.5%.
The 0.5% is the annual charge for the FHA mortgage insurance premium for HECMs originated after October 2, 2017.
Example: If the 1-year Treasury is 3% and the lender's margin is 3.5%, then the compounding rate is 7% (3% + 3.5% + 0.5%)
Here, the unused portion of your line of credit would grow by 7% (in reality, this is reflected simply as an increase in your credit limit -- your borrowing capability will have grown by an annualized rate of 7 percent).
HUD does not specify an index or interest-rate construction to produce the rates for a fixed-rate HECM loan; these interest rates are determined by lenders and/or their investors. For a fixed-rate HECM, the expected rate used to calculate how much money you can obtain is your loan's actual interest rate.
See current average offered HECM rates for both fixed-rate and adjustable rate HECMs.
How do line of credit variable interest rates HECMs work?
HECM Line of credit products carry a variable interest rate, adjustable either monthly or annually. To make the program as common everywhere as possible, lenders must use either a Treasury Constant Maturity (TCM -- also known as Constant Maturity of the Treasury, or CMT) or 30-day SOFR rate.
- For monthly adjustables: The index can be the 1-month CMT or 1-year CMT;
- For annual adjustables: The index can be either the 1-year CMT or the 30-day SOFR rate.
As the value of the index isn't set by the lender, this will be a constant from place to place. However, lenders are free to set their own markups (called "margin") on top of the index value to determine the rate (the index value + the lender margin = your HECM's interest rate).
If you're considering a variable rate offer, you should ask about the margin. A lower margin means a lower interest rate and will create lower costs over time. You may wish to check with several lenders to see if one has a lower margin than another.
Like "forward" ARMs, interest rate changes are limited by interest rate limiters, or caps. For annual-adjustable HECMs, these are currently limited to changes of no more than 2 percentage points each time the interest rate is scheduled to be changed. This is called a "periodic cap." The interest rate can never increase more than 5 percentage points over the HECM's original interest rate (called the "lifetime cap").
Like traditional home equity lines of credit, monthly adjustable rate HECMs have no periodic cap, but instead have a lifetime ceiling to limit how high the rate can be. The cap for monthly adjustable rate HECMs is the HECM's starting interest ("note") rate plus 10 percentage points. While it is theoretically possible that the interest rate could jump that amount in a single month, that's highly unlikely, as it would require the governing index (SOFR or CMT) to jump by that much.
What happens to the rate on my existing HECM now that LIBOR is discontinued?
While it was in the works for several years, LIBOR was finally discontinued on June 30, 2023. While new HECMs were prohibited from using LIBOR as an index since 2021, outstanding HECMs were still allowed to use it to govern interest rate changes, awaiting a new index to be approved for use for existing contracts. In May 2023, one was authorized by HUD to replace LIBOR for outstanding HECMs; it is called the "Refinitiv USD IBOR Consumer Cash Fallback." Like LIBOR, this comes in several terms ("tenors").
If you have an existing LIBOR-based HECM, the following indexes will now be used in place of LIBOR to govern interest rate changes:
- Annually-adjustable Rate HECMs will use an index called 12-Month CME Term SOFR
- Monthly Adjustable Rate HECMs will use an index called 1-Month CME Term SOFR
All other components of the adjustable-rate feature -- frequency of rate adjustment, margin and caps -- will remain unchanged.
Reverse mortgages are complex products that should be evaluated from both a financial and personal perspective. Part 3 of this guide addresses familial considerations.
Next: Discussing reverse mortgages with your kids
Previous: Reverse mortgage or HECM restrictions
