In the May 2024 reverse mortgage rates report, we discussed how reverse mortgage borrowers might benefit from higher interest rates over the life of the loan. While this is counterintuitive, one must often think about reverse mortgages in…well, reverse.
Of course, the reason for this is because the unused principal with an adjustable-rate Home Equity Conversion Mortgage (HECM) grows at the same rate that is applied to the loan balance. Therefore, those who obtain a HECM early and draw from their HECM Line-of-Credit (LOC) prudently over time will have greater borrowing power later. This power is enhanced by higher interest rates.
This is what I call “Organic” growth as it happens naturally without any action from the borrower. This is also one reason reverse mortgages are useful in retirement planning.
However, the HECM line-of-credit (LOC) also grows when making voluntary partial prepayments. “Prepayment” growth creates one of the lesser-known advantages of the HECM product — the flexibility to pay back funds when not needed and then draw them back at any time.
Do voluntary prepayments increase a HECM LOC ‘dollar-for-dollar?’
Yes. Voluntary prepayments with an adjustable-rate HECM will not only reduce the loan balance, but also have four potential benefits to the borrower – 1) more equity, 2) less interest accrual, 3) more available LOC, and 4) a potential tax deduction (though borrowers should consult a tax professional).
However, there has been widespread confusion about the application of prepayments with a reverse mortgage. When prepayments are made with a HECM loan, certain portions of the loan balance are paid back first, beginning with that portion representing mortgage insurance.
But let’s be clear — when a voluntary prepayment is made with an adjustable rate HECM, the line of credit increases, dollar-for-dollar, at the time the payment is posted. This is confirmed by U.S. Department of Housing and Urban Development (HUD) Handbooks.
Be aware that clients should always maintain a minimum loan balance of $100. Otherwise, the servicer could close the reverse mortgage, which would also close the LOC.
July 2024 update
The 10-year Constant Maturity Treasury (CMT) weekly average — used for calculating expected rates — decreased slightly month-over-month.
The current weekly average of 4.39% is added to the lender margin and in effect for new loan applications from July 9 through July 15. The 10-year CMT trend has changed multiple times over the last 30 days, based on the most recent economic reports.
Graphics by Dan Hultquist. This column does not necessarily reflect the opinion of HousingWire’s Reverse Mortgage Daily and its owners.
To contact the author of this story: Dan Hultquist at dan@understandingreverse.com
To contact the editor responsible for this story: Chris Clow at chris@hwmedia.com
