I am sure that you have heard that a reverse mortgage, or Home Equity Conversion Mortgage (HECM), is “more expensive” or “the costs are high” or something that would lead you to believe that the fees involved with a reverse mortgage are quite high and a negative factor.
However, to make a determination about the costs of loans, one must compare loans to each other. Let’s examine the comparison points.In their website “Shopping for a Loan” the U.S. Department of Housing and Urban Development (HUD) states, “The APR takes into account not only the interest rate, but also the points, mortgage broker fees and certain other fees that you have to pay. Ask for the APR before you apply to help you shop for the loan that is best for you.”
It is commonly understood that the Annual Percentage Rate (APR) is a good way to compare loans. Because different loans have different interest rates and cost combinations, it is often difficult for a layperson to make a determination as to the best combination. The Government has required lenders to make sure you have the APR for caparison. It’s a law. While lenders talk about their low costs and low interest rates, they often try to hide the APR in the fine print in ads and other paperwork.
The APR takes in to account not only the costs and interest rate, but also all the interest paid for the length of time of a loan. A simple way to think about it is adding the total of the interest for the time you keep the loan plus the costs. When looking at a 30 year loan, the time involved is the whole 30 years, even though most people do not keep loans that long.
A reverse mortgage is based on the borrower’s life, which varies for different people. So a typical APR for comparison is not possible. To overcome this, HUD has required that the APR be shown for 4 different time periods – 2 years, half the expected lifespan, the full lifespan, and 1.4 times the lifespan. The document showing the 4 APRs is called “Total Annual Loan Cost” (TALC). This allows the borrower a good comparison. Also of note, since the loan could end at any time, the costs are collected at the beginning of the loan by merely including them in the loan, so that the borrower is not burdened by out-of-pocket loan costs.
The illustration below compares a copy of the reverse mortgage TALC, for a 71 year old, with a quote from a bank website for an equivalent home equity loan (HELOC) and a 20 year fixed interest loan. The comparison is for the same point in time, and as the market interest rates change, both the Reverse Mortgage rate and the HELOC rate would change in relation to each other. The notes at the bottom are the “fine print” for the bank’s loan quote.
You can see that the APR for the reverse mortgage for the person’s lifespan is 3.96% compared to the HELOC of 3.99% and the fixed loan of 4.65%. However, if the reverse mortgage was only kept for 2 years the APR would be 4.962%, higher than the HELOC, but still lower than the 20 year fixed. By the way, the start rate for the reverse mortgage is just 2.528%*. Where else could you get that?
So, you tell me, is a reverse mortgage more costly than a traditional mortgage?
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*Rates subject to change according to the market.
Click on illustration to enlarge.
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