Home Equity Conversion mortgages are most popularly set up as credit lines. The most common option is to structure these credit lines with a once-per-year annual rate adjustment. An adjustable rate mortgage or “ARM” is a loan with an interest rate applied to the outstanding balance that varies with market conditions during the life of the loan. On regular “forward” hybrid ARM mortgages, the initial interest rate is fixed for a defined period. After this initial period, the interest rate resets periodically, at yearly or even monthly intervals. On forward mortgages, these rate changes come with corresponding monthly payment changes. HECMs do not. By definition, there is no required monthly payment and therefore no payment change! Historically, ARMs offer a lower interest rate than concurrent fixed rates.
ARM’s are sometimes called “floating” mortgages. Interest rates on the adjustable mortgage do not always go up. Just as often, the interest rate will go down. The way that the interest rate on an “ARM” is calculated is by a simple formula. Index plus margin equals the interest rate. Take for example a LIBOR (London Interbank Offered Rate) annual rate ARM. The loan will start out for the first year with the interest rate based on the current LIBOR plus the margin as offered by the lender. After the first year and annually thereafter the rate for each year will be determined by taking the then LIBOR rate plus the original margin. When deciding on reverse mortgage options, one should compare the proposed margin and the underlying financial index, as well as other expenses as offered by various lenders. Remember, it is the margin that will remain the same throughout the life of the loan. If the loan is an annual “ARM” the underlying financial index may change annually.
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