The US has enjoyed historic low interest rates for the better part of 9 years. But Yesterday the Federal Reserve Chair, Janet Yellen announced that the economy has strengthened, opening the way for her to raise the FED funds rate for the first time in almost a decade (effectively since July 2006, see chart below). Economists at Bloomberg anticipate Janet Yellen’s comments mean the Fed will begin raising its rates at ¼ of a percent.
For the tens of thousands of people considering a reverse mortgage, they may wonder how this reserve rate change will affect their qualification for a reverse mortgage. First, one must understand that the Federal Funds Rate is the rate that banks pay the Reserve or other banks for money borrowed overnight. Banks will pay these rates so they meet the minimum required reserves for them each day. The LIBOR rate, the amount banks charge each other for eurodollars on the London interbank market, follows very closely with the Federal Funds rate as US banks will borrow from the LIBOR if it is cheaper than the Federal Funds rate.
The HECM Annual, HECM Monthly, and HECM Fixed rates are based on the LIBOR rate or US treasury rates, the higher the rate, the lower the payout on a Reverse Mortgage. Given the relationship between the Federal Funds rate and the LIBOR rate previously explained, we will see that what a person will qualify for will drop, and could drop significantly as the Fed Funds Rate, the LIBOR, and the treasury rate increases over time.
As the Federal Funds and LIBOR rates rise, this will cause all interest rates to eventually rise. As interest rates rise, it will put downward pressure on home values. For example, a family looking to purchase a home with 20% down at a 5% rate would qualify for a 200,000 home, if the rates were to rise to 6% they would qualify for less than 180,000. Therefore, rising rates push home values to drop as buyers qualify for less. The reverse mortgage payout is based on the home value therefore a drop in value lowers the money one can get on a RM. For example, a 70 year old borrower would get $108,500 on their HECM Annual RM on a home valued at $200,000, this same borrower would get $97,500 on a home valued at $180,000, an $11,000 drop in their cash payout! If the interest rate were also to be higher, then the amount paid out on the RM would be even lower.
In short, the federal funds rate rising will lower potential RM clients’ cash payouts because of downward pressure on home values and rising rates; both negatively affect the money offered on this HUD guaranteed program. The good news is we still enjoy historic low rates today and home values are at 7 year highs. To see what you qualify for today, click HERE to use our Reverse Mortgage Calculator.