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How Is Interest Calculated on a Reverse Mortgage?

by
author image Rachel Nall
Rachel Nall began writing in 2003. She is a former managing editor for custom health publications, including physician journals. She has written for The Associated Press and "Jezebel," "Charleston," "Chatter" and "Reach" magazines. Nall is currently pursuing her Bachelor of Science in Nursing at the University of Tennessee.
How Is Interest Calculated on a Reverse Mortgage?
A woman is signing a document. Photo Credit Photodisc/Photodisc/Getty Images

Taking Out a Loan

Reverse mortgages allow a person to take out a loan against the home. In order to apply, a person (in most instances) must be at least 62 years of age and the home must be the person's principal residence. The funds can either be received as a lump sum or can be delivered in monthly installments. The moneys are typically used in order to finance a home renovation, pay off your mortgage or pay off other bills.

A person does not have to repay the loan or interest accrued until after a person moves out of the home, passes away or sells the home. Because there are different types of reverse mortgages, there are variations on how interest is paid.

Single-Purpose Reverse Mortgage

A single-purpose reverse mortgage is one that is granted by state and local governments as a means to offer a loan for one purpose only, such as renovations or property taxes. These loans are very specific in who can qualify and are not even offered in some areas. Because the idea behind single-purpose loans is to offer a loan that is very low in cost, the interest rate is typically very low, lower than most loan interest rates. As very few fees are associated with these loans, most often the loan is repaid at a fixed interest rate. Therefore, the calculation is the total loan amount times the percentage of interest agreed upon.

Home Equity Conversion Mortgages (HECM)

Considered the most popular of reverse mortgage options, the HECM mortgage is backed by the U.S. Department of Housing and Urban Development. Because it is a federally backed mortgage, the eventual interest rate paid must be lower than interest rates available in the private market.

These mortgage rates are either adjustable or fixed. Adjustable-rate mortgages for reverse mortgages vary in terms of tax rates over time. The lender offers a beginning interest rate with a period of time where the rate will not change. After this time, the rate can be adjusted based on current economic status (which is known as an index rate). However, the interest rate, particularly for HUD-backed loans, almost always has a cap on it that prevents the rate from rising. This interest is calculated based on the agreed terms of the loan, which means it could be calculated as a onetime payment or calculated monthly until the loan recipient experiences an action that would necessitate the loan being repaid.

The second rate is the fixed-rate mortgage. This type of mortgage means the interest rate remains constant throughout the life of the loan. In this instance, to calculate your interest expressed as a monthly payment, you would calculate the monthly interest rate (not necessarily multiplying the loan amount by the interest rate). To obtain the monthly interest rate, divide the percentage rate (for example, 10 percent) by 100--which would equal 0.1 percent. Then, divide this number by 12 (.0083) to get the monthly loan rate. Multiply this number by your monthly payment, and you have the interest amount you will be expected to pay every month until your loan is paid off.

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