The answer is maybe, but probably not for the reason you think. Rate caps restrict the movements of interest rates, and the conventional wisdom is that more restrictive caps are better for the borrower, right? Not necessarily.
Of course, we do not know what the future holds, but the easier question to answer is have they mattered in the past? While that depends on which Home Equity Conversion Mortgage (HECM) product was selected and when the loan was originated, I can answer the question.
Keep in mind the following items when discussing reverse mortgage rate caps:
- Monthly-adjusted HECMs do not have regulated cap structures. Historically, they have been offered with a Lifetime cap of 10% above the starting rate. Only in recent years have 5-cap monthly ARMs been offered.
- Annually-adjusted HECM ARMs do have regulated cap structures – the rate cannot move more than 2% (up or down) from year to year, and no more than 5% (up or down) from the starting rate.
- The LIBOR index was used from 2008 to 2020. However, for this analysis we’ll focus on the currently-used 1-year CMT index which dates back to the origins of the HECM program.
- The interest rate is the sum of the lender margin plus the appropriate index rate. Because the margin never changes and is not relevant to the analysis, we will only focus on the index portion.
Monthly HECM – 10% Lifetime Cap
Historically speaking, the monthly 10-cap HECM has never had interest rates restricted. We know this because the 1-year CMT has ranged between a low 0.06% and high 9.78% since the foundation of the HECM program in the late 1980s. Consequently, the interest rate has never moved more than 10% (up or down) during that time.
Monthly HECM – 5% Lifetime Cap
It doesn’t appear the monthly 5-cap HECM has been capped either. However, it should be noted that this cap option is relatively recent – offered on and off over the last 10 years when index rates have been low.
Annual – 2% Periodic and 5% Lifetime Caps
YES, this option has been capped in the past. Remember, annually adjusted HECM rates cannot go up OR down by more 2% from year to year or 5% over the life of the loan. Most of the restricted rates occurred on the lower bound (falling rates), not on the upper bound (rising rates).
Consider a borrower that obtained a HECM 20 years ago in January 2001.
- Starting date: 1/1/2001
- Starting index rate: 4.81%
The following chart demonstrates how the Annual HECM cap structure restricted the interest rate for this borrower over a 20-year period:
As you can see, this borrower’s interest rates would have been capped three times over the last 20 years; all three were a result of interest rates falling rapidly. Consequently, this borrower’s average index rate over the life of the loan is higher – calculated at 1.75%. A borrower with a monthly adjustable product would have benefited from an average index rate of 1.58% where their rates were free to drop freely.
While most borrowers think more restrictive caps protect them and always work to their advantage, this example proves that is not always the case. The monthly adjustable with 10% caps had lower index rates while the annual product with more restrictive (2%/5%) caps had higher rates because of the cap structure.
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