A reverse mortgage is a loan against the homeowner's equity, which is the current value of the home minus any debt against it such as a mortgage or home equity loan. Like an ordinary mortgage, the reverse loan charges interest, but the borrower makes no monthly payments. Instead, the debt, plus the gradually growing interest charges, are paid off when the borrower moves permanently, sells the home or dies. The debt can never exceed the proceeds of the home sale, so the reverse mortgage debt does not endanger the borrower's other assets. The most common type of reverse mortgage is the federally backed Home Equity Conversion Mortgage. Because there's no telling how large the borrower's debt could grow, reverse loans manage the lender's risk by providing less than 100% of the homeowner's equity at the time the loan is approved. A key factor in this calculation is the "expected interest rate." The lower it is, the more the homeowner can borrow, and rates are quite low today.
"For example, at an expected rate of 4%, which has been a common rate during 2013, a senior of 62 with a home worth $300,000 can draw an initial credit line of about $174,000," Guttentag says. "At an expected rate of 6%, the line drops to $140,000 and at 10% it falls to $54,000."
But the accrual rate has another function. Over time, the home presumably becomes more valuable, and therefore any unused portion of the borrower's credit line grows as the years go by. The accrual rate is used to determine how fast the credit line grows. The higher the rate, the bigger the credit line. That means the homeowner who does not need to take cash out of the home right now can use today's low expected interest rate to get the largest possible line of credit to start with, and then, if the accrual rate goes up as expected, the borrower will see the credit line grow. The ideal strategy, Guttentag says, is to hold off drawing against the credit line for as long as possible. That way you could remain free of debt, but would have a rainy day fund that could be much larger by the time you need it.