Speculation is mounting that the Federal Reserve Bank will hike its benchmark federal funds rate (FFR) at some point in 2010. The rate has hovered around 0% for more than a year now, and analysts reckon that the remaining time it can possibly be held at this record low is running out. The question – as far as readers of this blog are concerned – is: How should this potential change be weighed when shopping for a reverse mortgage?

Let me first offer some background. For the purpose of this discussion, reverse mortgages can generally be categorized as either fixed-rate or variable-rate. Fixed-rate reverse mortgages accrue interest at the same (fixed) rate for their entire duration, whereas the rate associated with variable rate mortgages rises and falls in accordance with a stated benchmark rate, such as the FFR, 3-month LIBOR, and other obscure rate indexes that you’ve probably never heard of. In short, when the associated benchmark rate rises, so does the mortgage rate. [This is the exact same principle that governs conventional mortgages, by the way].

In this case, if/when the Fed hikes the Federal Funds Rate, all variable-rate mortgages (reverse and otherwise) linked to the FFR will all rise by a fixed increment. Technically, those mortgages that are linked to other benchmarks won’t rise, but given that most of the oft-quoted short-term rates are highly correlated and tend to move in tandem, it’s likely that a Fed rate hike would affect all variable-rate mortgages.

Trying to predict how fixed-rate mortgages would be affected by a short-term rate hike is difficult to say. That’s because fixed-rates are determined by market forces, and fluctuate irrespectively to short-term variable rates. In the past, short-term rate hikes have typically been accompanied by slight increases in long-term fixed rates, but this relationship is anything but certain.

The takeaway from all this is that while variable-rate reverse mortgages currently accrue interest at lower rates than their fixed-rate counterparts, it’s not clear whether this will be the case for long. Moreover, if the credit crisis has taught us anything, it is that the ability to refinance (from variable-rate into fixed-rate, for example), can no longer be taken for granted. That means it’s important to make the right choice from the outset.

In the current borrowing environment, the right choice s quickly tilting towards fixed-rate. While some borrowers might still be tempted by the low rates offered by variable-rate providers, be advised that they won’t remain low forever. And once they start rising, you might wish you had just gone with a fixed-rate, and saved yourself the headache.

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