# Thread: Financial Calc (2002 SP-2)

1. ## Financial Calc (2002 SP-2)

Anyone have experience with reversed mortgages? I'm trying to set up a spreadsheet to look at historical data, but can't quite figure out how the interest is calculated. In the example the bank gave me with a beginning balance of \$138,384.71 and an interest rate of 3.41% their chart shows interest of \$4,097.00 for the first year. On my spreadsheet (beginning balance X interest rate) I get \$4,718.92 I know just about nothing about finance; is there some other method that is used to arrive at the annual accrued interest?

2. ## Re: Financial Calc (2002 SP-2)

Are there monthly payments that are reducing the outstanding balance?

The typical way installment loans in the USA work is:

Start of Month Balance+(Start of Month Balance*i/12)-Monthly Payment=End of Month Balance

The interest charged is the amount in parentheses.

The End of Month Balance becomes the Start of Month Balance for next month's calculation. As long as the monthly payment is greater than the interest charged, each balance is less than the prior balance. Therefore, each month's interest charged is less than the prior month. This would explain why your number is larger than the bank's number.

I'm not sure your problem is related to reverse mortgages. I have experience with those too, but I think your question has more to do with plain vanilla installment loan calculations.

Hope this helps.

3. ## Re: Financial Calc (2002 SP-2)

Hmm. I've never seen a reverse mortgage that has installment payments (kind of defeats the whole purpose in my view, but what do I know?). In this reverse mortgage there are no payments; the entire note (along with accrued interest) is due and payable on termination of the note (sale of the property/my demise). I have a choice of selecting a monthly or annual adjustment on the interest calculation, so I wanted to look at the historical performance. The note is based on the 1-year Treasury Constant Maturity Rate (+1.5% for monthly; +2.1% for annual).

4. ## Re: Financial Calc (2002 SP-2)

The interest on a reverse mortgage depends on the principal advance that you will get every month. See AARP's example . The spreadsheet that I've attached shows how the interest is calculated for the first year of the AARP example.

5. ## Re: Financial Calc (2002 SP-2)

Cathy:

Thanks for your input. From what I see, the interest amount is determined by (beginning balance X rate) for the first year. That is what I have done, but keep getting the descrepency with the loaner. I guess I'll just have to check with them to determine the method they use. Seems to me it shouldn't be that difficult, but this is a whole new world for me. I am not going to be taking a monthly draw, just a lump-sum for remodeling with the option to draw from the credit line at a later time (if needed). Thanks for the attachment, but it doesn't really work to show the annual accrued interest amount (other than what I have already tried).

6. ## Re: Financial Calc (2002 SP-2)

Cathy's example is doing the same calculation I described in my previous post.

If there is no cash being exchanged after the initial draw, then I think your calculation should be correct. Of course, the good news is that the bank's number is lower than yours. Good luck with getting the bank to explain their calculation. A typical customer service rep won't have a clue how to explain it to you. I'd be curious to hear the answer.

I'm not sure you need to look at historical results to make this choice. If you expect there to be more years of rising rates than falling rates, then it may be better to go with the annual adjustment. In today's interest rate environment, the consensus is that a rise is more likely than a decrease which is why the 2.1% "margin" is greater than the 1.5% "margin". However, once rates rise, the chances of a decrease become more likely. Even if rates rise and stay level, choosing Annual may make you a winner in the first year, but then you're paying an extra 0.6% every year thereafter and getting no benefit. If rates rise and then fall, you'll be cursing yourself as rates decrease but you stay locked in until the end of the year. Are these "margins" fixed forever or do they change periodically?

Assuming these margins are fixed forever, I would choose monthly because you'll always be paying the current market rate (which could be considered the "correct" rate). With the annual reset, you'll either be above or below the "correct" rate at any point in time. In the long run, being above or below should cancel out each other in which case you would have paid an extra 0.6% every year for nothing. The only scenario where paying the extra 0.6% makes sense is if you think there will be many more years where rates go up as opposed to years where rates stay level or decrease. Just my 2 cents.

7. ## Re: Financial Calc (2002 SP-2)

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8. ## Re: Financial Calc (2002 SP-2)

I think your analysis is spot on.

Here's some additional insight for you from someone who works with these kinds of rates and makes these kinds of decisions. As you said, there's a chance that interest rates go haywire. If the cap is very high, the bank really doesn't care because they will accrue more interest on your account. Therefore most of the interest rate risk is borne by you. Conversely, if the cap is low, then the bank has more risk since they've promised you a lower limit on the accrued interest. The only way it makes sense for the bank to take on this risk is to charge you an additional fee of 0.6%. You can think of it as buying insurance against high interest rates. As with all insurance premiums, there's usually a profit component built into it.

If this "cap insurance" is properly priced, then in the long run, you would be better off not buying the insurance, if you're willing and able to absorb the risk. That's a huge IF. Most of us buy auto, home, and health insurance even though we know companies are making a profit. That's because we're willing to pay a constant, predictable higher charge rather than absorb the risk of an improbable catastrophe. We don't buy insurance for small accidents, because we are willing to aborb risks of that size. Only you can decide if this is a big risk or a small risk.

9. ## Re: Financial Calc (2002 SP-2)

Thanks, once again, for your continued interest/input.
Becoming an "intelligent consumer" certainly is more a challenge to the intelligence than to the consumer aspect <img src=/S/grin.gif border=0 alt=grin width=15 height=15>

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