Cascade: No. 74, Spring/Summer 2010
Spotlight on Research: Is a Reverse Mortgage in Your Retirement Plans?
Individuals are constantly reminded to start planning for retirement as early as possible. This is sage advice given that it takes increasingly more in savings to supplement Social Security retirement benefits in order to live comfortably in the golden years. The recent economic downturn has made retirement planning even more challenging for many individuals who thought they had amassed the requisite amount of savings to ensure their future retirement.
Marvin M. Smith, Ph.D., Community Development Research Advisor
For elderly homeowners with equity in their homes, one option to smooth their consumption during the retirement years is to rely on a reverse mortgage, which allows them to borrow against their home. However, reverse mortgages are complex financial products that may or may not be a viable alternative. A study by Hui Shan provides valuable information about the reverse mortgage market.1 Following is a summary of her study.
Background on Reverse Mortgages
The most common of the different types of reverse mortgages — and the one studied by Shan — is the home equity conversion mortgage (HECM). Established by Congress in 1987, the HECM program is administered by the Department of Housing and Urban Development (HUD) and insured by the Federal Housing Administration (FHA). To be eligible for a HECM loan, an individual must be at least 62 years of age and live in a one-unit residence with no liens or with adequate equity to support the loan.2 In contrast to the traditional home equity loan or home equity line of credit (HELOC), a HECM loan has no maturity date. Thus, the loan becomes due (i.e., terminated) if the borrower dies or no longer lives in the home.3 Moreover, borrowers of home equity loans and HELOCs must be creditworthy and possess sufficient income to qualify, which are not necessary for HECM loans.4 According to Shan, elderly homeowners who are house-rich but cash-poor might be attracted to HECM loans.
The HECM loan amount is based on the borrower’s age, amount of equity in the home, and the interest rate.5 There are some upfront costs associated with a HECM loan such as the initial mortgage insurance premium (MIP),6 origination fee, closing costs, and monthly servicing fee. However, these costs are financed and not paid out of pocket by the borrower.
Borrowers can choose to receive the loan funds in the following ways:7
- Lump sum
- Tenure plan — Receive equal monthly payments while residing in the house
- Term plan — Receive equal monthly payments for a fixed period of months
- Line of credit plan — Take the money as needed
- Combination of a line of credit with tenure or term plans
Data and Methodology
Shan notes that most of the studies on reverse mortgages are not based on loan-level data and thus are not as accurate. Those that are based on loan-level data are limited in scope or “analyze only the data from earlier years of the HECM program.” To fill this void, the author used HUD data on all HECM loans made from 1989 to 2007. Each loan record contains demographic information on the borrower and the property as well as the amount and terms of the loan. After making adjustments to the data, Shan was left with a sample of 375,392 observations. The author then merged the HECM data with several other databases to form the data set that was used in her analysis.8 In addition to presenting descriptive statistics, Shan also used regression techniques to analyze the data.
Results
The author’s analysis focused on the following aspects of the HECM market:
Characteristics of HECM Borrowers and Loans. Shan found differences between HECM borrowers and the general population, as well as differences among HECM borrowers in the early years and those in 2007. HECM borrowers are slightly older than homeowners who are 62 years of age and older in the 2000 census data (with a median age of 73.5 versus 72.0). The data revealed that “single males and single females are more likely to purchase reverse mortgages than married couples.” Also, married couples comprise a lower percent (36 percent) of HECM borrowers compared with their counterpart (52.8 percent) in the general population. The author further noted that the “demand for reverse mortgages has been growing most rapidly among younger elderly homeowners.”
Shan used regression analysis to explore variation in the geographic distribution of reverse mortgages across and within metropolitan statistical areas (MSAs). She found that “reverse mortgages are more likely to originate in income-poor but housing-rich MSAs but not necessarily in income-poor but housing-rich ZIP codes within any given MSA.”
Termination and Assignment Outcomes. The author used different regression techniques to study the termination and assignment of HECM loans. Her “estimates suggest that borrowers who choose the line-of-credit payment plan, male borrowers, and borrowers with higher housing values terminate HECM loans sooner than other reverse mortgage borrowers.”
When a HECM loan balance reaches 98 percent of the maximum claim amount, a lender can assign it to HUD. If the loan balance exceeds the sale proceeds, the FHA insurance program covers the difference. An examination of assignment outcomes revealed that relative to term or tenure payment plans, loans with line-of-payment plans are more likely to be assigned to HUD and thus impose higher risks of financial losses.
Housing Price Appreciation. All things being equal, housing price appreciation should have an increasing effect on the demand for reverse mortgages. Shan’s estimates supported this effect.
FHA Mortgage Limits. Shan also examined whether FHA mortgage limits reduced growth in reverse mortgages. Her analysis found no such effect.
Concluding Observations
Shan concluded by discussing the misconceptions about HECM loans, two of which are:
- Once in the HECM program, borrowers relinquish their home to the lender.
Borrowers retain ownership of their home, but they must repay “the lesser of the loan balance or proceeds from the property sale.” - High costs for HECM loans imply a bad deal for elderly homeowners.
A HECM mortgage is costly due to the MIP to insure the lender and the borrower.
- 1Hui Shan, “Reversing the Trend: The Recent Expansion of the Reverse Mortgage Market,”
Board of Governors of the Federal Reserve System, Finance and Economics Discussion Series 2009-42 (2009). - 2These are nonrecourse loans, which “means that the borrower and [his or] her estate will never owe more than the value of the property and no other assets can be seized to repay the loan.”
- 3However, the mortgage may become due and payable if the borrower fails to pay taxes or insurance or make needed repairs.
- 4But the author points out that “borrowers who have [been] delinquent or defaulted on federal debt may not be eligible for HECM loans.”
- 5The calculation is also governed by the maximum claim amount (MCA), which is the “lesser of the appraised value of the property or the county-specific FHA mortgage limit for a one-family residence under Section 203 (b) of the National Housing Act.” This serves to “cap the amount of the housing equity the borrower can use to purchase reverse mortgages.” See Shan’s study for specifics regarding the calculation.
- 6This helps finance the FHA’s insurance program, which insures the borrower if the lender is unable to make the contracted payments and insures the lender up to the MCA if the outstanding loan balance exceeds the sale price of the property.
- 7According to Shan, line of credit disbursements are the most popular payment plan.
- 8Those data sets used in the merger include the 2000 census, First American CoreLogic data, 1990-2008 county-level FHA mortgage limit data, and a “dataset purchased from the United States Postal Service to match ZIP codes with counties for each HECM loan in [her] sample.” She also used 1989-2007 Survey of Consumer Finances (SCF) data on homeowners who are 62 years of age or older for comparison purposes.
