Should Retirement Planning Include Reverse Mortgages?
by Kimberly Burrowes and Maya Brennan
Once considered a last resort, reverse mortgages have become an increasingly popular way for older Americans to stay in their homes as they age and tap the equity to fund retirement.
Many concerns about reverse mortgages are fueled by misconceptions about how the program works (even the New York Times got it wrong). And previous concerns about borrowers’ risks have been addressed by new guidelines from the Federal Housing Administration, which insures these loans. Still, service providers and policymakers can do more to help older adults figure out whether reverse mortgages are right for them and ensure current policy protections stay in place.
Homeownership and Financial Challenges among Older Adults
The US population is aging, and the high costs of housing, food, and health care often become more challenging after retirement. Older homeowners can alleviate these financial burdens by tapping the assets accumulated in their homes. A traditional home equity loan or line of credit could accomplish that goal, but it would add a new payment. Reverse mortgages, however, allow borrowers to draw on their home equity without adding a new expense to their budget and without having to sell their home.
More than three in four older adults are homeowners. Even among adults over age 85, the homeownership rate exceeds the national average. More than 10 million of these older homeowners have low incomes, and around 2 million older homeowners are living on 30 percent or less of their area’s median income. Because Americans are living longer, the number of low-income older homeowners is expected to grow, reaching 18.2 million households by 2035.
Home equity accounts for about half of the typical asset portfolio of older adults. For low-income and minority homeowners, home equity makes up an even larger share of household assets. For example, older homeowners with income less than $15,000 a year have a median of $78,000 in home equity and just over $8,000 in nonhousing wealth. Older minority homeowners have $85,000 in median home equity and just over $16,000 in nonhousing wealth.
Among households ages 55 to 64, more than half (55 percent) have less than $25,000 in retirement accounts, and roughly 41 percent have no retirement savings. Although some of these households rely on a pension plan or Social Security, weak household savings leading up to retirement makes it unsurprising that more than a third of older homeowners are concerned about their financial situation. These worries are compounded by high rates of housing cost burdens among older adults and high out-of-pocket health care costs. What’s more, households’ weak retirement savings need to go further to accommodate the high cost of living and the likelihood of living longer.
The State of Reverse Mortgages
Reverse mortgages are typically offered through the Federal Housing Administration’s (FHA) Home Equity Conversion Mortgage (HECM) program. Homeowners ages 62 and older can use reverse mortgages to access equity as a line of credit, a defined monthly payment, or a lump sum. The loan must be repaid after the home is sold or when the last borrower or eligible spouse dies or has permanently moved out of the home. Typically, the payment requires proceeds from the home’s sale. Any assets that remain belong to the borrower or borrower’s estate, but a HECM borrower will never owe more than the proceeds from the home’s sale. If there is a shortfall, FHA insurance will cover the difference. Even without direct payments on the loan, borrowers can default by missing payments for property taxes or insurance or by allowing the property to fall into disrepair.
Since the beginning of the program, over 1 million HECMs have been originated. Compared with other older homeowners, HECM borrowers are more likely to be single (especially a single man), black, and college educated, and have lower incomes, lower nonhousing assets, and higher home equity.
To reduce borrowers’ risk of default, the HECM program guidelines have undergone several changes, including the following:
- All borrowers are required to compile a financial assessment demonstrating they can maintain the home and stay current on other housing bills.
- To avoid borrowers’ drawing down too much equity too early, only a portion of the equity can be tapped in the first year.
- A nonborrower spouse can remain in the home after the borrower dies without fear of foreclosure, as long as that spouse would otherwise have been eligible for the loan.
Recommendations for Improving Reverse Mortgage Access and Security
Although program changes have addressed several risks that have been documented by research, policymakers and organizations serving older adults can further increase access to reverse mortgages among suitable borrowers, identify owners who would be better assisted through other channels, and improve the security of these loans.
- Include Home Equity and Reverse Mortgage Topics in Financial Counseling
Housing counselors, financial advisers, and others who work with older homeowners can provide clear information about effective tools for supporting retirement needs through home equity. According to the Home Equity and Retirement Income Planning Survey in 2016, just one in four adults ages 55 to 75 feels comfortable using home equity as an income source during retirement. Of those comfortable with using home equity, a little more than one in three had considered reverse mortgages. Literacy about the loans was low, and 35 percent of respondents had a negative view of reverse mortgages. But as a senior’s literacy on reverse mortgages increases, so too does his or her optimism about using the program.
Older homeowners often avoid a reverse mortgage based on the belief that the program could leave debt for their family and would not allow their heirs inherit the home. Yet HECMs are nonrecourse loans, which means the maximum a borrower or estate would owe is the property’s value, even if the loan balance exceeds the home’s sale price. If the debt is less than the home’s value, the borrower or estate keeps the difference. So if a borrower is concerned about passing along the home’s value rather than the house itself, a reverse mortgage may still be a reasonable option.
Conventionally, reverse mortgages were conceived as a last resort for cash-strapped owners. But evidence suggests it may be better to access reverse mortgages earlier in retirement, perhaps as a line of credit. Owners may opt for a reverse mortgage to lock in estimated home equity in markets with inflated home values, or they may want to apply for a HECM before they run out of financial options because late bills or a low credit score may disqualify them from the program. Yet owners may lack credible information about the most strategic time to get a reverse mortgage.
- Recognize when the Program Is Not the Best Fit
Reverse mortgages are not for everyone. The higher cost of a reverse mortgage compared with other means of drawing down home equity means that owners should carefully consider their other options. In addition, the ability to pay other expenses affects an owners’ suitability for the loan. Those with a low credit score or delinquent housing bills face too high a default risk.
Older adults are increasingly bringing mortgage debt into retirement, which complicates a reverse mortgage because the reverse mortgage can be the only lien on the property. Its proceeds, however, can be used to pay off an existing mortgage. Depending on the level of mortgage debt remaining, older owners may have sufficient equity to cover the debt and have something left to draw down for income. Among people who received reverse mortgage counseling, owners who wanted to use the reverse mortgage to pay off an existing mortgage were less likely to borrow through the program.
- Support Policies for Sustainable Ownership during Retirement
Combined with adequate information and HECM screening, a supportive landscape of policy protections can improve reverse mortgage sustainability and support quality of life for older Americans wanting to age in place. Adding or sustaining programs for property tax relief, routine home maintenance assistance, or affordable home modifications can reduce default risks for HECM borrowers.
Policymakers can also ensure that the Consumer Financial Protection Bureau (CFPB) and housing counseling programs continue to support older owners. Because the CFPB regulates the mortgage landscape, including advertising, seniors can make informed decisions in their retirement planning. The bureau can offer educational sessions and materials to ensure potential borrowers can keep abreast of the changing HECM environment. Meanwhile, although reverse mortgage counseling is mandatory for all HECM borrowers, funding for housing counseling needs to be adequate to help owners get comprehensive and clear information about various methods of tapping home equity and which, if any, is right for them.
David Hinson, Serena Lei, Jerry Ta, Lydia Thompson, and John Wehmann of the Urban Institute contributed to this feature.
