REVERSE MORTGAGE INFORMATION: Tools, News and Resources to Help Seniors Decide

We wrote recently about a HUD-published study that looked at the “survival rates” of Home Equity Conversion Mortgages (HECM). The study’s authors sought to provide factual data about HECM loan pay offs that would be useful to investment bankers and others interested in development of an efficient secondary market for reverse mortgages.

Our earlier comments focused on data reported for all age groups of HECM borrowers and we found particularly noteworthy the fact that more than half of HECM loans are paid off (i.e. do not “survive”) beyond year six of the loan. This is noteworthy because financial advisor’s typically counsel that a 5-7 year HECM loan term generally is needed to amortize the high upfront costs and make the reverse mortgage a reasonably efficient borrowing tool.

The authors also studied HECM loan survival rates for three distinct age groups:

“younger borrowers (defined as those ages 64 to 66 at closing), typical borrowers (defined as those ages 74 to 76 at closing), and older borrowers (defined as those ages 84 to 86 at closing).”

The following graphs are based on data from the HUD-published study and show HECM loan termination rates for three categories (single female, single male, and couples) further broken out by age groups:

Observations:

• Most surprising is the fact that among all categories (female, male, couples) there is little difference in the observed termination rates between younger borrowers (64-66) and typical borrowers (74-76).
• Older borrowers (84-66) pay off their loans much faster than younger or typical borrowers due to higher mortality rates. The study notes “(t)his faster payoff results in the 10-year loan survival rate for older borrowers being observed at only 10 percent.”
• As expected, older borrowers (84-86) pay off their loans much faster than younger or typical borrowers due to higher mortality rates. The study notes “(t)his faster payoff results in the 10-year loan survival rate for older borrowers being observed at only 10 percent.”
• Only couples in the young borrower (64-66) group have better than a 50% HECM loan survival rate beyond year six. For all other groups, more than half of the HECM loans have been repaid by this point. For single males in the older age group (84-86), less than 1/5 of the loans survive into a seventh year.

Once again, the information provides a useful reality check for homeowners considering a reverse mortgage. The data show that a large share of HECM loans are paid off in relatively short periods – likely shorter than borrowers anticipated when the loans were taken out. The high upfront costs associated with HECM reverse mortgages can mean extremely high overall borrowing costs when loans are outstanding for shorter periods of time.

One of the key factors in assessing whether a HECM reverse mortgage makes financial sense is the length of time the borrower believes they will remain in the home. Remember, a reverse mortgage comes due in full upon death or moveout of the homeowner(s). Reverse mortgage advisors typically counsel potential borrowers that they should have strong expectations of staying in the home at least five years. (Many say seven years is a better threshhold.) Terminating early means you will have borrowed money at a very high cost for a short period of time.

But if borrowers start out with intentions of staying put for the long haul, data contained in a recent study from HUD shows that, for many, the reality winds up being quite different. The study’s focus is on developing data to help private investors understand the unique cashflows of HECM reverse mortgages in hopes of spurring development of an efficient secondary market for HECMs and other reverse mortgage products.

The data also serve as a reality check for senior homeowners contemplating a reverse mortgage. For example, as the table and graph below show, less than half (47.9%) of HECM loans for which observable history is available have “survived” past year six. Typical reasons for termination include death, moveout (voluntary sale, medical necessity, etc.), or refinancing. But whatever the case, a large share of HECM loans terminate in a relatively short period.

Couples, as would be expected, have longer loan tenures than either single female or single male borrowers. The study provides further details about loan terminations for borrowers who originate HECMs at different age levels. This topic will covered in a future post.

In interpreting this information keep in mind that the HECM program is not yet 20 years old and it has only been in the last 2-3 years that the popularity of HECM reverse mortgages has grown significantly. Better data will become available as these more recent loan originations mature.

A few weeks ago we wondered why some lenders were still promoting reverse mortgages carrying a 1.50% margin along side of newer, basically identical HECM products that carried only a 1.00% margin – a much better deal for the borrower. At the same time they promoted lower costs, higher cash availability and other benefits of the new HECM 100 loans, lenders trumpeted the continued availability HECM 150 loans offering “greater options for senior borrowers.”

We even checked with these lenders to see why a senior homeowner would “choose” a HECM 150 instead of a HECM 100 and no could give a rational reason why someone would make this choice.

We were reminded of this today when we saw this post from Next Generation Financial Services, a subsidiary of 1st Mariner Bank directing lenders in the field to “recommend the HECM 100 as the loan of choice to our senior clients.”

We have run extensive scenarios on all three of the monthly Reverse Mortgage programs listed above. Without a doubt the HECM 100 is, at present, the best loan of choice when working towards “Doing What’s Right for the Senior. Whenever an application is requested from the field, if listed on the comparison and other documents as a HECM 150 or HECM Advantage, the application will be challenged by the home office to substantiate why the monthly HECM 100 was not used. The HECM 150 is only appropriate in the event the senior wishes an annual as opposed to a monthly interest adjustment.

In the complex, confusing world of reverse mortgages (made more so with frequent new product introductions), it’s refreshing to see a lender publicly cut through some of the confusion and give some straightforward direction.

In a prior post we discussed the relationship between home value appreciation and reverse mortgages. We noted that reverse mortgages are described as rising debt, falling equity loans. Yet, in areas that have rapidly rising home prices, home equity growth can actually outpace rising reverse mortgage debt (rising debt, rising equity).

Conversely, in areas having little or negative home appreciation, the demise of home equity can hyper-accelerate as interest accrues and home values decline (rising debt, rapidly falling equity). (In these situations, the borrower remains protected by the non-recourse feature which assures reverse mortgage debt never exceeds the home’s value.)

Still, it behooves anyone considering a reverse mortgage to pay attention to the dynamics of their community’s housing market. This is especially true for borrowers hoping to leave a bequest that includes home equity.

There’s no way to know where home prices in your area will head in the future. But we thought it would be interesting and useful to take a look back and compare housing price changes (as reported by OFHEO) to the average rate of interest paid on the popular monthly-adjusting HECM reverse mortgage. The difference or “variance” between these two rates provides a simple indicator of how the rate of change in your home’s value compares to the interest accruing against your reverse mortgage.

For a simple example, assume you have a $200,000 home and take a lump-sum $100,000 reverse mortgage leaving a beginning equity position of $100,000 (50%). If both the value of your home and the interest rate on your loan remain at 4%, after 10 years you would have a home worth $296,049, a reverse mortgage balance of $148,024 and an equity position of $148,024, still equal to 50% of your home’s value.

Now if the home value grew at just 2% while the mortgage accrued interest at 4%, at the end of ten years your home would be worth $243,799 and the accrued loan balance would be $148,024 leaving a 39% equity stake ($95,775). On the other hand, if the home’s value grew at 6% while the loan remained at 4%, the end of ten years would show a home worth $358,170, a loan balance or $148,024 and equity of $210,145 (59%).

These are oversimplified examples that don’t take into account variable interest rates, irregular loan payments, and numerous other factors. Still, they help illustrate the importance of paying attention to the interplay of interest rates and home appreciation rates when contemplating a reverse mortgage.

We put together a little tool to help you in this regard using the OFHEO Housing Price Index data. You can click on any state and see the variance between average HECM interest rates for the 1- and 5-year periods ended 9/30/06 and housing appreciation rates for the same period states and/or and major metro areas within states. Here’s a sample showing average figures for the whole United States:

To find the HECM Rate Variance for your your community, check out our HECM Rate Variance Tool.

You are likely aware that the popular Home Equity Conversion Mortgage (HECM) reverse mortgage program offers borrowers a variety of payment options by which they can receive the borrowed funds:

• line of credit – by far the most popular option under which borrowers can draw funds down as needed;
• lump sum
• term – fixed payment for specified number of years
• tenure – equal monthly payments for as long as the borrower remains inthe home
• combinations of the above

We’ve written before about reasons why the tenure option (or “lifetime income plan”) may be the best payment option for seniors – even though relatively few select it. Like an annuity, the tenure payment option provides a regular monthly income stream that can help protect borrowers from outliving their resources.

Now comes a detailed study from the Center for Retirement Research at Boston College that clearly demonstrates that the HECM lifetime income plan (tenure option) is the best financial choice for seniors under almost all scenarios:

“We find that over a wide variety of assumptions about asset returns, the optimal strategy for all but the most risk tolerant households is to take a reverse mortgage in the form of a lifetime income. We are informed by the National Reverse Mortgage Lenders Association that only a small minority of borrowers choose this option, as most choose a line of credit. Our findings appear to be yet another manifestation of the widely documented reluctance of households to annuitize their wealth in retirement. There are substantial differences in reverse mortgage equivalent wealth among strategies, and in our base case a household with average housing and financial wealth…would be 33 percent better off taking a lifetime income at age 65 relative to taking a line of credit when financial wealth is exhausted.”

(From “OPTIMAL RETIREMENT ASSET DECUMULATION STRATEGIES: THE IMPACT OF HOUSING WEALTH, Wei Sun, Robert K. Triest, and Anthony Webb – November 2006 – emphasis added)

The study is based on an analysis of actual historical investment returns for the period 1975-2005 and simulates outcomes under a variety of potential scenarios and assumptions. As an academic study, the paper is, unfortunately, not an easy read for the average person. Much of it focuses on details of the methodolgy and other academic issues.

Still, as the reverse mortgage marketplace continues to grow, the study highlights an important issue that reverse mortgage counselors, lenders, policymakers and, most importantly, borrowers need to be cognizant of: Most senior homeowners would be financially better off choosing the lifetime tenure payment option. But, according to this graph from AARP’s HECM counselor training materials, only about 5% of HECM borrowers historically have chosen the tenure payment option:

Not only do the study’s findings run counter to the actual decisions being made by reverse mortgage borrowers, but also to much of the information and advice being given to potential borrowers. For instance, popular literature on reverse mortgages tends to be somewhat biased toward line of credit option because of the flexibility it offers and the fact that the HECM credit line “grows” while it remains unused. Examples:

“A credit line. You decide when and how much you wish to withdraw. This is, sensibly, the most popular choice.” (The Reverse Mortgage Advantage, p.99)

“This is what I believe to be the remarkable feature of the reverse mortgage…No other mortgage that I know allows this type of growth in a line of credit.” (The New Reverse Mortgage Formula, p.29)

Hopefully the Boston college study will spur additional discussion on the issue.

A new brief released by the [tag]Center for Retirement Research[/tag] at [tag]Boston College[/tag] examines the extent to which [tag]baby boomer[/tag] homeowners can count on tapping home equity wealth through reverse mortgages to support [tag]retirement[/tag] living expenses.

The report notes that two major factors that go into the [tag]reverse mortgage[/tag] calculus – interest rates and home values – have been very favorable in recent years. Yet, even with this advantage, most reverse mortgage borrowers can only get access to about 50% to 60% percent of their home’s value through a reverse mortgage. Enough to provide a siginificant supplement to [tag]retirement income[/tag], but not enough to ensure a secure retirement:

As an example, consider a 65-year-old homeowner with an income of $50,000 and a home worth $200,000.9 At today�s interest rates, this homeowner could borrow approximately 49 percent of the home�s value � about $98,000 � a figure that is net of closing and loan servicing costs of $14,907. If this household took its reverse mortgage in the form of a lifetime income, the monthly payment would be about $600 (or $7,200 annually). This amount could significantly improve a household�s standard of living by supplementing Social Security, pension income, and other financial assets. But, by itself, a reverse mortgage does not guarantee retirement security.

The paper also provides an important caution for baby boomers whose [tag]retirement planning[/tag] may include a future reverse mortage. Interest rates alone can have a major impact on the percentage of home value available for borrowing:

If interest rates increase, the percentage decreases…the variation in the percentage that can be borrowed has been quite dramatic � ranging from 5 percent in 1981 to 51 percent in 2002 for a household aged 65. Interest rates today are close to historic lows, and even increases that are modest by historical standards could substantially reduce the amount that a household
can borrow.

(A footnote to the report notes that the impact of higher interest rates can be moderated somewhat by taking payments under the tenure lifetime income option rather than as a lump sum or the line of credit.)

At only three pages, the report provides a lot of good, free information for anyone considering a reverse mortgage – now or as part of their future plans. Here’s the link to access Will Reverse Mortgages Rescue Baby the Boomers?

California, the nation’s hot spot for reverse mortgages, has enacted legislation specifically aimed at [tag]reverse mortgage fraud[/tag].

According to the Contra Costa Times, Gov. Arnold Schwarzenegger signed into law SB1609 as summarized below:

Existing state and federal law regulate the activities of financial institutions. Existing state law defines and regulates reverse mortgage loans and provides a disclosure notice that a lender must provide an applicant, which informs the applicant that a reverse mortgage is a complex financial arrangement and advises the applicant of the wisdom of seeking financial counseling before entering the agreement.

This bill would prohibit a lender from requiring the purchase of an annuity as a condition of obtaining a reverse mortgage loan. The bill would prohibit a reverse mortgage lender or a broker arranging a reverse mortgage loan from offering an annuity to the borrower or referring the borrower to anyone for the purchase of an annuity prior to the closing of the loan or before the expiration of the borrower’s right to rescind. The bill would, among other things, require a lender to refer a prospective borrower to a housing counseling agency for counseling, as specified, prior to accepting a final and complete application for a reverse mortgage or assessing any fees, and would prohibit a lender from accepting a full and complete application for a reverse mortgage loan or assessing any fees without receiving certification, as specified, that the borrower had received this counseling. The bill would make changes to the disclosure notice provided to an applicant for a reverse mortgage and would require a lender to provide a specified list of independent loan counselors.

Existing law requires any person engaged in a trade or business who negotiates primarily in Spanish, Chinese, Tagalog, Vietnamese, or Korean in the course of entering into specified contracts to deliver to the other party, prior to the execution of a contract or agreement, a translation of it in the language in which it was negotiated.

This bill would include contracts for reverse mortgages within these provisions. The bill would require a lender to ensure compliance with these provisions in the case of brokered loans.

Impetus for the legislation came from Shirley Hochhausen, a Community Legal Services attorney in East Palo Alto, who had seen the devastation caused by reverse mortgage scammers to her clients.

Interestingly, the legislation was not not endorsed by the National Reverse Mortgage Lenders Association (NRMLA). According to testimony from NRMLA:

[tag]Reverse mortgages[/tag] offer an important choice and benefit to senior homeowners. Reverse mortgages do not give rise to the perceived abuses that Senate Bill 1609 is intended to address. The principal reverse mortgage product being offered in the United States today is comprehensively regulated by the federal regulations that authorize such loans. Other products adhere to similar safeguards. In that regard, abusive practices that might occur in connection with reverse mortgages have already been addressed by a comprehensive federal regulatory scheme and industry standards for best practices.

Hopefully the new legislation is more than window dressing and will provide seniors with real protection against fraud.