Home equity is the most important asset many seniors bring into retirement. They're far more likely than younger Americans to own their own home – often mortgage free.
And, with many baby boomers entering retirement with inadequate retirement savings, home equity is an attractive candidate to tap. There's just one problem, of course, and it's a big one: the 2008-2009 housing crash. Two recent studies illustrate the pressure that the housing meltdown is putting on older homeowners – and the risks associated with draining home equity.
New research by the AARP Public Policy Institute finds that about 3.5 million homeowners over age 50 are "underwater" on their mortgages, meaning they owe more than their properties are worth and have no home equity at all. The study—which is based on analysis of national loan data—found that 600,000 loans to people over age 50 were in foreclosure last year, and another 625,000 loans were 90 or more days delinquent. From 2007 to 2011, more than 1.5 million older Americans lost their homes as a result of the mortgage crisis.
The crisis has hit middle class households hardest. AARP found that 53 percent of foreclosures among homeowners over age 50 occurred on loans where borrower income was between $50,000 and $124,999; another 32 percent occurred where borrower income was less than $50,000.
The percentage of older homeowners carrying mortgage debt into retirement is rising, too – the legacy of the housing bubble's inflated housing values. Between 1989 and 2010, the percentage of homeowners age 55-64 carrying mortgages jumped 45 percent, to 53.6 percent; among homeowners age 65-74, the percentage rose 87 percent, to 40.5 percent. Perhaps most alarming, the percentage of homeowners over age 75 carrying a mortgage jumped 284 percent, to 24.2 percent.
Rising debt and falling home values pose considerable retirement planning challenges. Some underwater homeowners may be able to wait out the market, especially if their mortgages are only modestly higher than the value of their homes. While the high backlog of foreclosed properties and vacant homes continue to pressure prices, there have been tentative signs in recent months that the market is bottoming out. For example, a Reuters poll last month showed most economists think the U.S. housing market has now bottomed and prices should rise nearly two percent in 2013 after a flat 2012.
But many older homeowners don't have time to wait for a turnaround, especially if they are deep underwater. That will leave them with limited options in the event that they need to sell.
One tool available to seniors for tapping home equity is a reverse mortgage. But a recent report by a federal government watchdog points to growing risks associated with these loans.
The report was issued by the new federal Consumer Finance Protection Bureau (CFPB), which was assigned the task of regulating mortgages under the Dodd-Frank Wall Street reform law. The law directed the CFPB to conduct a detailed study on the reverse loan market – and to issue new regulations if its research uncovered unfair, deceptive or abusive practices.
The CFPB's report confirms concerns about the risks associated with reverse loans that have been voiced for several years by consumer watchdogs and industry critics. A growing number of borrowers are taking out large lump sum loans at higher fixed interest rates at younger ages – often using the proceeds to retire traditional forward mortgages. That is leaving a growing number without a cushion to meet unexpected expenses, or even to pay taxes and insurance on their homes – a condition of the reverse mortgage. And a growing percentage of outstanding loans are at risk of default.
Perhaps most troubling: HUD data shows that 9.4 percent of outstanding reverse loans are in danger of default as a result of borrower failure to pay taxes and insurance – a figure that is on the rise.
Reverse mortgages are available only to homeowners over age 62, and they are designed to allow seniors to turn their home equity into cash while staying in their homes. Unlike a forward mortgage, where you use income to pay down debt and increase equity, a reverse mortgage pays out the equity in your home as cash; your debt level rises and equity decreases.
The most popular loan type is the Home Equity Conversion Mortgage (HECM), which is administered and regulated by the U.S. Department of Housing and Urban Development (HUD), and insured by the Federal Housing Administration (FHA).
HECMs are different than traditional home equity lines of credit in two critical ways:
– Repayment of a reverse mortgage typically isn't due until the homeowner sells the property or dies.
– Borrowers can't be disqualified based on personal assets or income; lenders are required to accept all applicants, so long as their homes are judged to have sufficient equity to support the HECM.
HECM growth started falling soon after the housing crash, and it's been weak ever since. New loan originations were down 23 percent in the first half of this year compared with the same period in 2011, according to Reverse Market Insight, which tracks industry trends. And first-half volume this year was just half what it was in the comparable period of 2009.
The squeeze on equity is a key cause of the reverse mortgage market's weakness; loan limits depend on the amount of equity in your home and your age--the older you are, the more cash you can get. “When you have less equity in your home, you qualify for a smaller reverse mortgage,” says John K. Lunde, president of Reverse Market Insights.
Another factor is the decision by several very large reverse mortgage lenders to stop originating new loans, including Wells Fargo, Bank of America, Financial Freedom and Metlife. Those departures removed large numbers of loan originators and marketing resources. The lenders that have remained are showing growth – new loans were up 6 percent in the first quarter this year, and 10 percent in the second quarter.
The CFPB report predicts that reverse loan activity will make a comeback in the years ahead. The aging of the baby boomer generation will create a much larger pool of potential borrowers. And many boomers will enter retirement with inadequate savings, which will lead them, in turn, to tap their home equity.
The industry – and some planning experts – also are pushing to get reverse mortgages integrated into future-oriented retirement plans.
Several papers published recently in professional journals make this case. One advocates using HECMs as a standby resource aimed at boosting the probability that clients will meet retirement goals; a second examines strategies for using reverse mortgage credit lines to increase safe maximum initial rate of retirement income withdrawals; and a third looks at reverse loans in the context of overall asset allocation.
But most of these arguments are pinned to a relatively new type of adjustable-rate reverse mortgage, called the Saver HECM. The amount that can be borrowed via a Saver HECMs is smaller, they have far lower costs and offer greater flexibility than fixed-rate lump sum mortgages. But Saver HECMs still represent a very small part of the overall reverse loan market – just 8 percent in the second quarter this year.
The CFPB report could set the stage for new regulations of the industry. But in the meantime, the agency is cautioning seniors to take the time to really understand what they're getting into with a reverse loan.
It's also important to take seriously the counseling provided by HUD-approved advisers before loans can be issued. Industry experts say many seniors arrive at counseling having already decided to take out a reverse loan, rather than viewing it as an opportunity learn more about the product and weigh the pros and cons.
The reverse mortgage industry also recently launched a new education initiative aimed at helping seniors better understand the product.
Mark Miller is a journalist and author who writes about trends in retirement and aging. Mark edits and publishes RetirementRevised.com, featured as one of the best retirement planning sites on the web in the May 2010 issue of Money Magazine. He is a columnist for Reuters and also contributes to Morningstar and the AARP Magazine. Mark is the author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living (John Wiley & Sons, 2010).