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U.S. home prices have surged during the pandemic with median existing home prices hitting $375,300 in March, a record with data back to 1999, according to the National Association of Realtors. Although mortgage rates have jumped sharply and sales weakened recently, odds are the market remains resilient with housing supply down to a 20-year low.
The beneficiaries from the strong housing market include near-retirees and retirees since nearly 80% of adults ages 65 years and older own their home. Even more suggestive, a majority of individuals ages 62 and over with no retirement savings or pension are homeowners, notes Shai Akabas, director of the Economic Policy Project at the Washington, D.C.-based Bipartisan Policy Center in Congressional testimony late last year. Home equity is the largest asset for people at retirement age.
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Economic security later in life can be enhanced by turning illiquid housing wealth into money to live on. There are several ways aging homeowners typically turn their home into cash. Sell and downsize into a smaller, less expensive place; take out a second mortgage; or secure a home equity line of credit. Yet the math of downsizing is increasingly unattractive with surging prices for smaller homes. A second mortgage means taking on a monthly debt obligation that has to be paid. Home equity lines of credit are typically reserved for those with high incomes and stellar credit scores.
Another alternative is the reverse mortgage, a loan taken out against the value of your primary residence. Unlike a regular mortgage, you don’t repay the loan amount and accrued interest until you no longer live in your home, usually when you move or die.
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I’ve never been a fan of reverse mortgages. It’s a complicated high-fee product with a history clouded by bad actors taking advantage of the financially vulnerable. Consumers have never embraced the main reverse mortgage product that dates back to 1989. Less than 1% of eligible homeowners have taken out one.
“Consumers are right,” says Laurence Kotlikoff, economist at Boston University, president of MaxiFiPlanner.com. and author of “Money Magic: an Economist’s Secrets to More Money, Less Risk, and a Better Life.” “The whole thing seems sleazy to me.”
Reverse mortgage abuses are sleazy. Period. But the real problem with the product done legitimately–a majority–is that it always seemed a niche product. The dramatic run-up in home prices suggests it’s time for many older homeowners to take another look. The record shows that older homeowners are more likely to take out reverse mortgages when home prices are high, perhaps as a way to lock in equity values. Higher home prices also mean more people will qualify for the loan. Although I still can’t wax enthusiastic about the product, reverse mortgages are worth the time to research and consider.
“Most retirees don’t have much money in the stock market,” says Christopher Mayer, finance professor and chief executive officer of the reverse mortgage company Longbridge Financial, LLC. “Home equity is huge. Why wouldn’t they use home equity in retirement?”
Key to revisiting reverse mortgages is that the product has been improved following reforms from 2013. For example, one way borrowers can lose their home is if ongoing home insurance, taxes and maintenance costs aren’t paid. A number of reverse mortgage scandals involved older homeowners living on low and unstable incomes failing to keep up with these payments. The 2013 reforms, such as mandatory credit checks on borrowers, greatly reduced default risk.
The big lure, of course, is that a majority of older adults near and in retirement don’t have pensions and scant retirement savings. A reverse mortgage is one way to bolster the household balance sheet and income flow if included as part of a comprehensive retirement strategy. For instance, a reverse mortgage might make it practical to delay filing for Social Security, a smart way to boost benefit payments. “Reverse mortgages are becoming a more viable tool for many homeowners,” says Stephanie Moulton, faculty director for research at the John Glenn College of Public Affairs at The Ohio State.
Reverse mortgages are complicated, but here are core features. To qualify for the most common reverse mortgage, the federally backed Home Equity Conversion Mortgage (HECM), you must be 62 years or older. You must live in the home and own the property outright or have paid down much of the mortgage.
Like taking out a conventional mortgage, you’re required to show that you can pay for the ongoing costs of homeownership–homeowners’ insurance, taxes and upkeep. Unlike a conventional mortgage, you’re not required to make out-of-pocket payments during the life of the loan even as interest is added to the loan. A reverse mortgage comes with high upfront costs. The loan value is calculated by a formula that takes account of your age, the home’s value, and interest rates. You must attend a mandatory counseling session. Borrowers may access their funds a number of ways, with lump sum distributions and line of credit the most popular. A non-recourse loan, you’re not responsible for the balance that exceeds the value of the home at sale.
Economists studying the market note that it’s increasingly used to pay down existing mortgage loans and other debts. Little wonder considering the share of households headed by someone 65 years and older with housing debt has doubled over the past three decades to more than 30%. Tapping into home equity with a reverse mortgage can relieve financial pressure.
“You’re replacing one form of debt for another,” says Moulton. “But the way it’s structured you end up with more cash flow.”
Reverse mortgages without additional reforms are probably too complicated to move from the retirement product tributaries into the financial mainstream. Nevertheless, odds are reverse mortgages will play an increasingly larger role in generating income for cash-poor and asset-rich aging homeowners. “I really think that home equity is an important part of retirement security for older Americans,” says Mayer.
He’s right.
