Two economists — Makoto Nakajima of the Federal Reserve Bank of Philadelphia and Irina Telyukova of the University of California-San Diego — have written a working paper on a mystery that has long puzzled LTC planners: The relatively small size of the U.S. reverse mortgage market.
In the United States, a reverse mortgage is a loan that homeowners over the age of 62 can use to get cash backed by the value of their homes without selling their homes. If a couple owns the own, the couple must pay back the loan when both spouses have moved out, or died. Any remaining equity ends up in the couple’s estate.
A little less than 10 years ago, when the world was young and U.S. housing prices were high, the National Council on Aging published a report in which an author suggested that older Americans could use reverse mortgages to pay about $3 billion to $5 billion in nursing home bills in 2010 alone.
At this point, it seems unlikely that consumers are using reverse mortgages to pay billions of dollars in nursing home or home care bills. Some LTC planners have successfully included advice about use of reverse mortgages on their shelf of LTC funding tools. Mike Patton reported in May that a private real estate investment trust (REIT), Reverse Mortgage Investment Trust, had recently geared up for a reverse mortgage market recovery by raising $230 million.
Other LTC planners have not seen much actual use of reverse mortgages in LTC finance in the wild.
The Great Recession hit home equity, homeowners and federal mortgage finance agencies hard. The Federal Housing Administration, for example, tightened its reverse mortgage program rules after finding that it was losing $2.8 billion in its $88 billion reverse mortgage portfolio.
Researchers at Harvard’s Joint Center for Housing Studies found that only 55,000 took out reverse mortgages through the federal Home Equity Conversion Mortgage (HECM) program in 2012, down from 114,600 a few years earlier.
Nakajima and Telyukova said the latest penetration data they could find, for 2011, showed that only 2.1 percent of eligible U.S. homeowners had reverse mortgage loans.
Why are so few homeowners using reverse mortgage loans to pay LTC bills and other bills?
One observation the economists make is that use of reverse mortgages is actually more common among some groups of older consumers: Among the eligible homeowners in the lowest fifth in terms of income, for example, the take-up rate is 5.5 percent, and the take-up rate is about 17 percent for low-income householders with heads aged 90 and older.
Here are four other ideas drawn from the economists’ paper:
1. Taking out a reverse mortgage loan is difficult.
The economists made additions to older models for reverse mortgage loan demand and found that theirs seemed to do a better job of predicting real-world loan volume.
Their model shows that the changes the FHA made in 2013 will, by themselves, all other factors being equal, reduce demand for reverse mortgages by 60 percent.
2. Government safety requirements add a feature — and an expense — that the borrowers don’t really want.
A reverse mortgage is a “nonrecourse loan.” That means the lender cannot recover more than the value of the home if the price of the home falls below the loan value.
“We find that retirees do not value this insurance component,” the economists said.
Just as many consumers assume that they will use Medicaid to pay nursing home bills, they assume that Medicaid and other calamities of the kind would bring the nonrecourse provision in a reverse mortgage into play.
Cutting the cost of that unwanted insurance benefit from the cost of a reverse mortgage could increase demand 73 percent, the economists estimate.
3. Couples do see a reverse mortgage as a tool for paying for LTC costs — but, if they actually move into a nursing home soon after taking out a line-of-credit-style reverse mortgage, that’s a problem.
Most of today’s users of reverse mortgage loans get a line of credit that acts like a credit card, not a lump sum.
Using a reverse mortgage to pay for home care makes sense, but “the worst outcome for [reverse mortgage loan] borrowers is to a face a compulsory moving shock shortly after paying the large up-front cost of a reverse mortgage but before utilizing the line of credit,” the economists say. “Eliminating this possibility makes these loans more attractive.”
4. The Great Recession reduced what many households could borrow by slashing home prices.
The economists used housing data showing that mean 2010 housing wealth was 22 percent below the 2006 mean, and that mean financial wealth was 10 percent lower.
The economists did a number of statistical experiments involving various assumptions about how the drop in home equity and other recession effects would change reverse mortgage loan demand.
“Overall, for all ages and all incomes, we see that the short-run loss in wealth for current entrants into retirement results in a 29 percent decline in [reverse mortgage loan] demand relative to the baseline,” the economists say.
They say demand could drop to 1.2 percent of retirees, from a baseline of about 1.7 percent.
But income pressure counteracts some of the effects of the drop in home equity on very low-income homeowners, and the Great Recession could do lasting damage to the retirement income of today’s workers, the economists say.