Are We Currently in a Reverse-Mortgage Renaissance?

During the housing boom, the reverse mortgage was touted as a way for retirees to turn their home equity into cash. In essence, homeowners with a reverse mortgage take a loan against the equity in their home and do not have to pay it back while they are alive, so long as they remain in the home.

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But when housing went bust, it took much of the reverse mortgage market with it.

Today, home equity conversion mortgages backed by the Federal Housing Administration make up a large percentage of the reverse mortgage market. But how can you choose the best reverse mortgage for your situation?

Stephen Malpezzi, a professor at the Wisconsin School of Business' Graaskamp Center for Real Estate in Madison, offers some thoughts in the following interview.

What happened to the availability of reverse mortgages after the housing bust?

Unsurprisingly, they fell dramatically, though for reasons I don't fully understand, they didn't peak until 2009. The housing slide started in most markets in 2006, and the recession officially started in December 2007.

Here's the data from FHA (Federal Housing Administration)-insured home equity conversion mortgages (HECMs), which dominate the U.S. reverse mortgage market.

Private-label reverse mortgages basically went away after the crash. FHA's HECM is most of the market, except for a small number of high-value transactions at the luxury end. I don't see much reliable data on this small part of the market, so I don't have a view on the outlook for private label going forward.

Note that the FHA program has lost a lot of money because default rates of pre-bust HECMs have been high. FHA has been making a number of changes to the program -- for example, removing the option to take a fixed rate. It's unclear to me at this point how effective these reforms will be, should we have another boom-bust cycle.

However, there is certainly room for this market to expand somewhat as market conditions improve, if FHA's reforms take hold. There are about half a million HECMs outstanding, but there are roughly 25 million homeowner households with a head 62 or older.

If someone got a reverse mortgage after the housing bust, how can they take advantage of rising home values? Can they refinance with a bigger reverse mortgage?

The bust reduced the home equity that's the basis for the loan. So in general, the bust reduced the amount of loans most folks could obtain. Now that house values are rising, and balance sheets for many (not all) households are improved, there is expanding scope for such loans. Here's Federal Reserve Board data on house equity, in the aggregate.

You can see the big drop after 2006 and the start of the recovery. (And recent increases in house prices will be reflected in a further upward movement when we next update this Fed data). This improvement is especially important to middle-class Americans. Housing equity is a bigger fraction of the assets of middle-income folks than of rich folks, even though it's smaller in dollar terms. For example, according to the Federal Reserve's 2009 Survey of Consumer Finances, about 70% of households around the middle of the income distribution own their homes, and of those between the 40th and 60th income percentiles who own, their house equity averages about $100,000. For comparison, in the top 10% of the income distribution, more than 90% own, and their average house equity is somewhat north of $500,000.

For many middle-income Americans, that house equity is very important -- often a bigger chunk of their balance sheet than the bank accounts, stocks and other purely financial assets that first come to mind when we think about savings. Taking all financial assets into account, but excluding housing and other nonfinancial assets, the typical middle-income household has about $80,000 in stocks, bonds, bank and retirement accounts, and so on; households in the top 10% of the income distribution average about $1.4 million in purely financial assets. These SCF data include both elderly and nonelderly, only become available with a lag of several years, and should be viewed as indicative rather than precise. Nevertheless, they are sufficient to make the point that finding ways to safely and appropriately tap housing equity is an especially important component of good financial planning for many in the middle class.

What consumer protections have been put in place in the last few years in the realm of reverse mortgages?

The Department of Housing and Urban Development and FHA have primary responsibility for HECMs, and the new Consumer Financial Protection Bureau also weighs in. They are apparently issuing rules that aim to reduce the potential for conflicts of interest in loan origination -- for example, to reduce the possibility that originators might steer borrowers to higher-cost products to increase their fee income. There's prima facie evidence that this happened more often than we'd like with regular "forward mortgages" during the subprime run-up in the early 2000s.

Servicers are also subject to some CFPB regulation that aims to provide greater transparency and more effective dispute resolution.

Appraisals are a key element to any mortgage transaction. After Dodd-Frank, borrowers have to be given more information about these appraisals without additional charges.

There are numerous other regulations in place or being contemplated. The regulatory environment for all kinds of mortgages is devilishly complex at the moment.

How can a consumer distinguish the difference between a beneficial reverse mortgage and one that's not in the homeowner's best interests?

That question is really too complicated and dependent on an individual's situation to answer fully in a short article. But here are a few points to keep in mind:

First, HECMs are only available to those who meet certain qualifications. You have to be 62 or older, and you have to have sufficient equity in your home (no mortgage, or a small loan balance relative to the value of the property that can be paid off with some of the proceeds from the HECM).

Second, with a regular mortgage -- first or second lien, home equity line of credit, etc. -- the borrower has to plan to pay the loan back, and both they and the lender (we hope!) require a sufficient financial cushion to repay and avoid default. With an HECM or other reverse mortgage, you are not paying the loan back out of your regular income because it will come out of your house equity. However, the borrower/homeowner is still responsible for property taxes, maintenance, etc., so there is still a need to consider your overall financial situation.

Third, researchers are still trying to figure out why so few people have taken HECMs to date. It's hard to pin down exactly, but our best guess is that much of the problem is the psychology of not leaving the family house to your heirs. If the value of the house is large enough to pay off the HECM with money left over, there will be a contribution to the estate, but of course the heirs will see less of this equity after the HECM is paid off. But in the end, it seems that many households see the decision to take an HECM as something more complicated than a simple net present value calculation. Research by economists such as Tom Davidoff and Irina Telyukova, among others, suggest these considerations are part of the story behind the low takeup rate so far. But we have much to learn about this, quite frankly.

Fourth, once someone decides to take out a reverse mortgage, there are other important decisions to make -- for example, whether to take all the money at once or to take the money in some schedule of payments (i.e., to turn your house into an annuity). It surprises many economists that most people who take HECMs take all the cash upfront. Economists love the idea of annuities, but normal people apparently love them a lot less!

Katie Doyle, managing editor at Bankrate.com, contributed the questions for this interview.