Ebook Reverse Mortgages: A Closer Look at HECM Loans
One of the most important questions facing researchers and policy makers is whether Americans are saving enough for retirement. The answer to this question depends crucially on how housing wealth should be treated are elderly homeowners willing and able to consume their housing equity in retirement? Housing wealth is often the largest non-pension wealth component for many elderly homeowners.
For example, the 2004 Survey of Consumer Finances (SCF) data suggest that for 27.8% of homeowners aged 62 or above, housing wealth represents at least 80% of their total wealth. In addition, 13.3% of homeowners aged 62 or above have a house-value-to-income ratio of at least 10. Economists believe that reverse mortgages have the potential to increase consumption of house-rich but cash-poor elderly homeowners while allowing them to continue living in their homes.
Reverse mortgages are a financial product that is similar to home equity loans except that the borrower does not pay back the loan until she dies or permanently moves out of the house. They were first introduced about 20 years ago. The most common type of reverse mortgage loans is the Home Equity Conversion Mortgage (HECM), insured by the Federal Housing Administration (FHA) and constituting over 90% of all reverse mortgage loans originated in the U.S. market. Despite its economic appeal, using reverse mortgages to finance consumption after retirement has been the exception rather than the rule among elderly homeowners. From its inception in 1989 to the end of 2007, out of tens of millions of eligible homeowners, only about 400,000 loans have been originated through the HECM program.
A number of factors have been suggested in explaining the small size of the reverse mortgage market, including but not limited to high costs, regulatory and legal barriers, moral hazard and adverse selection, financial awareness and literacy, perception of housing equity as a safety net for large medical expenses, bequest motives, and the difficulties associated with reverse mortgage securitization. Unfortunately, we have little evidence on to what extent each of these factors has prevented reverse mortgages from being more dominant among eligible homeowners.
On the other hand, the reverse mortgage market in recent years has experienced significant growth. In the early 1990s, only a few hundred HECM loans were originated each year. In contrast, over 100,000 reverse mortgage loans were originated through the HECM program in 2007 alone. Is the rapid growth due to higher house values, lower interest rate, increasing awareness of the product, or something else? Is the expansion transitory or will the trend continue in the coming years? Addressing these questions is not only essential to understanding of elderly homeowners’ desire to consume housing wealth, but also provides supporting evidence for regulators to conduct cost-benefit analysis and to design more efficient policies.
In this paper, we examine all HECM loans that were originated between 1989 and 2007. The first part of the paper presents descriptive analysis of these HECM loans, focusing on showing the differences between borrowers and non-borrowers and between early borrowers and recent borrowers. The second part illustrates the effect of termination and housing price risks on the FHA insurance program using numerical simulations. Such a analysis is a key step toward understanding who reverse mortgage borrowers are and how various macroeconomic factors such as housing prices and termination rates may impact the reverse mortgage market and the profitability of the FHA insurance program. In addition, current policy makers are concerned that the premium charged to insure HECM loans are excessive. The well publicized Housing and Economic Recovery Act of 2008 will reduce such insurance premium for HECM borrowers. Our results will offer insight on how the reduction may impact the long-term viability of the HECM program.
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