Reverse Mortgages—the Next Hot Spot?
A reverse mortgage is a special type of home loan that allows eligible homeowners to convert a portion of their home's equity into cash. Despite recent troubles in the national mortgage market, reverse mortgages are growing at a rapid rate. Expansion of this hot spot in mortgage lending is expected to continue with increasingly flexible products, new sources of capital and a growing supply of potential borrowers. As the reverse mortgage market develops, it is important that potential borrowers are educated about this complex product to protect them from taking out unsuitable loans.
Reverse mortgages are characterized by the payment flow: Rather than making mortgage payments, the borrower receives cash from the lender. A reverse mortgage enables senior citizens to borrow against their home equity to create a tax-free source of income while they continue living in their home. Borrowers have no monthly repayment obligation until the home is no longer their primary residence.
According to the National Council on Aging, the development of the reverse mortgage is an important tool for seniors intending to live at home as they grow older, also known as "aging in place." These loans can provide seniors with vital income for home maintenance, taxes and health care. Some older adults use reverse mortgages for indulgences such as a second car, family gifts or lavish vacations.
The American Association for Retired Persons also supports reverse mortgages as a valid financial option, but urges borrowers to carefully consider whether the reverse mortgage is the correct product to meet their needs. To that end, borrowers should determine whether there are less costly options to access needed cash, make a long-term plan for managing assets, and develop a clear understanding of the reverse mortgage product.
The Reverse Mortgage Explained
The reverse mortgage market is dominated by the Home Equity Conversion Mortgage (HECM), a product administered by the Department of Housing and Urban Development (HUD) and insured by HUD's Federal Housing Administration (FHA). HECM loans are originated by private lenders and purchased by Fannie Mae. With 90 percent of the reverse mortgage share, HECM has led this market since becoming active in 1989. In 1995, Fannie Mae introduced the initial HECM competitor with a proprietary product known as the Home Keeper Mortgage.
HECM and Home Keeper share characteristics that have defined the reverse mortgage market to date. Both products require borrowers to be at least 62 years old and have a substantial amount of equity in their principal residence. Each product uses a formula to determine the maximum amount of principal a homeowner can borrow. Neither product supports "jumbo loans," loans that exceed $417,000.
Borrowers can draw down payments in monthly installments, lump sums, lines of credit or a combination of these options.
HECM and Home Keeper are adjustable rate mortgages. Fees for these products include closing costs, a monthly servicing fee and, for HECM, an insurance fee. For both products, the loan principal increases with each payment, as interest and other charges accrued are rolled into the total funds advanced to the borrower.
Borrowers are not required to repay a reverse mortgage until a "maturity" event, namely the death of the borrower, sale of the property or violation of the mortgage agreement. Although borrowers are not required to make payments until they no longer inhabit the home, they are required to maintain the property, pay property taxes and pay the home insurance.
Borrowers and lenders are protected from payment risk with both HECM and Home Keeper loans. HECM loans carry FHA insurance that ensures that the borrowers will receive all payments due and the lender will receive full repayment of the loan balance. Fannie Mae guarantees Home Keeper loans.
Despite the dominance of HECM, proprietary products have been entering the reverse mortgage market. In 1999, Financial Freedom Senior Funding Corp., a subsidiary of IndyMac Bank of F.S.B, introduced the first private-sector reverse mortgage, known as the Cash Account.
The onset of new products is bringing more consumer options, including lower age requirements; greater principal amounts, including jumbo reverse mortgages; more flexible rate structures, including fixed rates; and lower fees. However, the majority of new products do not include mortgage insurance.
Growth in the Market
The introduction of reverse mortgages was marked by a period of very slow growth from 1990 to 2002, followed by exponential growth in recent years. Reverse mortgages represent only 1 percent of the overall mortgage-lending market, but these loans are expected to expand by as much as tenfold in the next 20 years. According to HUD, since 1990, senior citizens have taken out more than 308,000 HECMs, which represent nearly 90 percent of the reverse mortgage market. And, between 2000 and 2006 alone, there has been a tenfold increase in the number of HECMs.
More recently, bigger players in the mortgage market have gained interest in reverse mortgages. As a result, the latest growth in the reverse mortgage market has occurred across products, with new proprietary products slowly pilfering market share from the established HECM market. Overall, approximately 90,000 reverse mortgages, totaling $10 billion in loans, were originated in 2006, doubling the number from 2005.
Interest in reverse mortgages continues to grow by both lenders and consumers. As noted, the reverse mortgage can enable older adults to "age in place" on a fixed income. As the industry grows, consumer interest will potentially be driven by the increase in product options, including jumbo loans, fixed rates and more flexible eligibility options. Furthermore, the growing number of reverse mortgage lenders has brought increased competition to the industry, which is resulting in lower pricing and additional product innovation.
Consumer growth in the reverse mortgage market is expected to continue rapidly due to national demographic changes. Today, there is already an estimated $4.3 trillion in home equity held by Americans age 62 and over. As baby boomers quickly become age-eligible, this number will increase dramatically.
Lenders' interest in the reverse mortgage market also is increasing as additional capital becomes available from the development of a secondary market. An established secondary market for reverse mortgages would provide increased liquidity and could broaden the lender distribution channels and expand the investor base. Securitizing these products is complicated, but the market is slowly adopting techniques to do so.
In 2006, the Lehman Brothers issued the first HECM-backed securities to investors. Later that same year, Ginnie Mae announced that the organization is in the process of creating a HECM securitization program. With its new program, Ginnie Mae intends to deepen the availability of HECM lending, create a broader secondary market for HECM loans, reduce the costs to borrowers and broaden options available to lenders and homeÂowners. Private investors are anticipated to be players in the reverse mortgage securitization market in the near future.
Reverse mortgages are a new and complicated financial product that are being offered at an increasing rate to the nation's seniors. With a growing number of products offering a variety of rate structures and features, it is increasingly difficult for borrowers to determine which reverse mortgage, if any, is a suitable financial option. Furthermore, most people lack familiarity with the reverse mortgage market, leaving eligible borrowers exposed to loans that they might not understand or that might not be appropriate for their needs.
Accordingly, it is critical that potential borrowers of reverse mortgages get adequate information and, preferably, counseling. To take out a HECM or a Home Keeper loan, borrowers are required to complete HUD-certified counseling. However, with private products that do not require counseling, consumers are increasingly left on their own to determine product suitability.
Government and industry efforts to increase quality counseling options have faced some challenges.
First, the quality of the reverse mortgage counseling available appears to vary greatly. HUD-certified counselors and their counterparts face different standards for counseling. HUD-approved agencies are, at a minimum, required to focus on product suitability for the borrower and the possible alternatives. But even within this certified circle, there is still a great deal of variety, as counseling may be offered by video, telephone or in person, and sessions may range from 10 minutes to two hours.
Second, counseling has been a troublesome issue from time to time due to a lack of available counselors in some locations, particularly those areas with an increased volume of reverse mortgages. Currently, the need to train counselors who specialize in reverse mortgages is competing with the national surge in training for foreclosure counseling.
Third, anecdotal evidence suggests that there is an increase in predatory lending practices around reverse mortgages. As a result, counselors must be even more equipped to educate borrowers regarding mass marketing for high-cost products, sales pressures and general financial planning.
One practice that has raised particular concern is a tactic to advise reverse mortgage borrowers to bundle their loan with a second financial product, such as an annuity or insurance. Because of the high cost of reverse mortgages, using this product to purchase annuities or insurance is almost always financially unsound.
Despite the risks, reverse mortgages offer consumers an increasingly important option for accessing additional cash as they age. Sound information can inform borrowers whether a reverse mortgage is a suitable product for them.
Bridges is a regular review of regional community and economic development issues. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.
All other community development questions