Reverse mortgages can be a powerful financial tool in retirement — especially as more Americans age in place. But the product’s design today isn’t meeting many borrowers’ needs.

By design, reverse mortgages are meant to make retirement easier — and keep people in their homes.

Nelson Haynes, who worked at Deering Savings & Loan in Portland, Maine, is traditionally credited with creating the first reverse mortgage back in 1961. He wanted to help the widowed wife of his high school football coach stay in her home after her husband died.

In that era, “people observed that there were a lot of windows,” said Martin Neil Baily, a senior fellow in economic studies at Brookings and the former chairman of the Council of Economic Advisers under President Clinton.

“It was a time when a lot of men had pensions, and when the man died, the pension died as well. So these were women that didn’t have anything much to live on, but maybe they were living in a house that was quite valuable,” Baily said.

Reverse mortgages allow homeowners to tap into one of their largest financial assets (their home) and to forgo the monthly payments associated with a typical mortgage. Yet adoption has always remained limited.

In the 1990s, only a few hundred reverse mortgages were originated on an annual basis. By 2009, there were nearly 115,000 home-equity conversion mortgages (HECMs), as the federally-insured reverse mortgage is called, originated that year. That’s when the reverse-mortgage market hit its peak, said Stephanie Moulton, an associate professor at Ohio State University who specializes in housing and consumer finance policies.

“HECM volume has never been large — never more than 2% of eligible older homeowners,” Moulton said.

as a time when a lot of men had pensions, and when the man died, the pension died as well. So these were women that didn’t have anything much to live on, but maybe they were living in a house that was quite valuable,” Baily said.

Reverse mortgages allow homeowners to tap into one of their largest financial assets (their home) and to forgo the monthly payments associated with a typical mortgage. Yet adoption has always remained limited.

In the 1990s, only a few hundred reverse mortgages were originated on an annual basis. By 2009, there were nearly 115,000 home-equity conversion mortgages (HECMs), as the federally-insured reverse mortgage is called, originated that year. That’s when the reverse-mortgage market hit its peak, said Stephanie Moulton, an associate professor at Ohio State University who specializes in housing and consumer finance policies.

“HECM volume has never been large — never more than 2% of eligible older homeowners,” Moulton said.

Reverse-mortgage proponents say it could serve a valuable role in retirement planning if it were retooled to fit the needs of more consumers. Among the suggestions are products designed to address specific needs in retirement, whether that be paying down other debts or funding the cost of assisted living.

How reverse mortgages work in the U.S. today

With the more common forward mortgage, a bank loans a borrower a sum of money that they must repay in monthly installments over a set period of time, such as 30 years.

But with reverse mortgages there are no monthly payments. Instead, the borrower can draw on the equity in their home like a line of credit. The loan comes due either when the borrower dies or moves out of the home. Often, the home is sold and the proceeds go toward paying off the loan.

In the U.S., reverse mortgages are exclusively available to people over the age of 62. Homeowners often refinance into a reverse mortgage, but eligible seniors may also use a reverse mortgage to fund the purchase of a home.

As with a typical mortgage, someone who takes out a reverse mortgage must pay origination fees, mortgage insurance and other closing costs. The loans still carry interest, though unlike your usual forward mortgage the rates on reverse mortgages tend to be variable. Also, reverse mortgage borrowers must continue to make their periodic property tax and home insurance payments to stay current.

Hong Kong as a guide for innovation

America has the oldest and largest reverse-mortgage market in the world, but many other countries have introduced these loans or similar financial products to enable retirees to utilize their home equity later in life. Some of these countries have taken different approaches to these loans in terms of regulations and how the product is marketed, which could serve as a model for how the U.S. could transform reverse mortgages.

In Hong Kong, reverse mortgages are a fairly new product compared with many other countries. The Hong Kong Mortgage Corporation, a government-owned entity that provides insurers to private lenders and securitizes loans similar to Fannie Mae and Freddie Mac, launched a pilot program for the loan product in July 2011. But despite reverse mortgages having been on the market for less than a decade, the corporation has already toyed with innovation to allow the product to better suit seniors’ needs.

In 2019, HKMC reworked the rules surrounding the product so that reverse-mortgage borrowers no longer had to live in the property backing the mortgage. That would make it so elderly individuals could take out a reverse mortgage to finance their retirement but opt to move in with family or into a nursing home or assisted-living facility.

What’s more, in Hong Kong, these borrowers can also request approval to lease out the home that is backed by the reverse mortgage, providing them with another source of funds. “Rental income in addition to the monthly and lump-sum payouts of the [reverse-mortgage] loans allow borrowers to enjoy more financial security in planning their retirement,” an HKMC spokesperson told MarketWatch in an email. As of December 2020, the corporation has approved 16 applications for renting out properties backed by a reverse mortgage.

Such a model could provide much-needed flexibility to households in retirement. Plans can change — and when they do, having a reverse mortgage can become a hindrance.

Here in the U.S., as in most countries, people with reverse mortgages are required to live in the homes backing the loan. Today, most defaults on reverse mortgages happen because the borrower moved out of the house without paying off the loan, Baily said.

“For those that are in nursing homes, their financial needs are higher than ever before,” said Peter Knaack, a policy consultant at the World Bank who co-wrote a paper on the use of reverse mortgages around the world. “The last thing they want to worry about is the house.”

The extra source of income from renting out the home can also assuage the concerns many reverse mortgage holders have about the inheritance they leave behind. Donald Haurin, a professor emeritus at Ohio State University who has performed numerous studies about the reverse mortgage market, said that one survey he and his colleagues conducted “indicated that a lot of people want to bequeath their house to their kids. They didn’t want to take out a mortgage on their house because they were worried about the implications for the bequests later on,” Haurin said. In a scenario where the property is rented out, those funds could be stashed away to pay off the loan upon a parent’s death.

Why aren’t reverse mortgages more popular?

Between 2011 and 2018, participation in the Federal Housing Administration’s Home Equity Conversion Mortgage (HECM) program actually dropped from over 73,000 loans to just 33,000 mortgages originated.

“Although volumes dipped after the recession of 2008 to 2009, they have remained steady over the past five years and last year increased 25% from 2019,” said Steve Irwin, president of the National Reverse Mortgage Lenders Association. 

In 2020, the number of federally-insured reverse mortgage loans originated was the lowest since 2003, but the dollar-volume of new reverse mortgage originations grew because of the emergence of private-label loans.

These days, seniors have more equity in their homes than ever before. Home prices have rebounded — and then some — from the declines that occurred following the housing crisis. As of the second quarter of 2021, homeowners ages 62 and older had accrued more than $7.82 trillion in home equity, according to the most recent data released by the National Reverse Mortgage Lenders Association.

So why aren’t more people getting reverse mortgages to take advantage of all that equity? To some extent, it stems from a lack of understanding about what having a reverse mortgage entails.

“There have been misperceptions about the way the product works — we all continually need to educate about these misperceptions,” Irwin said. Among the more common misperceptions surrounding reverse mortgages is that the bank owns the title of the house or that they’re only loans of last resort.

Plus, much like in the traditional mortgage market, a wave of foreclosures hit the nation’s retirees. A report from the U.S. Government Accountability Office found that between 2014 and 2018 borrower defaults on reverse mortgages increased from 2% to 18%. The falling volume of new reverse mortgages could be an indication that news coverage of past foreclosures may have dinged the product’s popularity, even though lawmakers and regulators have put safeguards in place in recent years to protect consumers, in the wake of the foreclosure surge that hit seniors.

But there’s also evidence to suggest that reverse mortgages, by design, aren’t meeting retirees’ needs as well as they could. One of the biggest barriers preventing more Americans from taking out a reverse mortgage is the fact that they’re already saddled with a ton of debt.

A couple of decades ago, around 20% of Americans over age 65 had a mortgage, but today that figure is over 40%. Consequently, it’s not surprising that paying off existing mortgage debt is one of the main motivating factors for many seniors in choosing to get a reverse mortgage.

“It’s equivalent to raising their disposable income by whatever their mortgage payment was,” Haurin said. “That’s presumably a significant help for a lot of people.”

But one of the primary reasons why people get denied for reverse mortgages is because they have too much housing debt already. The reverse mortgage must be the primary mortgage on a property, so for a homeowner who already has a standard home loan the reverse mortgage must pay that off entirely.

But the FHA now limits how much equity a borrower can take out of their home with an HECM to just 58%. As a result, for many seniors their existing mortgage debt can be prohibitive.

“It’s this Catch-22 of I’m carrying more mortgage debt into retirement, but carrying more mortgage debt into retirement actually makes it harder for me to get something like a reverse mortgage,” Moulton said.

Conversion-style loans could fill in the gaps

One mortgage lender is rolling out a hybrid loan product that it believes could be the solution for many retirees when it comes to the debt they carry into retirement.

Finance of America Reverse, one of the largest lenders that specializes in reverse mortgages, last week unveiled a new “retirement mortgage” product called EquityAvail. It functions as a hybrid between a traditional forward mortgage and a reverse mortgage.

With EquityAvail, homeowners refinance into a mortgage that cashes out a lump sum right at the start. For the first 10 years they have the loan, they must make monthly payments, albeit at a reduced amount compared with other traditional mortgages. After those 10 years, they are no longer required to make monthly mortgage payments, as with a typical reverse mortgage. (Also, like with a standard reverse mortgage, borrowers must continue to pay their taxes and insurance.)

Finance of America Reverse President Kristen Sieffert says the company’s new product is meant to fill a gap in the market. “A reverse mortgage oftentimes doesn’t provide enough proceeds, and a forward mortgage really isn’t the best product for a borrower even if they can qualify for it today,” she said.

The product also represents an “elegant solution” to some of the other challenges involved in getting a reverse mortgage, Sieffert argued, particularly for people who are older and may not readily have access to all the paperwork and documents needed to qualify.

“Getting the reverse mortgages is a hard process for a lot of borrowers,” Sieffert said, but with EquityAvail “you do everything all at the beginning, and then the loan just ages with you.”

Researchers Haurin and Moulton recently co-wrote a study calling for lenders to explore forward-to-reverse conversion mortgages like EquityAvail — products that they compared with an annuity.

They argued that a conversion product could entice traditional lenders to enter the reverse-mortgage market. In the past, major lenders like Wells Fargo and Bank of America exited the reverse-mortgage business as the federal government ramped up regulation.

If borrowers were to encounter more household names when shopping for reverse mortgages, they might feel less anxious about taking out such a loan. And because a borrower would be working with one lender throughout the life of their loan, the product could be easier to understand. They would be educated about the product before they enter retirement, and it would remove the need to deal with multiple companies.

“Right now in order to get a reverse mortgage, you can’t go to your bank — most banks aren’t selling reverse mortgages,” Moulton said. “You actually have to go to an obscure broker that you haven’t heard of before or have only seen commercials on TV — they’re not being marketed alongside other products that seniors might be thinking about.”

But the challenges Finance of America Reverse has faced in launching its new product demonstrate the hurdles lenders will face if they attempt to innovate. Because EquityAvail encompasses elements of both forward and reverse mortgages, the company must follow regulations that apply to both types of mortgages. Finance of America Reverse even had conversations with the Consumer Financial Protection Bureau, Sieffert said, to discuss the new product and familiarize regulators with how it worked.

Another issue: The software that most mortgage lenders use is either designed for traditional loans or reverse mortgages — not both. “There is no system out there besides the one that we happened to use that does reverse and forward mortgages,” Sieffert said. “So it’s just really difficult to build a product from scratch in an engine that doesn’t support both rules.”

The failed rollout of small-dollar reverse mortgages shows how timing is key.

Aside from paying off an existing mortgage, seniors commonly take out reverse mortgages to pay for discrete, sometimes one-off expenses, researchers say. They’re trying to pay off a credit card, cover an unexpected medical expense or upgrade their home.

“If there’s just a targeted, project specific need, like home improvement for aging in place, the full available lending amount isn’t wanted or needed,” Irwin said, noting that he’s a major proponent of a small-dollar product.

In late 2010, the FHA rolled out a trial version of a small-dollar reverse loan, called the HECM Saver, to meet that demand. But take-up fell short of expectations, and the product was rolled into the standard HECM program by 2013. “That was being marketed at a time when we had all of these other problems in the reverse mortgage industry and so it’s not clear it was a real test of whether there’s demand for that kind of a product,” Moulton said.

Researchers argue that small-dollar reverse loans still hold promise. A small-dollar reverse mortgage would function similarly to a home-equity line of credit in being geared toward these expenses. Much like with the forward-to-reverse conversion product, a small-dollar reverse mortgage would be less risky for lenders. Rather than originating a loan with a balance of $300,000, for instance, they could offer $20,000 or $40,000 loans.

Because of the smaller lending amount, these loans would require a smaller mortgage insurance premium, Irwin said, reducing the costs associated with the loans for borrowers. These loans could also provide a lifeline to people with high debt balances who might not have enough in terms of other sources of retirement income to qualify for a standard reverse mortgage.

“It’s hard to see what the downside of this would be — the only thing that could happen is nobody uses it, but that’s not a problem,” Haurin said.

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