Editor’s note: This feature originally appeared in the January issue of DS News, out now.
In 1961, Deering Savings & Loan officer Nelson Haynes in Portland, Maine, originated the first reverse mortgage to Nellie Young, the widowed wife of Haynes’s high school football coach. Mrs. Young continued to live in her home after losing her husband with the help of this loan.
In 1969, UCLA Professor Yung Ping Chen testified before the Senate Committee on Aging that he supported an “actuarial mortgage plan in the form of a housing annuity” that would allow homeowners to stay in their home based upon their home equity.
In 1983, the Senate approved a proposal to have reverse mortgages insured by the Federal Housing Administration (FHA), and in 1987, Congress passed the FHA insurance bill called the Home Equity Conversion Mortgage Demonstration. President Ronal Reagan signed the bill into law in 1988, and HUD began insuring reverse mortgage through FHA.
The first FHA-insured reverse mortgage was originated in 1989, and 157 loans were issued in 1990, with a peak of 114,692 in 2009. According to HUD, 48,359 reverse mortgages were originated in 2018, the decrease attributable to the market crash 10 years earlier.
Other countries use reverse mortgages, which are being touted as a policy strategy for aging population not prepared for retirement. In Canada, where the industry is entirely private, reverse mortgages grew 40% between 2017 and 2018. The Australian government began a government-sponsored equity release program in 2018 for homeowners over the age of 65, which may continue to expand as private lenders leave the reverse market. China—which has 241 million people over the age of 60 as of December, 2017, amounting to 17% of that country’s population—began promoting reverse mortgages in 2013, though there is only one company offering them, and only 132 people have taken out the mortgages to date. The Chinese people typically leave property to their children, so there is a cultural prejudice against reverse mortgages.
A review of the reverse mortgage starts with its definition, and then how it works, who qualifies for one, its protections, and the risk involved with a reverse mortgage. The analysis is based on the Home Equity Conversion Mortgage (HECM) program reverse mortgage, which is insured under the Federal Housing Administration (FHA) and accounts for all but a handful of reverse mortgages.
The stated purpose of the HECM program, FHA’s reverse mortgage program, is to ease the financial burden on elderly homeowners facing increased health, housing, and subsistence costs at a time of reduced income. The FHA’s mission is to serve underserved markets which must be balanced with U.S. Department of Housing and Urban Development’s (HUD) obligation under the National Housing Act to protect the FHA insurance funds.
Pursuant to 15 USCS §1602(cc), “the term ‘reverse mortgage transaction’ means a non-recourse transaction in which a mortgage, deed of trust, or equivalent consensual security interest is created against the consumer’s principal dwelling:
- securing one or more advances; and
- with respect to which the payment of any principal, interest, and shared appreciation or equity is due and payable (other than in the case of default) only after:
- the transfer of the dwelling;
- the consumer ceases to occupy the dwelling as a principal dwelling; or
- the death of the consumer.
The concept of a reverse mortgage can be more easily understood by starting with a traditional mortgage, where the borrower’s home equity increases and the loan balance deceases over time as the borrower makes payments to the lender. With a reverse mortgage, borrowers’ home equity decreases and the loan balance increases over time as borrowers receive cash payments from the lender and interest accrues on the loan. Reverse mortgage functions as a means for elderly homeowners to receive funds based on their home equity, because repayment can usually be deferred until death. As well, reverse mortgages are generally non-recourse loans, meaning that if a borrower fails to repay the loan when due, the lender has no recourse outside of the sale of the home.
Through the Housing and Recovery Act of 2008, Congress raised the loan limit to $417,000 for a reverse mortgage, and then in 2009, through the American Recovery and Reinvestment Act, Congress raised the loan limit to $625,500. The limit was raised again by FHA in 2018 to $675,650, then to $726,525 in 2019, with an increase up to $765,600 coming in 2020.
The FHA insures HECM program reverse mortgagors, and this insurance provides protection for both borrowers and lenders. Borrowers pay a mortgage insurance premium for this protection, but in return, borrowers may remain in the home indefinitely, even if the loan balance becomes greater than the value of the home, so long as the borrower meets certain conditions (age: at least 62 years old; ownership of property; principal residence of borrower; no existing mortgages; and property standards must be met). Further, FHA protects the borrower against the risk that the lender does not make the “loan disbursements.” This mortgage insurance premium also protects the lender in that it provides the lender its amount due, and continues to pay the borrower (on a monthly plan or from any unused credit line) until the borrower dies or sells the home, if the lender follows an assignment option created from the FHA insuring process.
FHA Commissioner Brian Montgomery advocates for continued support and growth of the HECM program. In July, 2018, approximately a month after his confirmation, Montgomery noted that the HECM portfolio sustained a $14.5 billion loss in 2017 but that the program itself is valuable as long as corrections are made. “I have been a strong advocate of the reverse mortgage program,” he said, noting the lack of government assistance for senior homeowners who face income challenges. “This program allows seniors to age in place, which they want to do. It’s the best kind of program [in that it offers] assistance you pay for yourself … It’s up to us to fix it for the long term.”
Program changes over the past few years have made the mortgages less risky for borrowers and for the government. Mortgage insurance premiums have been adjusted to provide more lender/insurer protection as well as preserving more equity for borrowers (higher upfront premium offset by lower annual premiums); assessable equity amounts are limited for the first year of the loan; and as of 2015, HUD requires a financial assessment to analyze potential borrowers’ income sources and credit history, to ensure that borrowers have set-aside funds to pay property taxes and homeowners insurance.
If the borrower meets the above requirements for a reverse mortgage, then the borrower would continue to have three primary ongoing obligations: 1) the borrower must continue to occupy the property as a principal residence; 2) the borrower must remain current on all property taxes and homeowner’s insurance. If the borrower fails to pay property taxes or maintain current homeowner’s insurance, and fails to bring these accounts current when notified, the lender can foreclose and the borrower could lose their home; and 3) the borrower must keep the home in good repair. As long as the borrower complies with these ongoing obligations, the borrower will be able to defer payment of the loan until they die, sell, or move out of the home.
As well-meaning as this sounds, reverse mortgages cost more than regular mortgages, both at closing and during the life of the loan. With both types of loans, borrowers pay mortgage insurance, but with a regular mortgage, borrowers can avoid mortgage insurance with a down payment of at least 20%, but not with a reverse.
The reverse mortgage premium equals 0.5% for a loan equal to 60% or less of the appraised value of the home. The premium jumps to 2.5% if the loan totals more than 60% of the home's value. If a home is appraised at $450,000 and a $300,000 reverse mortgage is taken out, it will cost you an additional $7,500 on top of all of the other closing costs. Annual mortgage insurance premium is .5% of the outstanding mortgage balance.
Most of the fees and costs can be rolled into the loan, but unlike a regular mortgage, which compounds interest on a lower amount each month, a reverse mortgage compounds interest on a higher number.
Despite the promotion of reverse mortgages to address the lack of retirement assets held by an aging population, less than 2% of eligible households take out reverse mortgages, which is small given that nearly 80% of retired households own a home, compared to only about 50% with retirement assets, and given that retirement security for many households is considered to be precarious. Several factors could positively influence growth, namely, aging population not just in the United States but throughout the world (approximately 18% of U.S. population is over 62 years old); housing wealth continues to increase; and retirees prefer to age in place. Other factors negate growth, such as complexity and cost of reverse mortgages; a perception that reverse mortgages are a last resort; and the desire to leave an inheritance.
Suggested improvements for the program include lowering initial and ongoing HECM product costs, expansion of private lenders, improvement of the availability of long-term care insurance, and tightening of Medicaid eligibility rule. These changes could increase HECM loans to approximately 12–14 % of all retired households, which would minimize government exposure and better target borrowers.