Jack M. Guttentag (www.mtgprofessor.com) is Professor of Finance Emeritus, formerly Jacob Safra Professor of International Banking, at the Wharton School of the University of Pennsylvania.
The Home Equity Conversion Mortgage (HECM) product is an ingenious instrument that has no counterpart anywhere in the world. Developed by the US Department of Housing and Urban Development (HUD), the program provides homeowners several ways to draw spendable funds by borrowing from the equity in their homes, without the need to move out. The specific vehicle is a reverse mortgage which permits homeowners to borrow money using their home equity as security, with no repayment obligation so long as they live in it. Moreover, HECM lenders are insured by the Federal Housing Administration, protecting the lender if the borrower should be unable to pay taxes and insurance costs.
Nevertheless, the HECM reverse mortgage program has attracted only a tiny sliver of the potential market. Roughly 6,000 US homeowners turn age 62 every day, but fewer than 150 of them take out HECMs. Potential borrowers are often deterred by fears about product complexity, as well as by negative publicity, sometimes from the regulators themselves. Helping people remain in their homes in later life can particularly important, since the majority of older Americans wishes to remain in their homes in their later years.
Reason for dysfunction
There are two ways that homeowners can access the funds from their HECM product. One is to exercise the credit line option and draw the maximum amount permitted. The second, and in our view, method that is more consistent with retirement planning, is to receive a fixed annuity payment for as long as he or she remains in the house. It should be noted that the second option is also valuable in that the federal government insures the benefit payment.
Nevertheless, most HECM borrowers tend to take large cash withdrawals early on, instead of converting the equity to a lifetime annuity. This results in many homeowners withdrawing maximum cash in the first year, while leaving them nothing to cushion rising tax and insurance payments in later years. In our view, it would be preferable for HUD to encourage homeowners to integrate a reverse mortgage with an annuity, to minimize borrower defaults.
Yet HUD-approved counselors, with whom potential borrowers must consult before submitting a loan application, are instructed by HUD to warn borrowers to beware of annuities. For instance, on HUD’s website, the following advice is provided: the counselor must “explain that in some cases, fixed monthly annuity advances that continue for life may be smaller than the fixed monthly loan advances from a reverse mortgage that continue for as long as the client lives in his/her home.” This is likely to mislead borrowers, in that the payments on a combination HECM/annuity, assuming competitive terms on both, will exceed the payments on a HECM tenure option, and the combo payment runs for life rather than for the period of home occupancy.
I recently examined the websites of 24 HECM lenders including all the largest ones to see what information they provided on various HECM withdrawal options. Five of the 24 provided information on of cash draw amounts, three provided information on credit lines, and none provided information on monthly payment options.
Why the HECM market is dysfunctional
The HECM reverse mortgage is by far the most complex financial instrument that homeowners are likely to encounter in their lifetimes, and some must deal with it after they are beyond their intellectual prime. Trying to shop HECMs on-line can also be an exercise in futility, because lenders (with exceptions noted below) tend not to provide all of the information a potential borrower needs to compare one offer with another.
An exception: HECM lenders who “dare to compare”
There is an exception, however, consisting of six lenders who “dare to compare” their terms with others. These are All Reverse, Goodlife Home Loans, Longbridge Financial, Mid America Mortgage, Mutual of Omaha Mortgage, and Signet Mortgage. These lenders report their loan terms on two of my websites (www.mtgprofessor.com and www.kosher-reverse-mortgage.com).
The information these lenders provide to my sites contrasts sharply with industry practice:
- Shoppers need not identify themselves until they have made a selection from among the six lenders.
- All six lenders provide rate/points/amounts for all the withdrawal options available.
- Shoppers can identify which direct-to-customer lender offers the best terms on the specific HECM features that best meet their needs.
This is important information for elderly homeowners, since my comparison of potential spending offered by 10 insurers and 11 reverse mortgage lenders in 2020 showed that the best option paid out 15% more per year, for life, compared to the worst option. This could make a substantial difference in retirees’ consumption.
A better approach
A better approach would help homeowners integrate a reverse mortgage into a well-rounded retirement plan, which would include financial asset management and annuities. Such a plan could include a life annuity with rising payments over time, helping HECM borrowers meet their spending obligations.
To enlarge the availability of spendable funds for homeowners with limited financial assets, as well as to reduce the number of borrowers ending up in a financially fragile state, it would be helpful for policy to avoid discouraging annuities and, instead, to encourage them. Ideally, the consumer would be provided HECM/annuity combinations with demonstrably competitive terms on the withdrawal options available. This is now easy to do, as there are third-party databases revealing annuity payments per dollar, by many insurers.
Revisiting this important financial product could increase market size by at least ten times.
Views of our Guest Bloggers are theirs alone, and not of the Pension Research Council, the Wharton School, or the University of Pennsylvania.