Fixing The Dysfunctional HECM Reverse Mortgage Market
More seniors should be funding their retirement years by drawing funds from their home equity through reverse mortgages under the U.S.-insured Home Equity Conversion Mortgage (HECM) program offered by the Department of Housing and Urban Development. But not enough homeowners do it because of a dysfunctional HECM market, as well as fear, ignorance and distrust of reverse mortgages that make seniors stay away, according to Jack Guttentag, Wharton professor of finance emeritus and founder of the consumer-oriented mortgage website, The Mortgage Professor. His site has information on HECMs and includes HECM prices submitted by seven reverse mortgage lenders with whom he has a business relationship. The site also has an HECM calculator designed to optimize borrower choices.
In this opinion piece, he proposes solutions to make the HECM market a true shoppers’ haven that will be attractive to seniors, replacing the current ‘gotcha’ market where prospective borrowers face formidable obstacles if they want to look beyond the first loan provider that gets their attention. In a true shoppers’ market, lenders compete and borrowers have choices.
HECM Reverse Mortgage
HECM reverse mortgage – The HECM Program
HECM reverse mortgages provide seniors 62 and older with multiple ways to convert their home equity into spendable funds to meet a variety of needs while they remain in their homes. Under the program, borrowers are fully protected against the small print abuses that have arisen in some private programs, and investors who fund HECM reverse mortgages are insured against loss by the Federal Housing Administration.
Here are the major ways in which seniors can draw funds:
- Seniors who still have a mortgage balance on their home when they retire can convert the mortgage into an HECM reverse mortgage that has no required payments.
- Seniors with equity remaining in their home can draw cash at closing with a fixed rate, or a larger amount over a year with an adjustable rate, to be used for any purpose.
- Seniors who face a drop in income on retirement can supplement their income by drawing a “tenure” monthly payment that lasts as long as they reside in their house.
- Seniors who want to purchase a house for any reason can finance the purchase partially with an HECM reverse mortgage, reducing the assets that must be liquidated for that purpose.
- Seniors who intend to finance their retirement years by drawing down accumulated assets can hedge the risk that their money will run out because they live too long — they can take an HECM-based credit line, which grows continually so long as it is not used.
- Seniors with retirement income from variable sources can use an HECM credit line to stabilize their income, drawing on it when other income sources drop, and repaying it when other sources increase.
- Seniors who need to supplement their income for a limited period, while they wait for social security to kick in or for any other reason, can draw a “term” monthly payment for a specified period.
The need for the HECM program is large and growing. At the end of 2015, there were about 24 million homeowners aged 65 and over, with the number growing by about a million each year. The Center for Retirement Research at Boston College estimates that more than half of them “may be unable to maintain their standard of living in retirement.”
Yet HECMs have barely dented the problem. Fewer than a million reverse mortgages have been written since the HECM program began in 1987, and the current annual rate is only about 60,000. Why is this?
Some senior owners don’t need them, of course, and others attach high importance to leaving a debt-free home to their children. But aside from those groups, millions of others would see their lives enhanced by an HECM. They are not concerned about enlarging their estate, but desist nonetheless. The reason is likely some combination of fear, ignorance and distrust.
HECM reverse mortgage – Major Roadblocks
Fear: The principal fear is the loss of their house, which has a smidgen of substance because HECM borrowers can be foreclosed on if they don’t pay their property taxes or homeowners insurance, or if they don’t maintain the property. These obligations, and the danger of foreclosure if they violate them, are the same as those on a standard mortgage.
The difference is that a borrower with a standard mortgage can lose her house by defaulting on the monthly payment, and this accounts for almost all foreclosures on standard mortgages. HECM borrowers, in contrast, have no required payment and no default risk. If they pay their taxes and insurance, their tenure is secure until they die or move out of the house permanently, but that simple message doesn’t always get through to seniors who don’t understand how HECMs work.
Other fears are not as easy to dismiss. They include the fear of making a mistake in choosing among the various HECM draw options and price combinations, the fear of being subjected to self-serving advice, and the fear of being overcharged. All these fears are rooted in a dysfunctional market structure.
Fewer than a million reverse mortgages have been written since the HECM program began in 1987, and the current annual rate is only about 60,000.
Ignorance: It is widespread because HECMs are complicated and very unlike the standard mortgages with which most seniors purchased their homes. While there is no shortage of reliable information on the subject, most seniors get their information from articles that they read in popular media and online, many of which are misleading, and from the advertisements of lenders, which in some cases are worse.
Distrust: It is the natural consequence of a ‘dysfunctional’ market, as explained later below. Shoppers’ markets, in contrast, generate trust.
HECM reverse mortgage – Characteristics of a Shoppers’ Market
I recently purchased a camera in a shoppers’ market. I specified the make and model number to multiple sellers who quoted prices for it without asking me any further questions, and I selected a seller in whom I had confidence would deliver the product as agreed.
A shoppers’ market meets these conditions:
- Consumers know and can specify exactly what product or service they want to buy.
- The price of the product or service is readily available to shoppers without any obligation to buy.
- The consumer has confidence that the seller selected will deliver the product specified at the agreed-upon price.
None of the three features of a shoppers’ market are found in the HECM market, where complexities abound.
Decisions on draw amounts: Seniors often do not know how they want to receive money under the HECM — whether as upfront cash, monthly payments, credit line, or some combination of them. Making a choice can be complex because the amounts for which they qualify depend on their age, the appraised value of their home and on the prices charged by the lender. In some cases, lenders are not neutral because HECMs with larger upfront cash draws are worth more in the secondary market.
Availability of price data for shopping: There is no published, widely available data on the HECM prices of individual lenders, as there is in other well-established markets, including the