Whatever happened to the mainstreaming of reverse mortgages in retirement plans?
Retirement researchers have been pushing the idea for years, arguing that despite the high costs, financial planners need to consider the benefits of reverse loans as a way to tap home equity in retirement.
But loan activity remains flat. Volume for home equity conversion mortgages (HECM) finished 2021 at 53,020 loans—an 18.7% bump from 2020 but still in the range where originations have bounced around since 2012, according to Reverse Market Insight. And, loan volume is far below the peak year of 2008, when 115,000 loans originated.
From a market penetration standpoint, HECMs are barely a blip. “If you look at current loans measured against the number of eligible households, it works out to a little more than a 2% penetration rate,” notes John Lunde, Reverse Market Insight's president.
HECMs are administered and regulated by the U.S. Department of Housing and Urban Development (HUD). The federal government made several reforms during the past decade aimed at clamping down on abusive loan practices. Defaults had become a problem in the industry—especially when newspapers started publishing stories about seniors losing their homes. Although the loans have no payments, borrowers must keep their homeowner’s insurance and property taxes current and maintain the property.
The changes reduced total available loan amounts, raised fees and, importantly, introduced a required financial assessment to make sure borrowers had the capacity to meet their obligations and terms under the HECM.
Nearly all reverse mortgages are generated under the HECM program. Fixed rate and variable rate HECM loans are available, but fixed rate loans are unusual and require that the borrower take the entire allowed credit upfront as a lump-sum payment. More often, an HECM is structured as a line of credit that can be used for any purpose.
Since the distributions are loans, they are not included in the adjusted gross income reported on tax returns—which means they don’t trigger high income Medicare premiums or taxation of Social Security benefits. The government insurance is provided through the Federal Housing Administration (FHA), which is part of HUD. This backstop provides critical assurances to both the borrower and the lender.
For the lender, the assurance is that the loans will be repaid even if the amount owed exceeds proceeds from the sale of the home. The borrower receives assurance that she will receive the promised funds, that heirs will never owe more than the value of the home at the time they repay the HECM and the protections afforded by stringent government regulation of a very complicated financial product.
Reverse mortgages are available only to homeowners ages 62 or over. As the name implies, they are the opposite of a traditional “forward” mortgage, where the borrower makes regular payments to the bank to pay down debt and increase equity. A reverse mortgage pays out the equity in the home as cash, with no payments due to the lender until she moves, sells the property or dies.
Repayment of an HECM loan balance can be deferred until the last borrower or nonborrowing spouse dies, moves or sells the home. When the final repayment is due, the title for the home remains with family members or heirs; they can choose to either keep the home by repaying the loan or refinance it with a conventional mortgage. If they sell the home, they retain any profit over the loan repayment amount. If the loan balance exceeds the home’s value, the heirs can simply hand the keys over to the lender and walk away.
Retirement researchers have been advocating for the use of HECMs for some time now. Most recently, Wade Pfau, professor of retirement income at The American College of Financial Services, explores the benefits in his encyclopedic new book, Retirement Planning Guidebook: Navigating the Important Decisions for Retirement Success. In an interview, he argued that it’s critical for advisors to understand how income from an HECM can be integrated into a plan.
“If you can either just lower your withdrawal rate from your investments a little bit, or avoid distributions after a market downturn, that has such a huge positive impact on the subsequent portfolio value,” he said. “That's really the secret sauce of the reverse mortgage. You can't look at the reverse mortgage in isolation, you need to consider its impact on the overall plan, and specifically the investment portfolio.”
And Pfau does see some signs of interest, especially among registered investment advisors. “I think there's, at least, more willingness to consider when they might have a role in a plan. So, you'll see more RIAs using them.”
Steve Resch, vice president of retirement strategies at Finance of America Reverse, says it is frustrating to watch FHA product volume remain stuck in low gear. “In a fiduciary environment, you’re looking at all sorts of things that might be right for a client. And so how do you look at someone's situation and think, ‘well, home equity could really work well for them,’ but not mention it to them?
But he does see growing interest from RIAs in using HECMs for a variety of retirement planning purposes. One challenge many clients face as they reach retirement is the need to move a portion of assets from tax-deferred accounts to Roths to manage tax liability—and that can be expensive from a tax standpoint. “We are seeing some advisors using lines of credit to fund those tax liabilities,” he says.
Resch also sees growing interest from advisors in proprietary reverse mortgages, which have higher loan limits. These are not part of the HECM program, and not federally insured, but they also are nonrecourse. It’s a much smaller part of the overall market, but it is growing more quickly, he says.
“The loan to value ratios are not quite as generous as you would get with the FHA products because those are insured, and here the lenders are taking all the risk. But they are still nonrecourse loans, and the borrowers, or their families, are not liable for any loan balance that exceeds the value of the property,” he adds.
Mark Miller is a journalist and author who writes about trends in retirement and aging. He is a columnist for Reuters and also contributes to Morningstar and the AARP magazine.