Why Seniors Choose Reverse Mortgages to Tap Home Equity

Senior homeowners looking to tap into their home equity have a variety of options, but whether someone chooses a reverse mortgage or another method depends of several factors, according to a recent report published by the Federal Reserve Board.

Home prices, credit availability, as well as other socioeconomic factors, all impact a senior’s propensity to access home equity via Home Equity Conversion Mortgages (HECMs), says the report, “How House Price Dynamics and Credit Constraints Affect the Equity Extraction of Senior Homeowners,” released this month.

Produced by researchers from both the Federal Reserve Board and Ohio State University, the report uses data from the New York Federal Reserve/Equifax Consumer Credit Panel, the U.S. Department of Housing and Urban Development (HUD), and other sources to estimate the decision to extract equity through channels like reverse mortgages, home equity lines of credit (HELOCs), second liens and cash-out refinancing.

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Using credit panel data from the housing boom and bust periods, as well as data on HECM originations during the same period, the report is the first known study to model the choice of reverse mortgages alongside other modes of equity extraction.

For reverse mortgages, researchers used HUD data on HECM loan originations from 2004 to 2012, combined with consumer credit data from the Fed New York/Equifax and house price index data from CoreLogic.

While previous research has found that credit constrained households were more responsive to home price gains than non-constrained households, the Fed-Ohio State study suggest that this response varies depending on the borrowing channel.

For example, as home prices increased, researchers found that cash-out refinancing increased in credit-constrained areas, but HELOCs rose in less credit-constrained areas; furthermore, when home prices fell, reverse mortgage originations increased, particularly in credit-constrained areas.

The research also analyzed differences in responses to credit constraints and house price changes in minority versus non-minority neighborhoods.

“As house prices decrease, households in non-minority neighborhoods are more likely to borrow through HECMs, presumably as a hedge against further house price declines,” researchers write. “By contrast, HECM originations in minority neighborhoods are not as responsive to house price declines.”

With regards to HECMs, previous studies have found higher rates of originations in ZIP codes with higher percentages of African-American and Hispanic homeowners. Meanwhile, other research of HECM originations between 1989 and 2010 have confirmed the positive relationship between minority share in a neighborhood and HECM originations, even after controlling for house price dynamics.

Neither study, however, explained the use of HECMs relative to other equity extraction levels.

Households’ decisions for extracting home equity also take into consideration borrowing costs. The interest rate on the loan, as well as upfront fees and transaction costs, differ between financial products, thus influencing households’ desired channel for equity extraction in different ways.

“The perception of high upfront costs for reverse mortgages has been cited as a primary factor contributing to a lack of demand,” researchers stated. “Despite higher upfront costs, HECMs may be preferable for households constrained by the credit standards for other channel options.”

In their conclusion, researchers found “there are no uniform responses” to changes in home values or credit constraints “applicable to all areas or all extraction types.” In other words, the preferred method of accessing home equity differs depending on a variety of factors.

“Equity extraction is the result of a more complicated decision process that responds to the interplay between house price dynamics, racial makeup, credit availability, financial understanding, and institutional policy,” researchers concluded.

View the report.

Written by Jason Oliva

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  • This was an interesting study in that it provides insight into the reason we are not seeing higher endorsements when home prices are up in about 75% of the country. It was surprising as home values tanked during fiscal years 2008 and 2009, endorsements were still rising. Of course the four month lag rule is part of that but still we saw our highest endorsement numbers in those two years. It was after those peaks our endorsement volume began its precipitous drive to the lowest annual volumes we have seen in ten years.

    While the study is intriguing it will take some time to absorb and understand. It seems one of our industry’s weak points is highlighted in the study which is financial understanding. This is an area where as an industry we lack and it shows in our production numbers.

  • What the study points out are weaknesses and flaws in our education prior to fiscal 2013 if downward home price trends were a significant factor in increases in HECM endorsements.

    Our experience also brings up questions about their research. For example, the article above quotes the study as concluding: “‘As house prices decrease, households in non-minority neighborhoods are more likely to borrow through HECMs, presumably as a hedge against further house price declines,’ researchers write. ‘By contrast, HECM originations in minority neighborhoods are not as responsive to house price declines.’” Yet we saw a substantial upward trend in endorsements starting in fiscal 2002 and not ending until fiscal 2010. The first 6 and 1/2 of those years saw dramatic increases in home values across the country. It was in the last two and 1/2 years that home values were caving. So why were endorsements rising in both conditions?

    Since fiscal 2012 we have seen no trend in endorsement volume, just volatility which in part was very heavily influenced by HECM policy changes. It will be very helpful to dig into that study to hopefully get a better idea about how economic conditions in US residential real estate impact our little industry.

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