New Research Links Reverse Mortgages to Financial Well-Being

Senior homeowners can tap into their home equity in a variety of ways, whether that means taking a reverse mortgage, a home equity line of credit (HELOC) or cash-out refinance. But when it comes to deciding between these different extraction methods, reverse mortgages can have a positive impact on financial well-being of borrowers, according to the results of a recent study.

Extracting home equity through borrowing allows households to smooth consumption access liquidity without the substantial costs of selling the home. It also may allow seniors to pay-off higher cost debt and diversify their asset portfolio, says the study from Ohio State University titled, “How Home Equity Extraction and Reverse Mortgages Affect the Financial Well-Being of Senior Households.”

But unlike more common methods of equity extraction, such as HELOCs, Home Equity Conversion Mortgages (HECMs) provide distinct advantages to borrowers in that they cannot be reset in future periods with declines in home values or borrower credit quality, noted the study researchers, who include frequent reverse mortgage researcher Stephanie Moulton from Ohio State’s John Glenn College of Public Affairs; and Donald Haurin from Ohio State’s Department of Economics.

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“Establishing a HECM may provide a buffer against financial shocks, thereby increasing liquidity and reducing default,” the researchers write.

With the participation of Samuel Dodini and Maximillian Schmeiser of the Federal Reserve Board, Moulton and Haurin analyzed equity extraction via reverse mortgages and how this impacts the financial well-being of senior households in regards to credit trends, both pre- and post-extraction.

Seniors extracting home equity through HECMs are more likely to undergo a credit shock within the two years prior to extraction, according to the findings.

“These consumers appear to have the most improvement in credit outcomes after extraction,” researchers write. “Compared to non-extractors, borrowers using other channels of extraction not more likely to have had a prior credit shock.”

Researchers also found that cash-out and second lien borrowers had higher foreclosure risk, while HECM and HELOC borrowers were not significantly more likely to experience foreclosure post-extraction, relative to individuals who did not extract their home equity.

HECM borrowers were also found to have a spike in credit card balances before loan origination, and then a sharp decline in credit card balances that persists thereafter—a unique pattern not observed for other extraction channels.

Such a pattern, according to researchers, may indicate a need for liquidity that is met with credit cards in the short term, and then substituted with home equity borrowing through a HECM; to the extent that HECM borrowing is lower cost than credit card borrowing, this could lead to improved financial well-being.

Looking ahead, researchers note the importance of monitoring how seniors seeking HECMs are being affected by policy changes, namely the Financial Assessment implemented in April 2015.

“A policy challenge for the HECM program moving forward is to preserve access of the program to seniors who may be cut-off from other home equity borrowing channels, while minimizing the risk that borrowers will be unable to afford to maintain the home, including payment of property taxes and homeowners insurance,” researchers conclude.

Written by Jason Oliva

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  • What is not presented in the post above is that the link from the word “study” above is to a series of presentation slides, a large number of which are marked Ohio State University. That is certainly not a study most likely it is nothing more than highlighted topics from the study.

    Jason writes: ” It also may allow seniors to pay-off higher cost debt and diversify their asset portfolio, says the study from Ohio State University….” While Jason covers the advantages of paying off higher interest costs, he ignores any explanation on the the topic of diversification of asset portfolios and does not even address what the researchers call ” bring forward consumption.” Perhaps there is a good reason why Jason is derelict in this regard; the Powerpoint slides provided no information on either subject.

    While Jason is justified in not presenting anything on portfolio diversification, he is not so justified in at least mentioning that there is no foundation for that conclusion. There is absolutely no justification for not addressing the topic of “bring forward consumption” since it was one of the three plausible conclusions in the following statement: “Extracting equity through borrowing allows households to smooth consumption and access liquidity without the substantial costs of selling the home (Hurst and Stafford 2004; Mian and Sufi 2010; Mian and Sufi 2011); also may allow seniors to payoff higher cost debt, diversify asset portfolio and bring forward consumption.”

    The following is nothing more than “to dream the impossible dream”: “’A policy challenge for the HECM program moving forward is to preserve access of the program to seniors who may be cut-off from other home equity borrowing channels, while minimizing the risk that borrowers will be unable to afford to maintain the home, including payment of property taxes and homeowners insurance,’ researchers conclude.” The way to accomplish that is to maximize principal limit factors and expand the required use of LESAs; however, the continued maximization of the principal limit factors is exactly the policy that all but ended the HECM program in fiscal years 2012, 2013, and 2014.

    Modeling using a 4% home appreciation growth rate seemed so logical in the past but now with the recent history of a housing depression, it is clear that the 4% assumption is now overstated and must be adjusted as the real estate economic environment changes. If one calculates the present principal limit factors, the assumed home appreciation rate is about 3%.

    It was disappointing not to see how HECMs help diversify portfolios. If that is true, such information could be vital to our industry. On the other hand, if the foundation for that conclusion is as weak as the statistical bias found in the underlying study itself, one must question all of the conclusions in the study to determine their validity.

  • The_Cynic, can you explain what you mean by stating “If one calculates the present principal limit factors, the assumed home appreciation rate is about 3%”

    • Reverse Engineer,

      No one will ever know you have addressed them unless you use the reply “button”. Perhaps you did not want a reply. Want it or not, here it is.

      Are you familiar with HECM financial model? If not, you need to go to your industry mentor and keep moving up the line until you find someone who can verify what I write here.

      Principal Limit Factors (PLFs) are based on:

      1) the HECM life expectancy of the youngest borrower using that borrower’s HECM age plus the life expectancy as displayed on Pages 86 and 87 of the “Revised HECM Financial Assessment and Property Charge Guide,”

      2) home appreciation of 3% (originally 4%), and.

      3) FHA mortgage insurance premiums.

      First the estimated home value (as limited by the Maximum Claim Amount) is computed as of the calculated year of death. Then the present value of that amount as of today is calculated.using various interest rates and the life expectancy for each age shown in the table using monthly compounding. Finally the ratio of the present value of the calculated amount to the present value of the home is computed for the related interest rate used in the computation.

      Then other considerations enter into the adjustments to the factors such as an adjustment for expected deferred maintenance especially for older borrowers as of the borrower’s date of death. To offset balances due exceeding the actual future value of the home, HUD sets rates for mortgage insurance which they collect for note holder reimbursements and losses and other costs related to assignments.

      Expecting that home values would rise by 4% created much higher PLFs than we see today. It is believed that the over optimistic appreciation rates were at the root of the overall losses the MMI Fund suffered over the last seven years.

      If you have further questions, please use the reply button after writing out those questions.

      • Reverse Engineer,

        I am more than happy to entertain your questions online as comments on this website only but with the info provided, you should be able to “reverse engineer” something close to the HECM financial model. I see no benefits to taking this discussion offline but please give me your reasons for this request.

        I am not interested in teaching a course on PLFs since I have no connection with HUD. I have learned from those at HUD and would therefore turn you to HUD and your mentors for instruction. After all they are paid to keep you informed; I am not!

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