Last week, Urban Institute researchers Karan Kaul and Laurie Goodman released a detailed report on the reasons why older Americans aren’t considering their home equity as an essential retirement asset. As RMD reported, the pair found a wide variety of factors that stop people from using reverse mortgages, home equity lines of credit, and other similar financial tools, from fear to misunderstanding to deep-seated behavioral patterns.
In order to find out more, RMD spoke with Kaul and Goodman by phone last week. This interview has been condensed and edited for clarity.
What are the most prominent reasons why seniors are reluctant to tap into home equity?
Kaul: The main reason, as we pointed out in the report, is that they just don’t want it. They just don’t want to extract equity from their homes. They just don’t want to have debt, for the reasons we mention in the report.
Having said that, there are also these structural barriers to the extraction that have to do with things like tight credit, or having not a good understanding of how these products work, or misinformation, complexity. … But again, the big elephant in the room is that they just don’t want debt. And I’m not sure anything could be done because a lot of it is driven by their behaviors and their inherent attitudes, and those are things that are really difficult to change.
A lot of people in the reverse mortgage space say it’s a generational issue — there’s a long-standing fear of debt among older Americans, either because they may have grown up during the Depression, or because they thought their homes were something to pay off, not a source of money.
Goodman: And the other thing to bear in mind is that this generation has a lot of equity that could be tapped, and for some reason, tapping home equity is considered a measure of desperation rather than a legitimate retirement tool by many. And sort of moving the various products that can be used to tap equity into retirement planning, I think, is one of the most powerful suggestions we make in this paper.
Why do you think there’s a perception that the reverse mortgage is more complicated than other financial tools? Home equity lines of credit, and even forward mortgages, are also relatively complex products.
Kaul: I think the main reason for that is that most people don’t even think about reverse mortgages until they approach retirement age or are already well into their retirement years — unlike other products like stocks and bonds and annuities and forward mortgages, which most people get familiar with in their 20s and 30s and 40s. So if you’re talking to someone who’s in their 60s, and you introduce this entirely new concept of reverse mortgages … it’s just really hard for them to understand this product at this age. If they had been introduced to this product when they were younger, there is a chance that they would have a better understanding of this product from a younger age, and therefore [there would be] less skepticism when they are finally in their retirement. That may just increase the likelihood that they would eventually use it.
And the other problem is the misinformation and fraud that just scares a lot of people. They just don’t want to have anything to do it unless they’re really desperate, and so they just try to stay away from it unless they really, really have to get into it.
Goodman: Most of our parents had mortgages. It’s a product they’ve used, know what it is, from a very early age. You understand that payments have to be made, et cetera. And reverse mortgages are a far newer product and a much less used one.
[A Fannie Mae survey asked asked] what, if anything, concerns you the most about reverse mortgages? If you take out “none of the above,” 20 percent of the people said they were afraid of getting scammed. And I think part of that reflects the fact that the reputation of the industry hasn’t been great. Moreover, the participants in this industry are by and large not household names. They will eventually become household names as this product continues to grow, but that’s just a learning curve for everyone. Out of the top four lenders in this business, most homeowners have heard of zero.
Goodman: It’s such a legitimate retirement product, and it’s just so underutilized. I have a ton of friends who are taking retirement at 62 and are beginning to take Social Security. And I’m thinking: “You dummy! Retire at 62, but then take Social Security when you’re 70 and use all the home equity you’ve built in your home to live off of for your next eight years because your life expectancy is another 30 years, and you will be so much better off rather than taking the reduced payment.
In your research, you recommend instituting a draw period and a repayment period for HECM loans, similar to home equity lines of credit. Is it more about simplifying the system, or reducing potential costs?
Goodman: Both. But it’s more about reducing the costs by reducing the risk.
Kaul: When a borrower gets a reverse mortgage today, the line of credit option, the line of credit pretty much stays open. There’s no end date to it unless they sell the home or they die. So what that does is it creates uncertainty for lenders. They have no idea if the borrower will tap their line today, five years from today, or 15 years from today. So they have got to assume that a certain percentage of borrowers will tap into that equity at some point, and that factors into their pricing decisions. And so one of the things we think would happen if one were to put a term limit on that line of credit, it would give lenders more certainty that after that limit has passed, five years or ten years, they could finally release whatever liquidity they had to keep behind it in order to fund those lines at some point in the future. Just a way for lenders reduce their uncertainty, and the hope is that once that uncertainty goes down, then lenders will not have to price for that uncertainty, and that might end up reducing the cost a little bit.
What are the most important suggestions you made in the report?
Goodman: The two most important, in my view, are making it a more vital part of reitrement planning, and somehow reducing the marketing costs. A huge amount of the cost of these loans are just marketing costs. Whether it’s fewer participants who do more of this product or what, reducing the marketing cost would help lower the cost structure substantially, which would substantially improve the product.
Kaul: I totally agree with those two. As Laurie mentioned, the marketing costs for the loans are high because you just have an industry that is extremely fragmented compared to what we had back in ’07 and ’08. So you have smaller players who are originating fewer loans, and the fixed costs are spread out over those fewer loans, so the loan cost goes up.
The one thing I would add is counseling. A lot of the onus about educating reverse mortgage borrowers right now lies on the companies making these loans. There is HECM counseling available, but there are ways to improve that by counseling based on borrower needs. So if you have a high-income borrower who has a lot of equity their home and wants to tap into reverse mortgages, you could tailor that counseling toward making sure that the borrower gets a reverse mortgage only if they really need it. On the other hand, if a lower-income borrower — who perhaps has limited income, limited assets, limited savings — if they decide to go for a reverse mortgage, you may want to focus the counseling more on effective coping strategies and how to minimize borrowing and how to minimize their cost of living to better educate them about what might be in their best interest.
Written by Alex Spanko