Since reverse mortgages are a relatively niche product with low utilization among American seniors, there are possible strategies that can be employed to increase its prevalence among those looking for funding solutions in retirement. This is according to a new research paper released last week during an event by the Brookings Institution, authored by Ohio State University researchers Stephanie Moulton and Donald Haurin.
These possible strategies for reverse mortgage reform include streamlining product offerings to target specific consumer segments, the use of risk-based underwriting and preventative servicing. These are aimed at reducing the probability of default, foreclosure, and crossover risk while lowering levels of market difficulty for consumers and lenders.
Low utilization among seniors
One of the reasons that seniors don’t leverage home equity in retirement is because they have an attachment to the property, the researchers say, but another reason is that it is generally costly to convert their illiquid home equity into a liquid asset. Still, for those homeowners who opt for a more traditional approach and downsize into a lower-priced home, those seniors tend to be financially better off even though only a fraction of the population is even going as far as taking that step.
“Between 1998 and 2014, only about one-fourth of homeowners age 50 and older who moved purchased a home of a lower price, allowing for liquidation of some portion of home equity,” the paper reads. “Older homeowners who sell their homes and move tend to have higher incomes and wealth than homeowners who do not move prior to death.”
While reverse mortgages present a viable option for seniors to convert their home equity into a liquid financial asset, issues of supply and demand continue to hamper the potential effectiveness of reverse mortgage product options for seniors that would otherwise be open to them, the paper says.
“Our general premise is that in order for the reverse mortgage market to provide a viable option to liquidate home equity in retirement, we need product options that meet the needs of different consumer segments while mitigating risks to borrowers, lenders, private investors, and government,” the paper reads. “The product options need not (and likely should not) all be provided by government.”
New, small-dollar HECMs
To that end, the authors of the research paper propose two new, additional product options designed to better meet the needs of a broader base of potential borrowers.
“Our first proposal is to create streamlined Home Equity Conversion Mortgage (HECM) product options that target specific consumer segments,” the paper reads. “We focus on two consumer segments: (1) those who have demand for short-term liquidity from home equity but are unlikely to access a forward mortgage home equity loan or HELOC; and (2) those who have a desire to eliminate existing forward mortgage debt to free up monthly cash flow for consumption. We refer to these options as a ‘small-dollar HECM’ and ‘forward mortgage conversion HECM,’ respectively.”
Since there is an untapped segment of older consumers that may find themselves being better served by a more short-term reverse mortgage arrangement, creating a new product category that has the potential to serve people in that situation just makes sense, according to Moulton.
“If somebody really only needs $30,000 or 30% of their available equity, then it makes sense to create a product that might meet that consumer segment, that’s [cheaper than other options],” Moulton says in an interview with RMD. While acknowledging that smaller dollar reverse mortgages existed in the past during the days of the “HECM Saver,” Moulton doesn’t think the product category stood a chance when it was compared with other, more attractive options available to borrowers in its own time.
“The fact that we had Saver exist on the government-insured side suggests that there could be an appetite for it, at least from the supply side,” Moulton says. “Now, there wasn’t demand at the time, but I think it wasn’t really given a fair shot. When Saver was introduced in 2009, at the height of the fixed-rate, full-draw mortgage time, that was just such a more attractive product that the Saver didn’t really have a chance for consumers during that time period.”
Forward-to-reverse conversion products
The second new product proposal made by Moulton and Haurin revolves around a more direct forward-to-reverse mortgage conversion product offering, designed to answer the observable trend of more seniors carrying forward mortgage debt into retirement.
“More than 60% of HECM borrowers used at least a portion of their proceeds to pay off a forward mortgage, with paying off the forward mortgage ranking as one of the top two reasons survey respondents reported obtaining a HECM—indicated by 38 percent of respondents,” the paper reads. “Given the expressed preference to use a reverse mortgage to pay off forward mortgage debt, combined with the increasing mortgage debt burden faced by older adults, it is sensible to explicitly design a HECM product for the purpose of converting forward mortgage debt into a reverse mortgage. In essence, paying off a forward mortgage operates as a type of annuity, freeing up monthly cash flow for other needs.”
While there’s nothing in the current market that necessarily prevents a forward-to-reverse mortgage conversion from taking place on a functional level, some of the motivation for making this recommendation comes from a desire to pivot product education into a direction that helps seniors realize that this could be an option if they are seeking to eliminate a costly forward mortgage payment, Moulton says.
“[In terms of] the current HECM, [much] of the time [borrowers are] taking a forward and converting it into a reverse,” Moulton says. “So, it’s not that this idea is new in that regard. But, I think if we notice that’s happening, the idea is to think about designing a product for that population specifically, [and asking] what we would do differently. One thing we could do differently is to think about how folks come to learn about this product, and how they could learn about whether or not it’s a good fit for them.”
Functionally, a specifically-designed forward-to-reverse conversion product could serve as a fixed-rate, closed-end mortgage with the only draw being the payoff of existing mortgage debt, the researchers describe. Imposing this restriction can help to make a product like this one more attractive in the market.
“This restriction reduces draw uncertainty and thus attractiveness to investors in HECM securities, potentially resulting in a higher premium for the closed-end, fixed-rate securities and a lower interest rate charged to borrowers,” the paper says. “In addition, forward mortgage lenders could directly offer the product to their customers, substantially reducing the sales and marketing costs associated with HECMs and further reducing costs to consumers. These loans would likely have higher principal limit factors than those of the small-dollar HECMs, resulting in a higher mortgage insurance premium to offset increased crossover risk.”
Limit crossover risk through underwriting, servicing reform
Additionally to the product proposals, introducing risk-based underwriting and refinements to servicing practices will further help to address issues of crossover risk in HECM lending, the researchers say. Since low credit scores at the time of loan origination have correlated with increased rates of tax and insurance-based defaults on HECM loans, refining underwriting practices can help minimize these instances on the front-end.
“Rather than proposing a minimum floor credit score for HECM loans, we propose streamlining the underwriting process for HECM applicants with credit scores above 680,” the researchers write. “Based on prior research indicating very low risk for HECM borrowers with higher credit scores, we propose exempting applicants with credit scores above 680 from the financial assessment.”
Part of the inspiration for this recommendation stems from the general success of the financial assessment requirement handed down by FHA, which has “been associated with significant reductions in tax and insurance default among new HECM originations since its enactment in 2014.”
This recommendation could be interpreted as a “version 2.0” of the financial assessment, Moulton tells RMD. Still, it’s understandable that the reverse mortgage industry may have concerns about adopting this proposal due to its centering on credit scores.
“I think there’s nervousness about using credit scores, because there’s a concern about credit scores not being as predictive of default for older adults,” she says. “But, I think our research and the research of others has proven that wrong, and that credit score actually is very predictive of default for this segment. And in fact, using a credit score like we do in the forward mortgage market is actually, perhaps, more efficient and can [potentially] include more borrowers, not fewer. By doing something like that, you can reduce the transaction costs and burdens individuals in the process.”
In terms of “preventative servicing,” these are changes that could be implemented into the entire HECM book of business to apply to both newly-originated loans while retroactively applying to previously-originated HECMs, the researchers say.
“We can’t forget about those prior books of business because these are real older adults that own their homes that are facing foreclosures or facing issues, and so how do we help them,” Moulton said when presenting this proposal at the Brookings Institution last week. “We think preventative servicing [can make a difference], and many lenders are doing this, but I think not all are.”
Moulton then described an experiment she and Haurin conducted that took a more active approach in reminding borrowers about their obligations.
“We did a simple experiment with a counseling agency, where we provided reminders to pay property taxes and insurance,” she says. “We actually reduced default by almost half among individuals that got those reminders. Now, that seems like a no-brainer and many servicers may be doing this already, but some aren’t. And so, this is something that seems like a no-brainer. But having the money to pay that lumpy tax expenditure can be a huge shock for individuals.”
Read the full Moulton-Haurin reverse mortgage research paper at the Brookings Institution.