Older American homeowners are more likely to be denied traditional, “forward” methods of tapping home equity, a difficulty compounded by the cohort’s rising debt levels and insufficient retirement savings later in life. However, while collective senior home equity has increased to levels totaling over $9.5 trillion at last count, there is still a general aversion to the tapping of home equity even considering its increasing viability as a tool to increase a senior’s quality of life.
These are just some of the findings published this week in a wide-ranging report from the Urban Institute, titled “Mortgage Denial Rates and Household Finances among Older Americans.” The study, co-authored by senior research associate in the Housing Finance Policy Center (HFPC) Karan Kaul and HFPC research associate Linna Zhu, aims to examine the impact of shifting statuses and realities related to how senior borrowers are served by lending institutions, and how economic factors including rate environments and savings levels can impact the choices that seniors make related to their finances.
The research was funded by reverse mortgage lender Finance of America Reverse (FAR). However, the lender had no input or involvement in the data cultivated, nor in the way it is being presented in the final report. For additional context, RMD sat down with Kaul and Zhu to talk more specifically about their findings related to the Home Equity Conversion Mortgage (HECM) program.
The findings, and how reverse mortgages interact with seniors’ situations
The very general finding of the research, according to Kaul, revolves around the denial rates for seniors on equity extraction products, and the differences which emerge when examining “forward” equity extraction offerings and Home Equity Conversion Mortgage (HECM) loans, he says.
“What we’ve found is that when you look at denial rates over the last three years – 2018-2020 – there is generally a declining trend in denial rates for older Americans, and that’s good,” Kaul tells RMD in an interview. “But when you look at denial rates for different products – for instance, we looked at denial rates for purchase mortgages, for cash-out refinances, non-cash-out refinances, home equity loans and HECM – what we found is specifically within equity extraction products, HECMs tend to have the lowest denial rates for seniors, compared to things like HELOCs and cash-out refinances which tend to have much higher denial rates.”
Those denial rates have trended down over time in the past few years mainly due to falling interest rates, he says.
“If interest rates are going to be lower, then that just means monthly debt payment obligations are going to be lower as a percentage of a borrower’s income,” he explains. “So, it just becomes easier for folks who qualify on the debt-to-income (DTI) metric. But again, the big story is that we’ve seen denial rates decrease in these three years because of falling interest rates. Still, forward equity extraction products have denial rates which are significantly higher compared to what we find for HECMs.”
This is also in comparison to younger borrowers, said Zhu.
“We find that denial rates, especially for a HELOC and cashout refi, are much higher for senior homeowners,” she adds.
One of the reasons seniors are more likely to be approved for a reverse mortgage is the different circumstances that accompany a HECM when more directly compared with traditional forward equity extraction options, Kaul says.
“Obviously, on a reverse, the monthly payment obligation is not there, so a borrower doesn’t have to pay the loan back every month,” he says. “You don’t have to pay back the loan via monthly payments, which means DTI becomes much less of an issue. You need to have enough money saved to cover your T and I – taxes and insurance – every month, and that’s the element of underwriting that exists in a reverse mortgage. So, that means it’s just going to be easier for a lender to approve you [compared to] a forward mortgage.”
Reverse mortgage lenders naturally place less weight on income in the underwriting process, Zhu adds.
Senior sentiment towards reverse mortgages: ‘stable’ can also mean ‘flat’
While it is easier for a senior to get a reverse mortgage when compared to the other available forward equity extraction options, demand for the HECM product category has been relatively stagnant even though there has been a recorded increase in raw volume, Kaul says.
“Although HECM volumes did go up in the last couple of years, we’re talking really, really small numbers here,” he says. “It’s hard to speculate what might be driving that, but I’m pretty sure that part of it is rising home prices. Part of it may also be interest rates, but we’re talking around 35-40,000 loans a year compared to a much higher figure for cash-out refinances.”
Zhu had that much higher figure on hand.
“[There were] 330,000 [cash-out refis] in 2019,” she said.
It’s difficult to empirically track causality when it comes to questions of sentiment, Kaul says. It is empirically true that a modest increase in HECM volume accompanied a more favorable interest rate environment, but it’s a far less precise matter to determine what change there has been – if any – regarding reverse mortgage sentiments among seniors, he explains.
“Believe me, as an economist, nothing frustrates me more than these behavioral things, in that you just can’t measure them,” he says.
Another thing that may be holding back a broader penetration rate for the HECM product is cost, Zhu says.
“The problem is not just about the lack of financial literacy among senior homeowners,” she says. “It is also a very expensive product. The high upfront fees and the crossover rates are really high, especially for those who choose to take a lump sum extraction approach. So, when time goes by, the accumulated interest they’ll have to pay at the end is really high.”
Even if sentiment and these other behavioral components are challenging to measure, other ideas emerge when controlling for factors like home price appreciation.
“Even if we control for the house price appreciation rate, there are some other factors that we need to take into account like the expensive costs to extract home equity via the HECM channel, as well as the potential crossover risk, certainly in the current mechanism,” Zhu adds.
What the industry and its regulators should keep in mind
In terms of what can be done in the future by both the reverse mortgage industry and the government authorities that oversee the HECM program, making the product more accessible for future seniors will be critical in aiming to increase the uptake of a product that could make a difference for seniors needing to find adequate funding solutions in retirement, Kaul says.
“I think one of the things that I would say merits closer look is the HECM program at HUD,” he says. “I think what’s happened in the last 10-11 years is that we’ve actually made it – like with everything else in the mortgage market – more difficult for folks to qualify for. In terms of HECMs, the product has had some challenges in the past with respect to reputational risks and consumer education.”
Those difficulties have also forged a reverse mortgage industry that has made demonstrable progress, Kaul explains. Still, getting a reverse mortgage should not have the same kind of intellectual intensity as earning a degree in college, he says.
“The industry has, in my view, come a long way,” he says. “I think with certain targeted policy interventions, you can actually make the product simpler for consumers to understand so that applying for a reverse mortgage doesn’t feel like getting a bachelor’s degree. You just need to streamline the process, make it more efficient, bring down costs, and just make it easier for folks to understand what they’re getting into.”
Underwriting criteria may also be worth looking into for anyone inclined to reform the HECM program, he says, including for principal limit factors (PLFs).
“[PLFs] have cut the other way in recent years and just made it difficult for borrowers to use the product,” he says. “So, I would certainly hope that there is some movement in that direction in the coming years just to make it a little bit more accessible.”
Read the research at the Urban Institute.