mortgage

Rebirth of the reverse mortgage?

Professor Steve MalpezziDuring the housing boom, the reverse mortgage was touted as a way for retirees to turn their home equity into cash. In essence, homeowners with a reverse mortgage take a loan against the equity in their home and do not have to pay it back while they are alive, so long as they remain in the home.

But when housing went bust, it took much of the reverse mortgage market with it.

Today, home equity conversion mortgages backed by the Federal Housing Administration make up a large percentage of the reverse mortgage market. But how can you choose the best reverse mortgage for your situation?

Stephen Malpezzi, a professor at the Wisconsin School of Business' Graaskamp Center for Real Estate in Madison, offers some thoughts in the following interview.

What happened to the availability of reverse mortgages after the housing bust?

Unsurprisingly, they fell dramatically, though for reasons I don't fully understand, they didn't peak until 2009. The housing slide started in most markets in 2006, and the recession officially started in December 2007.

Here's the data from FHA (Federal Housing Administration)-insured home equity conversion mortgages (HECMs), which dominate the U.S. reverse mortgage market.

Annual home equity conversion mortgage production

Private-label reverse mortgages basically went away after the crash. FHA's HECM is most of the market, except for a small number of high-value transactions at the luxury end. I don't see much reliable data on this small part of the market, so I don't have a view on the outlook for private label going forward.

Note that the FHA program has lost a lot of money because default rates of pre-bust HECMs have been high. FHA has been making a number of changes to the program -- for example, removing the option to take a fixed rate. It's unclear to me at this point how effective these reforms will be, should we have another boom-bust cycle.

However, there is certainly room for this market to expand somewhat as market conditions improve, if FHA's reforms take hold. There are about half a million HECMs outstanding, but there are roughly 25 million homeowner households with a head 62 or older.

If someone got a reverse mortgage after the housing bust, how can they take advantage of rising home values? Can they refinance with a bigger reverse mortgage?

The bust reduced the home equity that's the basis for the loan. So in general, the bust reduced the amount of loans most folks could obtain. Now that house values are rising, and balance sheets for many (not all) households are improved, there is expanding scope for such loans. Here's Federal Reserve Board data on house equity, in the aggregate.

Aggregate homeowner equity as a share of aggregate homeowner house value

You can see the big drop after 2006 and the start of the recovery. (And recent increases in house prices will be reflected in a further upward movement when we next update this Fed data). This improvement is especially important to middle-class Americans. Housing equity is a bigger fraction of the assets of middle-income folks than of rich folks, even though it's smaller in dollar terms. For example, according to the Federal Reserve's 2009 Survey of Consumer Finances, about 70 percent of households around the middle of the income distribution own their homes, and of those between the 40th and 60th income percentiles who own, their house equity averages about $100,000. For comparison, in the top 10 percent of the income distribution, more than 90 percent own, and their average house equity is somewhat north of $500,000.

For many middle-income Americans, that house equity is very important -- often a bigger chunk of their balance sheet than the bank accounts, stocks and other purely financial assets that first come to mind when we think about savings. Taking all financial assets into account, but excluding housing and other nonfinancial assets, the typical middle-income household has about $80,000 in stocks, bonds, bank and retirement accounts, and so on; households in the top 10 percent of the income distribution average about $1.4 million in purely financial assets. These SCF data include both elderly and nonelderly, only become available with a lag of several years, and should be viewed as indicative rather than precise. Nevertheless, they are sufficient to make the point that finding ways to safely and appropriately tap housing equity is an especially important component of good financial planning for many in the middle class.

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