More seniors should be funding their retirement years by drawing funds from their home equity through reverse mortgages under the U.S.-insured Home Equity Conversion Mortgage (HECM) program offered by the Department of Housing and Urban Development. But not enough homeowners do it because of a dysfunctional HECM market, as well as fear, ignorance and distrust of reverse mortgages that make seniors stay away, according to Jack Guttentag, Wharton professor of finance emeritus and founder of the consumer-oriented mortgage website, The Mortgage Professor. His site has information on HECMs and includes HECM prices submitted by seven reverse mortgage lenders with whom he has a business relationship. The site also has an HECM calculator designed to optimize borrower choices.
In this opinion piece, he proposes solutions to make the HECM market a true shoppers’ haven that will be attractive to seniors, replacing the current ‘gotcha’ market where prospective borrowers face formidable obstacles if they want to look beyond the first loan provider that gets their attention. In a true shoppers’ market, lenders compete and borrowers have choices.
The HECM Program
HECM reverse mortgages provide seniors 62 and older with multiple ways to convert their home equity into spendable funds to meet a variety of needs while they remain in their homes. Under the program, borrowers are fully protected against the small print abuses that have arisen in some private programs, and investors who fund HECM reverse mortgages are insured against loss by the Federal Housing Administration.
Here are the major ways in which seniors can draw funds:
- Seniors who still have a mortgage balance on their home when they retire can convert the mortgage into an HECM reverse mortgage that has no required payments.
- Seniors with equity remaining in their home can draw cash at closing with a fixed rate, or a larger amount over a year with an adjustable rate, to be used for any purpose.
- Seniors who face a drop in income on retirement can supplement their income by drawing a “tenure” monthly payment that lasts as long as they reside in their house.
- Seniors who want to purchase a house for any reason can finance the purchase partially with an HECM reverse mortgage, reducing the assets that must be liquidated for that purpose.
- Seniors who intend to finance their retirement years by drawing down accumulated assets can hedge the risk that their money will run out because they live too long — they can take an HECM-based credit line, which grows continually so long as it is not used.
- Seniors with retirement income from variable sources can use an HECM credit line to stabilize their income, drawing on it when other income sources drop, and repaying it when other sources increase.
- Seniors who need to supplement their income for a limited period, while they wait for social security to kick in or for any other reason, can draw a “term” monthly payment for a specified period.
The need for the HECM program is large and growing. At the end of 2015, there were about 24 million homeowners aged 65 and over, with the number growing by about a million each year. The Center for Retirement Research at Boston College estimates that more than half of them “may be unable to maintain their standard of living in retirement.”
Yet HECMs have barely dented the problem. Fewer than a million reverse mortgages have been written since the HECM program began in 1987, and the current annual rate is only about 60,000. Why is this?
Some senior owners don’t need them, of course, and others attach high importance to leaving a debt-free home to their children. But aside from those groups, millions of others would see their lives enhanced by an HECM. They are not concerned about enlarging their estate, but desist nonetheless. The reason is likely some combination of fear, ignorance and distrust.
Fear: The principal fear is the loss of their house, which has a smidgen of substance because HECM borrowers can be foreclosed on if they don’t pay their property taxes or homeowners insurance, or if they don’t maintain the property. These obligations, and the danger of foreclosure if they violate them, are the same as those on a standard mortgage.
The difference is that a borrower with a standard mortgage can lose her house by defaulting on the monthly payment, and this accounts for almost all foreclosures on standard mortgages. HECM borrowers, in contrast, have no required payment and no default risk. If they pay their taxes and insurance, their tenure is secure until they die or move out of the house permanently, but that simple message doesn’t always get through to seniors who don’t understand how HECMs work.
Other fears are not as easy to dismiss. They include the fear of making a mistake in choosing among the various HECM draw options and price combinations, the fear of being subjected to self-serving advice, and the fear of being overcharged. All these fears are rooted in a dysfunctional market structure.
Fewer than a million reverse mortgages have been written since the HECM program began in 1987, and the current annual rate is only about 60,000.
Ignorance: It is widespread because HECMs are complicated and very unlike the standard mortgages with which most seniors purchased their homes. While there is no shortage of reliable information on the subject, most seniors get their information from articles that they read in popular media and online, many of which are misleading, and from the advertisements of lenders, which in some cases are worse.
Distrust: It is the natural consequence of a ‘dysfunctional’ market, as explained later below. Shoppers’ markets, in contrast, generate trust.
Characteristics of a Shoppers’ Market
I recently purchased a camera in a shoppers’ market. I specified the make and model number to multiple sellers who quoted prices for it without asking me any further questions, and I selected a seller in whom I had confidence would deliver the product as agreed.
A shoppers’ market meets these conditions:
- Consumers know and can specify exactly what product or service they want to buy.
- The price of the product or service is readily available to shoppers without any obligation to buy.
- The consumer has confidence that the seller selected will deliver the product specified at the agreed-upon price.
None of the three features of a shoppers’ market are found in the HECM market, where complexities abound.
Decisions on draw amounts: Seniors often do not know how they want to receive money under the HECM — whether as upfront cash, monthly payments, credit line, or some combination of them. Making a choice can be complex because the amounts for which they qualify depend on their age, the appraised value of their home and on the prices charged by the lender. In some cases, lenders are not neutral because HECMs with larger upfront cash draws are worth more in the secondary market.
Availability of price data for shopping: There is no published, widely available data on the HECM prices of individual lenders, as there is in other well-established markets, including the market for standard mortgages. With few exceptions, lenders do not post HECM prices. But even if borrowers had ready access to interest rates and origination fees of all lenders in the market, only the few who select fixed-rate HECMs might be able to shop effectively. Those selecting adjustable-rate HECMs would be hamstrung by the dual role of interest rates in this market.
On one hand, as in other debt markets, higher rates disadvantage reverse mortgage borrowers by increasing the amount they owe and must repay. On the other hand, borrowers who defer drawing funds by holding a credit line benefit from higher rates because credit lines grow faster at higher rates. The same is true of those selecting monthly payments because these are, in effect, the equivalent of drawing a fixed amount from a growing credit line.
If they pay their taxes and insurance, their tenure is secure until they die or move out of the house permanently.
This makes price shopping for an adjustable rate HECM uniquely difficult. Effective shopping would ignore the interest rate and origination fee, focusing instead on the relevant consequences for the individual borrower. These vary from case to case and include maximum cash draws, maximum monthly payments, maximum initial credit lines, future debt and future credit lines.
Confidence in product delivery: HECM borrowers can be confident that the draw amount they were promised will be delivered because this is based on an ‘expected rate’ that is locked when the loan is reported to the FHA. However, the interest rate they end up paying on the HECM, which determines how much they will owe in the years ahead, is not locked until shortly before the closing, which exposes them to potential skullduggery. The lock price should be the price the lender would quote on an identical new transaction, which I call the ‘twin-sibling rule,’ but regulators do not monitor adherence to this rule.
The ‘gotcha’ feature: The objective of HECM lenders is to attract potential borrowers into making contact, then collecting the information needed to entangle the prospect in a process that discourages them from looking elsewhere. Prices are disclosed only after the homeowner discloses the property address, their email address and in some cases also their social security number.
Such disclosures often consist of hard copy exhibits that illustrate various HECM options available to the borrower from the lender. The formats of these exhibits are unique to each lender, defying easy comparison to those of other lenders. These exhibits can also make the borrower who wants to shop another lender feel like an ingrate.
It is not surprising that very few prospective HECM borrowers contact more than one lender. Shopping lenders for the ‘best deal’ in the way that I shopped for a camera is not possible because very few lenders post their prices for shoppers to see. Even if lenders did post prices, very few borrowers would be able to use the information effectively, for reasons explained above.
Counselors aren’t much help: HECM reverse mortgages are unique in that the law requires that every borrower must be counseled by an independent expert before submitting an application to a lender. These counselors could easily advise borrowers on whether their selected draw options made sense, and whether the price shown in the lender exhibit — most borrowers bring that to the counseling session — was competitive.
But they don’t. For one thing, that would be against HUD rules, which states that “the job of the counselor is not to steer or direct you towards a specific solution, a specific product or a specific lender.” Even if the HUD rule was removed, counselors would not provide advice on pricing because it could cost them referrals from lenders. Almost all borrowers select a lender before getting counselled, and then select a counselor from a list provided by that lender. The counselor who identifies a lender as a ‘high-priced source’ would not receive any more referrals from that lender.
There is no published, widely available data of the individual lenders’ HECM prices as compared to other well-established markets.
Poor decision-making: HECM Borrowers sometimes make poor decisions about how they will draw funds. The most common mistake is to draw cash upfront for which the borrower has no immediate use. Cash-in-hand is always tempting, and some lenders encourage this because it increases the loan amount at closing, making the HECM worth more in the secondary market. Most of the income earned by loan originators is the premium paid on the loan amount.
Creating a Shoppers’ Market for HECMs
The fear, ignorance and distrust that now pervade the HECM market would disappear if a shoppers’ market replaced the ‘gotcha’ market. A shoppers’ market in HECMs would have the following major features:
Multi-lender website: This would be the core of the market, since it is where prospective borrowers would go to explore their draw and lender options. The site would be open to any lender willing to accept the operating rules stipulated by the operators of the market.
Lender transparency: There are lenders in the HECM market employing ‘gotcha’ principles who would prefer to operate in a well-functioning competitive market if they had the opportunity. The shoppers’ market would give them the opportunity. Their major obligations would be the following:
- Transmit complete HECM prices directly to the website, without the intermediation of loan officers, in real time. Prices of adjustable-rate HECMs must include all factors affecting future rate adjustments, which can impact future debt, credit lines and borrower equity.
- Guarantee that the prices submitted to the website are as low or lower than those they offer through any other channel.
- Accept the role of the market operator as the de facto ombudsman for borrowers in the event of a conflict.
- Pay the lead fee or license fee charged by the market operator.
Competitive pricing: The website would always disclose the best lender price for the borrower, in real time.
HECM price database: The market would be the authoritative source of published data on HECM prices.
HECM calculator: Its main purpose would be to identify the combination of draw options that best meet the borrower’s needs. To do that, the calculator must have the following features:
- Use prices from participating lenders that are most advantageous to the borrower.
- Allow borrowers to try out different combinations of draw options to see the implications for future debt, credit lines and homeowner’s equity.
- Allow borrowers to try out different combinations of interest rate and origination fees, whether by different lenders or the same lender.
- Allow borrowers to monitor changes in the price of their transactions until the price is locked.
Neutral counseling support: Counselors would have no financial interest in the draw options selected by the borrower.
- Against lock abuse: Borrowers who have selected a lender can monitor that lender’s prices until their loan is locked.
- Against overcharges: Prices are sent electronically to the market from the lender’s pricing system, and cannot be changed by the loan officer working with the borrower.
- Against bad decisions on draw options: The HECM calculator provides the best possible projections of future consequences for any set of draw options.
- Against abuses by lenders: All participating lenders agree to accept the market operator’s designee as the borrower’s ombudsman.
Who Should Be the Market Maker?
There are good arguments that it should be the U.S. government. As the HECM insurer, HUD is a logical choice because a shoppers’ market will reduce interest rates and origination fees, which will reduce loan balances and claims against the insurance reserve fund. In a similar vein, the major responsibility of the Consumer Financial Protection Bureau is protecting consumers, and a shoppers’ market in HECMs will result in much greater protection for seniors than lawsuits against malefactors and a complaint hotline. However, unless the HECM market issue becomes political, the likelihood that either agency will do it is vanishingly small.
In all probability, the market maker will have to come from the private sector. Useful characteristics would include a good name, internet-based access to millions of consumers, and an interest in public service. A driving force, of course, would be the prospect of generating revenue, probably in the form of lead fees paid by lenders.