A high number of retirees have equity in a home that could generate additional income, but few see the Home Equity Conversion Mortgage (HECM) as a viable option. In this opinion piece, Wharton emeritus finance professor Jack Guttentag, who runs a website called The Mortgage Professor, offers suggestions on how the HECM market could be substantially improved.
People reaching retirement age are living longer than ever, and retiring with less capacity to maintain their living standards. The Center for Retirement Research at Boston College estimates that more than half of the households entering retirement “may be unable to maintain their standard of living in retirement.”
Yet a sizeable segment of retirees have equity in a home that could generate additional funding through the use of a Home Equity Conversion Mortgage – the only variety of reverse mortgage insured by the federal government. The HECM program is well-designed and provides options for meeting a wide variety of retirees’ financial needs. Yet few seniors use it. At current rates, only about 60,000 HECMs will be written in 2015, which is a drop in the bucket compared to the need. To put this in perspective, about 3 million homeowners turn 65 every year.
The stunted growth of the HECM program mainly reflects market failure, as opposed to a considered preference by senior homeowners not to participate. For reasons explored in my working paper titled, “HECM Reverse Mortgages: Is Market Failure Fixable?,” the HECM market is the most dysfunctional and least competitive of all the major financial service markets. Lenders don’t display their prices anywhere, and borrowers don’t price shop. Most originators always charge the maximum origination fee allowed by law, regardless of how much they are making on the transaction. Markups are 2.5 to 3 times larger than in the standard mortgage market, though the work load involved in writing an HECM is much the same.
Some years ago, I decided to invest the money I had made in a moderately successful business venture in developing and maintaining a website to help consumers deal with home mortgages, later extended to reverse mortgages. My partners in this effort were Daryl Tubbs, Jack Pritchard and Allan Redstone. As I became aware of how and why the reverse mortgage market was so dysfunctional, I also realized that some of the tools my colleagues and I had developed to improve decision-making, if deployed more widely, could substantially improve the market. This article summarizes our game plan, which requires help from a number of quarters.
Establishing an Identity: Our approach to fixing the dysfunctional HECM market is to create an identifiable segment of the market that is functional, which over time will replace the segment that is not. For this to work, the new segment must have an easily recognizable identity that is associated with the features that distinguish it from the dysfunctional segment. Thus was born the “Kosher HECM,” with apologies to my Orthodox Jewish friends, for whom the term kosher means so much more.
“The stunted growth of the HECM program mainly reflects market failure, as opposed to a considered preference by senior homeowners not to participate.”
The Kosher HECM is designed to maximize the benefits a senior receives from a reverse mortgage, and avoid the hazards inherent in a very complicated transaction. The following are its major features as compared to the non-kosher alternatives.
Optimizing the Selection of HECM Options with the Kosher Calculator: A major positive feature of HECMs is the wide range of options available to seniors for withdrawing funds. They can draw cash up front, get a monthly payment for a specified period, take a credit line, or combinations of two or three of these. In addition, they can alter these combinations in the future. But this introduces enormous complexity, and a danger that the borrower may make poor choices.
To reduce this risk, we created a Kosher HECM calculator that allows a senior to see exactly what the options are in the sense of, e.g., “If I take less of this, how much more can I draw of that?” The calculator determines option amounts using the lowest of the competitive prices posted by participating lenders. In addition, the calculator shows the changes in the senior’s future finances that would result from any combination of options taken now.
The Non-Kosher Alternative: No existing calculator shows users the tradeoffs between different draw options, or the consequences for their future finances. Part of our game plan is an offer to license and maintain the Kosher HECM calculator at no charge for HUD, the Consumer Financial Protection Bureau and perhaps others. It can be accessed here.
Optimizing the Selection of HECM Options with Disinterested Option Experts: Because not all seniors can navigate the Kosher HECM calculator on their own, we have created a group of “option experts” to offer seniors free and disinterested help in assessing Kosher HECM options when they are in an exploration stage. The option experts are a select group of reverse mortgage brokers and loan officers who are proficient in the use of the calculator, who will advise on how best to integrate an HECM into a longer-range retirement plan, and who provide their services pro bono.
Seniors will be assigned to an expert who is not licensed to originate loans in the senior’s state. This eliminates any financial inducement to steer a session in one or another direction. The experts have no financial interest in whether or not the senior ends up with a HECM.
The Non-Kosher Alternative: Draw option decisions are often made haphazardly, usually to meet pressing financial needs. There are no financial tools that balance one type of draw against others or project results over future years.
The loan officers or brokers involved in a transaction may be competent and conscientious, but they also have a financial interest in a deal getting done, and an even bigger interest in writing a deal with a large initial loan amount. Selecting a loan advisor is a crap shoot, and borrowers have no chance to learn from their mistakes.
While HUD requires seniors to consult independent counselors before applying for a HECM, these counselors do not involve themselves in whether or not the senior is making the right decisions regarding HECM options. Under HUD protocols, that is not viewed as part of a counselor’s charge.
Options for withdrawing HECM funds introduce “enormous complexity, and a danger that the borrower may make poor choices.”
Obtaining Competitive Prices: Participating loan providers post their interest rates and origination fees on www.mtgprofessor.com, using a pricing widget we designed to assure all price bases are covered. Seniors can select the loan provider offering the best price on their desired options package. Since the price consists of both an interest rate and an origination fee, the Kosher HECM calculator shows the rate/fee combination that generates the lowest debt over a future period specified by the senior.
The Non-Kosher Alternative: Borrowers do not price shop because there are no prices to shop. There are no published data on HECM prices, and very few lenders post prices on their websites. NRMLA, the trade association of reverse mortgage lenders, lists over 200 members with websites. We found only one that posted both rates and origination fees.
Price sheets distributed by lenders to their loan officers show a wide range of acceptable prices, and a corresponding range of markups. This indicates an extraordinary amount of discretion and indeterminacy in the prices.
Price Lock Protection: The Kosher HECM pricing system assures that the price that is locked shortly before the closing is identical to the price that would be quoted to the senior’s identical sibling pricing the identical transaction. This is the “twin sibling rule.” The senior can always verify that their lock price is correct by checking it on the site as a shopper.
The Non-Kosher Alternative: Seniors are highly vulnerable to lock abuse because the mortgage price is not locked until shortly before closing, while the expected rate used to calculate draw amounts is locked at time of application. With the draw amounts fixed, seniors may pay little attention to the mortgage price when it is locked, especially if the market rate falls prior to the lock date. Under those circumstances, the lender should reduce the rate, but there is no one around to question a decision to do nothing.
Multiple Price Combinations: Loan providers who post prices on the Kosher HECM network offer multiple combinations of interest rates and upfront origination fees. This meets the needs of seniors with different expectations regarding how long they will have the reverse mortgage — including seniors with short time horizons who seek HECMs with low or no upfront costs
The Non-Kosher Alternative: While it has long been commonplace in the standard mortgage market to offer a variety of price combinations, it is very uncommon in the reverse mortgage market.
Availability of Ombudsmen: The built-in protections notwithstanding, something may go wrong. If it does, I or my designee will act as an ombudsman for the senior.
The Non-Kosher Alternative: There is none.
Availability of Market Data: A well-functioning market generates the operating data that participants need to make rational decisions. We developed data on Kosher HECM prices and draw amounts in a series of tables that are updated as needed. Kosher Reverse Mortgage Tables are available at no charge and with free maintenance for anyone who wants to repost them.
The Non-Kosher Alternative: There is none.
Comments and questions can be left at http://www.mtgprofessor.com.