During my lifetime, retirement planning has become more and more challenging. People are living a lot longer, which makes retirement periods longer, and fewer people retire with employer-provided defined benefit pension plans. On the positive side of the ledger, the rate of homeownership is higher, home equity is a major part of the wealth of seniors, and we now have the HECM reverse mortgage program that allows home owning retirees to convert that equity into spendable funds. This is a well-designed program with government insurance protecting both the retiree borrowers and the lenders who fund them.
The problem is that very few homeowner retirees use the program. While about a million homeowners retire every year, fewer than 60,000 HECMs will be written this year.
WHY THE HECM MARKET IS STUNTED
The fundamental reason is that most senior homeowners view reverse mortgages with anxiety, suspicion and distrust. HECMs are complicated, and very different from the mortgages they used to buy their homes many years earlier. Further, the capacity of retirees to process information about something that is new and complex is not what it had been. In addition, their home is at stake and the last thing they want to do is risk losing it.
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While seniors see many ads for reverse mortgages, they don't recognize any of the lender names. And while TV ads using celebrity spokespersons succeed in attracting some seniors to individual lenders, the ads repel many others; on balance, they may shrink the market.
The market for HECMs is highly dysfunctional. Marketing costs are high and markups are 2 to 3 times larger than they are in the forward mortgage market. There is no way for prospective borrowers to shop effectively for the best deal, which is itself a major source of anxiety.
MANDATED COUNSELING DOESN'T HELP
Because the Federal Government insures HECMs, and because elderly homeowners are a politically sensitive constituency, the HECM market is highly regulated. Under a counseling requirement that is unique to reverse mortgages, HECM lenders cannot accept an application from a borrower unless the borrower presents a certificate attesting to the successful completion of a mandated counselling session with a certified counselor committed to covering a long list of topics required by HUD. The problem with the list of counseling topics is that its focus is preventing sins of commission, where seniors take reverse mortgages who shouldn't. But the major problem is sins of omission, where seniors who badly need a reverse mortgage, don't take one. The existing counselling system doesn't deal with this problem.
THE COUNSELING SYSTEM THAT IS NEEDED
It should focus on the threefold problem of the senior contemplating a HECM reverse mortgage:
– Defining future financial status, including sources of retirement income, financial assets and their earnings, and planned lifestyle expenses.
– Fitting a HECM into the retirement plan in the most advantageous way possible, taking advantage of the multiple HECM options that are available, and the flexibility the program offers to change options in response to changing needs.
– Finding the lender offering the best terms on the HECM option that is needed.
Here is an over-simplified illustration. John is 62, intends to work until he reaches 67, and has a deferred annuity that he purchased some time back that will begin payments when he reaches 75. During the 8 years after he retires until the annuity kicks in, he will be short of spendable funds. John will use a HECM to supplement his income during that period. To do that, he will take a credit line at 62, allow it to grow for 5 years, at which point he will use some or all of it to purchase a term payment for 8 years. Whatever part of the line he does not need for the term payment he will retain as a reserve for future contingencies or special occasions.
Having identified the HECM he needs, John can now shop lenders for the best deal. He will be interested in the largest possible 8-year term payment beginning in 5 years. If he has concerns about his estate value, he will also be interested in how much he will owe on that HECM at some future time. The lenders John solicits will be obliged to generate the projections specific to his needs.
In sum, a central objective of a HECM counseling system should be to identify the HECM option that best meets the senior's expected future needs. The existing counseling system is so permeated by HUD's fear that seniors will be led astray that it discourages this type of analysis. In its instructions to applicants who are preparing to be counseled, HUD says "The job of the counselor is not to 'steer' or direct you toward a specific solution, a specific product, or a specific lender."
EXISTING MANDATORY DISCLOSURES ARE A TRAVESTY
Disclosure requirements are far more extensive than those applicable to forward mortgage borrowers. The packages are prepared by a lender or a counselor, depending on which one the senior contacts first; usually it is a lender. Since the borrower has not been counseled on the HECM option that best meets her needs, the documents must cover a range of possibilities, which is one reason the packages are so large. A recent document package I looked at had 97 pages covering a wide range of possible options that might or might not have had any bearing on the needs of the senior receiving it. She is expected to educate herself from an information fire hose.
Whether on balance these documents do more good than harm is debatable. Some seniors find the package so forbidding that they drop out of the market altogether.
DEVELOPING A NEW COUNSELING SYSTEM
The key to developing a HECM market structure that will work for seniors is a counseling system that focuses on identifying the specific HECM option that best complements the individual senior's financial situation. This is critical because a loan market will not work effectively if borrowers don't know what they want. The system must be independent of lenders yet have access to current HECM pricing. Since no one else seems inclined to do this, my colleagues and I have decided to do it ourselves. Stay tuned.
ABOUT THE WRITER
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. Comments and questions can be left at http://www.mtgprofessor.com.