Reverse mortgage (RM) loans are hybrid financial products that allow elderly homeowners to borrow against the collateral of their housing wealth. However, in contrast to a regular loan, the key element of a reverse mortgage contract is that the homeowner is not required to pay off the debt or make interest payments on the loan as long as he or she chooses to stay in the house. A reverse mortgage loan has to be paid off only if and when the homeowner decides to either move out or sell the house, or when the last surviving borrower of the loan passes away. Additionally, reverse mortgages offer an option for low-income homeowners, who would otherwise not qualify for home equity loans, to borrow money by converting their housing equity [1
]. Reverse mortgage loans can provide a financial buffer for elderly households that lack adequate retirement savings, or for those who are severely credit constrained. An alternative to borrowing against housing wealth would be for the elderly to sell their homes; the benefit of taking out a reverse mortgage loan instead is that the elderly homeowners do not have to move out or sell their homes to meet their financial obligations. The seminal paper on this subject by Rasmussen, Megbolugbe, and Morgan [2
] suggests that approximately 80% of older homeowners could benefit from taking out a reverse mortgage loan. Although the market for reverse mortgages has been growing steadily, it is still very small, with only about 2% of the eligible elderly homeowners reporting borrowing against their housing wealth [3
]. Nakajima and Telyukova [4
] find that households with low incomes, modest wealth, and poor health were most likely to benefit from reverse mortgages.
In addition to the financial liquidity afforded to otherwise financially constrained consumers, reverse mortgages also offer other benefits. According to a study by Apgar and Di [5
], a reverse mortgage provides a convenient alternative to many financially struggling older homeowners who are unwilling to downscale by selling their larger homes and moving to smaller homes. The trend of increasing number of households retiring with inadequate savings is expected to continue, as many of the employer-sponsored retirement plans have moved from a defined benefit plan (in which employers guarantee a retirement pension) to a defined contribution plan (in which employers match employee contributions up to a point, but the responsibility for saving for retirement rests with the employee). Due to the two large stock market downturns over the past 15 years, many recent retirees may look favorably upon reverse mortgages as a way to supplement their retirement income needs [6
]. Low participation rates of eligible households in the reverse mortgage market could be due to lack of information or to homeowners’ suspicion of such products. Additionally, Epstein [9
] argues that, although reverse mortgages provide substantial liquidity, these products may not be sufficient to provide households with a sustainable retirement income. The Great Recession of 2008 also showed that the volatility then present in the real estate markets could lower the actual principle of the house to a value lower than the amount of the loan taken out by many elderly homeowners. The Epstein [9
] study also finds that tapping into the housing equity through a reverse mortgage could be suitable for households in sudden need of liquidity resulting from the death of a spouse or due to deteriorating health.
There are two other important considerations for households deciding whether to take out a reverse mortgage. First, any money drawn potentially reduces inheritance that the elderly individuals would otherwise have given as a bequest. Second, converting housing assets to cash could adversely affect Medicaid eligibility for many households, since housing is exempt from Medicaid’s eligibility calculator, while cash is not.
Features of a Reverse Mortgage:
Reverse mortgage (RM) loans can be taken as a lump sum payment, as a fixed periodic annuitized set of payments, as a line of credit, or as a combination of any of these three types of distributions [10
]. In contrast to home equity loans, reverse mortgage participants do not have to pay interest on the loans they borrow. The amount of reverse mortgage loan that a homeowner can receive depends on the prevailing interest rates, and thus the amount of RM that is available to an individual is inversely proportional to the prevailing interest rate. Therefore, homeowners can borrow more when interest rates fall, and can borrow less when interest rates rise. The amount of RM loan available to a borrower also depends on the borrower’s age and the value of the house. The largest and most popular type of reverse mortgage, known as a Home Equity Conversion Mortgage (HECM), is administered by the Federal Housing Administration (FHA). HECM reverse mortgage loans account for more than 90% of all reverse mortgage loans originating in the American markets [11
]. HECM mortgages are available only to homeowners age 62 or older who live in their houses. The HECM applicants have to go through a mandatory HUD-approved homebuyer counseling session to be eligible for HECM loans.
The purpose of this study is to examine the determinants of elderly households’ participation in the reverse mortgage market. Specifically, the study examines whether factors suggested in previous literature, including households’ socioeconomic status, health, and marital status, as well as bequest motives, affect their decision to participate in the reverse mortgage market. In addition, the paper examines whether behavioral factors, such as the households’ financial planning horizon, risk aversion, perceived health status, and longevity expectation, are associated with their decision to look into a reverse mortgage. This paper also examines whether having long-term care insurance is negatively associated with the demand for reverse mortgages among elderly homeowners.
Reverse mortgages provide an opportunity for individual investors to diversify their portfolio. One recent study by Salter and Pfeiffer [17
] suggested that reverse mortgages, if used strategically, can work like an additional line of credit in case of financial emergencies. The Salter and Pfeiffer [17
] study suggests that using reverse mortgages as a retirement planning tool can reduce the risk in an individual’s investment portfolio and can reduce the longevity risk in a retiree’s portfolio. The findings from the current study indicate that risk averse individuals were more likely to participate in reverse mortgages. The potential benefits of reverse mortgage in reducing risk within individual retirees’ portfolios [17
] create a discussion opportunity for financial advisers when providing investment recommendations to their risk averse clients. Reverse mortgages can also be used effectively as a tool for estate planning purposes. Life expectancy has increased over time, with many individuals living beyond 80. Therefore, when receiving bequests, the average age of the beneficiary children in many cases will be older than 60. The elderly households could instead use reverse mortgages to borrow from their equity, and make intergenerational transfers to their children or grandchildren while they are younger and need the money more. Merton [18
] has suggested greater potential for reverse mortgages to play this role in making intergenerational wealth transfers more efficient, practical, and enjoyable for elderly households. However, the low participation rate for reverse mortgage identified in this study can be attributed to people’s lack of knowledge of the true utility of reverse mortgages as a retirement and estate planning tool [19
]. Financial planners need to be aware of these potential advantages of reverse mortgage loans in order to advise their clients effectively regarding their retirement portfolios. Munnell [6
] suggested that one reason for the small participation rate was that the currently available reverse mortgages were expensive. She suggested that the reverse mortgage market needed the government to take a more active role in the future, in providing guarantees or subsidies, in order to make the reverse mortgage market more efficient and liquid. Perhaps the creation of a secondary market for reverse mortgage loans could also increase liquidity and bring in greater industry participation in the RM market. Another interesting finding of this study was that having long-term care insurance coverage was negatively associated with having a reverse mortgage loan. This finding provides further support to Mitchell and Piggot’s [20
] findings that many people used reverse mortgages as a tool to meet their long-term care needs.
The results of this study reveal several interesting nuances in older homeowners’ decision to have reverse mortgage loans. This study finds that households with individuals younger than 66 were less likely to take out reverse mortgage loans, while households in the two top quartiles of net worth were more likely to participate in reverse mortgages. It is possible that at a later stage in their retirement many households understand the potential inadequacy in their retirement savings and thus explore options, including reverse mortgages, to supplement their income later in retirement. Previous studies suggest that reverse mortgages could be useful financial products for people with modest savings, people with poor health, and unmarried people [2
]. However, the results of this study indicate that households with a greater stock of human capital—higher net worth, better educational attainment, and higher income—were more likely to have reverse mortgages. From a policy perspective, more can be done to make reverse mortgages accessible to the eligible low-income households. Programs to educate lower income, low net worth, and less informed homeowners about the possibility of accessing a reverse mortgage loan could be very beneficial to qualified retirees.
Previous research suggests that although the personal residence accounts for the largest percentage of an elderly household’s net worth, few people are willing to sell their homes and downscale in order to monetize their assets for use in retirement. A reverse mortgage provides an opportunity for those households that may not have sufficient liquid assets or financial savings to convert some of their housing wealth to cash without needing to move or sell their residences. As baby boomers—the largest cohort of our population—continue to retire, reverse mortgages have the potential to benefit a number of these homeowners. This provides an opportunity for financial planners, non-profits, the government, and advocacy groups for retirees to educate elderly households about the potential benefits and pitfalls of using reverse mortgages as a retirement tool. One limitation of this study was the small number of respondents who reported having reverse mortgage in the HRS dataset. Further research is needed to examine the awareness of and demand for reverse mortgage products, perhaps using a more targeted dataset that includes a large number of reverse mortgage participants.