New Risks to Consumers

This chapter has identified five key trends present among reverse mortgage borrowers:

• Today’s prospective borrowers are more likely to have substantial existing mortgage debt and/or consumer debt than the general population of older homeowners, and they are more likely to have mortgage debt than borrowers in the past.

• Borrowers are taking more cash upfront than in the past.

• Borrowers are more likely to be in their 60s at origination than in the past.

• Borrowers in their 60s are more likely to have substantial existing mortgage debt than older borrowers.

• Borrowers in their 60s are more likely than older borrowers to choose a fixed-rate, lump-sum product.

Taken together, these facts suggest that borrowers today are increasingly using reverse mortgages as a way to refinance existing mortgage debt – while eliminating their monthly mortgage payments – early in their retirement or even before reaching retirement. Data obtained by the CFPB from one reverse mortgage lender supports this conclusion. This pattern of use is very different from what was originally intended when the product was first developed, and poses several significant risks to the consumer.

The original purpose envisioned for reverse mortgages was to enable older borrowers to convert home equity into cash they could use to help meet expenses in retirement.¹⁶⁶ Borrowers could choose between an income stream for everyday expenses, a line of credit for major expenses (such as home repairs and medical expenses), or a

combination of the two. It was anticipated that most, though not all, borrowers would use their loans to age in place, living in their current homes for the rest of their lives or at least until they needed skilled care. Upon the borrower’s death, or upon leaving the home, the borrower or the estate would sell the home to repay the loan and would receive any remaining home equity.

When borrowers instead use reverse mortgages as a method of refinancing an existing mortgage (or other debt), they essentially devote their existing home equity to servicing the debt on the property. While they gain additional cash flow (that previously was going to mortgage payments) for a period of time, they lose the ability to use their home equity as a cushion against other major expenses in retirement, such as needed

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home repairs or medical expenses. This risk is greater for the new surge of borrowers in their 60s with sizeable traditional mortgage balances and long life expectancies.

Refinancing a traditional mortgage with a reverse mortgage may well be a good choice for borrowers in their 60s who have adequate retirement resources to cover everyday expenses and who are unable to continue working or whose employment income does not support the current mortgage. This type of borrower receives something of considerable value – the ability to remain in the current home indefinitely – in exchange for assuming a rising loan balance that will slowly consume the borrower’s remaining equity.

Even for this relatively stable prospective borrower, however, choosing a reverse mortgage early in retirement is a riskier decision than it is for older borrowers with similar financial circumstances. Borrowers in their 60s have longer life expectancies than borrowers in their 70s. If borrowers in their 60s succeed in aging in place, they will most likely use up all of their home equity, but they will receive considerable benefit in exchange for that home equity. But if borrowers in their 60s do not succeed in aging in place indefinitely – if, due to health or other reasons they need to move at some point in their 70s or 80s – they are at high risk of having used up all of their home equity and having no financial resources with which to finance their move.

Meanwhile, if prospective borrowers do not have adequate savings and other retirement resources and are instead struggling to make ends meet, using a reverse mortgage to refinance an existing traditional mortgage can result in even greater long-term financial risk to the borrower. Some prospective borrowers’ financial situations may be

fundamentally unsustainable. Using a reverse mortgage to hold on to the home for the near term may simply postpone hard decisions, provide little long-term benefit to the borrower, and consume most or all of the borrower’s home equity in the process. This type of borrower is at high risk of getting behind on taxes and insurance, and facing foreclosure on the reverse mortgage.

According to an industry poll, the vast majority of older homeowners say that they want to live in their homes for the rest of their lives.¹⁶⁷ Nonetheless, some do

downsize.¹⁶⁸ Some portion of younger borrowers might be using reverse mortgages as a medium-term financing tool to increase cash flow prior to downsizing or otherwise selling their homes. In this case, there is less reason to be concerned that younger borrowers may be jeopardizing their long-term financial stability by tapping their home equity too early. However, traditional mortgage products may be more suitable for these borrowers than a reverse mortgage. Reverse mortgages carry a sizeable insurance premium to cover the risk that at the time the loan is repaid the loan balance will exceed the value of the home, either because the borrower outlived the actuarial tables or because home prices declined. If younger borrowers do not intend to live in the

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home long enough to need this coverage, traditional mortgage or HELOC financing may be a better option for those who can qualify.

In sum, reverse mortgage borrowers in their 60s, especially those seeking to refinance a sizeable traditional mortgage balance, are at higher risk than other borrowers of finding themselves with few financial resources with which to cover unexpected expenses or finance a move later in life. Prospective borrowers in their 60s with few other retirement resources may simply be prolonging an unsustainable financial situation by using a reverse mortgage to refinance a traditional mortgage. And prospective

borrowers in their 60s seeking to use a reverse mortgage as a way to increase cash flow for a few years before moving may find that traditional mortgage products are better suited to their situation.

Some borrowers also appear to be taking a lump sum upfront without refinancing a traditional mortgage. They too face increased risks of having fewer resources to draw upon later in life. Borrowers who save or invest the proceeds may be earning less on the savings than they are paying in interest on the loan, or they may be exposing their savings to risky investment choices. These borrowers also face increased risks of being targeted for fraud or other scams.

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4. Market

The reverse mortgage market has changed dramatically in the past few years.

Proprietary products, which had proliferated during the mortgage boom in 2006 and 2007, completely evaporated in the subsequent recession. In late 2007, Ginnie Mae^o introduced a new securitization model that led to the development of a new fixed-rate product in which borrowers are required to take all of their authorized loan proceeds upfront in a lump sum. In early 2008, FHA issued guidance stating that this fixed-rate product could be structured as a closed-end loan. In April 2009, Fannie Mae,^p which had been the dominant secondary-market purchaser of HECM loans since the

program’s inception, began scaling back its presence in the market. In its place, Ginnie Mae-backed HECM Mortgage-Backed Securities (HMBS) have become the nearly exclusive secondary-market instrument.

In mid-2009, changes in the interest rate environment coupled with the exit of Fannie Mae and the shift to the Ginnie Mae securities altered the cost and benefit calculus – for both consumers and lenders – of adjustable rate HECMs as compared to the new fixed-rate, lump-sum HECMs. In less than six months, the market share of fixed-rate HECMs swung from less than 10 percent to more than 60 percent of originated HECMs. Since August 2009, the market share of the fixed-rate, lump-sum product has ranged between 60 percent and 75 percent.

In October 2010, FHA introduced a variety of policy changes including a new product, the HECM Saver, which virtually eliminates the upfront mortgage insurance premium in exchange for lower proceeds available to the borrower. FHA also lowered the loan proceeds available to Standard HECM borrowers.

o Ginnie Mae is a special-purpose government-sponsored secondary market facilitator dedicated to facilitating the securitization of FHA-insured mortgages.

p Fannie Mae and Freddie Mac are government-sponsored enterprises, also known as GSEs, dedicated to facilitating the securitization of traditional, non-FHA insured residential mortgages.

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In early 2011, the two largest reverse mortgage lenders, Wells Fargo and Bank of America, announced their exit from the market. In April 2012, the largest remaining lender, MetLife, also announced its exit. These three lenders had large retail lending operations. With their departure, the market has become much more heavily dependent on mortgage brokers and small correspondent lenders.