Challenges for Reverse Mortgages

A reverse mortgage is a home loan available to seniors at least age 62 who have substantial equity in their homes. No payments must be made while the borrower remains living in the house. Interest accrues on the principal; the entire loan is repaid when the borrower moves, dies or sells the home. It is a non-recourse loan, which means the borrower is not personally responsible for repayment. Nearly all reverse mortgages are issued under a program run by the Federal Housing Administration.

Housing Values

• Housing values pose the single most significant challenge to reverse mortgages. Census records between 1940 and 2000, and national real estate sales data through spring 2010, demonstrate that U.S. median home values more than quadrupled over this time period. Gains are evident for every single decade within this 70-year span. However, within these decades there were periods of decline, most notably from 2006 to 2010. Housing values have to appreciate for the economics behind the program to work. How well the reverse mortgage program can work with intra-decade declines has yet to be fully revealed.

Exclusive Borrower's Benefits

• If the value of a home goes up significantly more than the value of the reverse mortgage loan balance, the borrowers or his heirs profit -- this spare equity goes to them. If the home value goes down and doesn't cover the loan balance, the borrower also benefits because he is not responsible for repayment. He got the benefits without risk. This is great for the borrower but puts the entire lending process at risk because in good times the FHA gains only incremental increases to the mortgage insurance fund by way of mortgage insurance payments, but when the market goes down substantially and for a lengthy period, the fund is wiped out. It is the mortgage insurance fund that repays lenders any difference between the home value and the loan balance when the loan is repaid.

Over-Reliance

• Reverse mortgages are a valuable tool in a retirement arsenal. But seniors cannot hope to rely solely on Social Security and a reverse mortgage to get them through retirement. With the median U.S. home value hovering under $200,000 as of mid-2010, the median maximum loan amount for a reverse mortgage would be under $120,000 for a 62-year-old borrower. That's a nice sum but hardly enough to last 20-plus years if the borrower has only a small Social Security benefit.

Appropriations

• The FHA reverse mortgage program was supposed to have been self-sustaining. Mortgage interest premiums were planned as a reserve that could repay lenders in the case of housing values not meeting loan balances. The recession, however, threw an unexpected and particularly large monkey wrench into that plan. The mortgage insurance fund is not large enough to cover the difference between home prices and home values in a steeply declining housing market. If borrowers benefit whether housing values go up or down, Congress must be prepared to fund the program through periods of sustained decline or the FHA must be prepared to substantially increase mortgage insurance premiums.

Significance

• A Center for Retirement Research study that looked at the early effects of the recession concluded that, as of 2009, over half of all seniors nearing retirement were at risk of not being able to maintain their pre-retirement standard of living into retirement. Reverse mortgages may be one of the few tools homeowners can use to help bridge the gap.