Reducing Default Rates of Reverse Mortgages

For many U.S. households, Social Security benefits and 401(k) assets will not provide enough for a com­fortable retirement. To supplement these sources, homeowners could turn to their other major asset: home equity. One way to tap home equity is through a reverse mortgage, which does not need to be paid back until the borrower dies, sells the house, or moves. The most common reverse mortgage is the Home Equity Conversion Mortgage (HECM), which is regulated by the U.S. Department of Housing and Urban Development (HUD). The HECM program insures both borrowers and lenders against certain risks but, in the wake of the financial crisis, rising loan defaults raised concerns about the program’s solvency. In response, HUD an­nounced new rules in 2013 to limit a borrower’s ini­tial withdrawals and require an up-front assessment of an applicant’s ability to pay property taxes and homeowner’s insurance. The goal of these changes is to lower default risk without significantly restricting access to reverse mortgages. This brief summarizes the results of a recent study that estimates the effects of such changes on both defaults and take-up of reverse mortgages using a unique dataset of applicant and borrower characteristics and loan activity. The brief proceeds as follows. The first section provides a primer on reverse mortgages and the re­cent HUD changes. The second section describes the dataset. The third section examines which borrower characteristics help predict defaults and take-up. The fourth section simulates how policy changes to impose initial withdrawal limits and underwriting standards – similar to those enacted by HUD – could affect defaults and take-up. The final section con­cludes that both policy changes are likely to reduce defaults, with only a modest impact on take-up.