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How Much Could Reverse Mortgages Contribute to Retirement Incomes?

Publication Date: September 01, 2008
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Abstract

Retirees who want to stay in their homes can tap into home equity through a reverse annuity mortgage that pays them a tax-free monthly payment. We show that conversion of home equity into a reliable income stream could provide a significant boost in retirement income, particularly for low-income homeowners with significant equity. The cost of initiating a RAM, however, and many older adults' concerns about borrowing against this asset have limited interest in RAMs. Recent turmoil in the mortgage market and declines in home prices raise additional uncertainties about the potential for using home equity to boost retirement incomes.


Introduction

Financially strapped older homeowners may be able to use the equity in their homes to shore up their retirement incomes (Munnell et al. 2007; Kohl 2007), and they don’t need to sell their homes to do it. Retirees who want to stay in their homes can tap into home equity through a reverse annuity mortgage (RAM) that pays them a tax-free monthly payment. Even taking into account the recent decline in house prices, RAMs can significantly boost homeowners’ incomes, but by how much? And what should homeowners watch out for when relying on retirement income through RAMs?

For many older adults, home equity represents their largest financial asset (Weller and Wolff 2005). Traditionally, older households have not tapped into their home equity unless some adverse event, such as the death of a spouse, forces a sale (Venti and Wise 2004). However, as home equity values have increased substantially over the previous decade, even accounting for the recent downturn, retirees may be more tempted to turn to their homes to help finance their retirement.

While only 400,000 reverse annuity mortgages have been originated through 2007, they are increasing in popularity—more than 100,000 loans originated in 2007 compared with some 6,600 in 2000 (NRMLA 2008). Many more older households use a home equity line of credit (HELOC) to tap into property value, but these loans need to be repaid right away. RAMs, in contrast, continue to generate income and do not need to be paid off until the house is sold. RAMs, therefore, may be the only solution for low-income older retirees who are less likely to qualify for a loan or line of credit that requires repayment to begin immediately.

In this brief, we use data from the Health and Retirement Survey (HRS) and estimate the potential for RAMs to increase older adults’ annual household income. The HRS data show that home equity values, after adjusting for inflation, have increased dramatically for older households from 1998 to 2006. Increases for homeowners have been uneven, favoring whites and Hispanics relative to blacks, and high-income homeowners relative to those in lower-income brackets. Homeowners in the lowest-income groups would receive relatively higher-percentage income gains from RAMs, as would single homeowners over married couples. RAMs provide the largest relative benefit to homeowners in the oldest age groups (since there are fewer years of payout). However, relatively low homeownership rates for low-income, single and the oldest seniors dampen the median boost to income for all older households in these groups.

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