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1 Qualitative Research of Reverse Mortgages QUALITATIVE RESEARCH OF REVERSE MORTGAGES: FOLLOWED BY QUANTITATIVE ANALYSIS OF VIRGINIA’S HECM REVERSE MORTGAGE MARKET A THESIS Presented to The Faculty of the Department of Economics and Business The Colorado College In Partial Fulfillment of the Requirements for the Degree Bachelor of Arts By Will Grossman May 2017 1 QUALITATIVE RESEARCH OF REVERSE MORTGAGES: FOLLOWED BY QUANTITATIVE ANALYSIS OF VIRGINIA’S HECM REVERSE MORTGAGE MARKET Will Grossman May 2017 Economics, Business Track Abstract Home Equity Release Products, commonly referred to as reverse mortgages, allow people 62 and older to sell equity or future appreciation in a home they own in return for liquid currency. The consumer of the product enters a contract that allows them to reside in the home and not pay back the loan until the primary borrower dies, moves out, or sells their home. The attraction of this special type of mortgage is that it allows people to smooth income at an older age. This is very important considering it increases financial safety to our aging population. After reading this thesis, I hope you have a better understanding of the reverse mortgage products offered in the United States, and understand why they are important in this day and age. After reading this you should also have an understanding of the regression models and can see how different independent variables can affect the length of a reverse mortgage contract. We live in a country where the population is aging and people are living longer, thus understanding how these reverse mortgage products work will increase financial safety to our elderly, taking burden off of younger generations. KEYWORDS: (HOME EQUITY RELEASE, MORTGAGE, REVERSE MORTGAGE, SHARED APPRECIATION, AGING POPULATION, ASSISTED LIVING, HECM, RISK) 2 ON MY HONOR, I HAVE NEITHER GIVEN NOR RECEIVED UNAUTHORIZED AID ON THIS THESIS Will Grossman Signature 3 Acknowledgement I would like to take a moment to thank the people who have helped me throughout this thesis. My advisor, Ester Redmount, helped organize my thoughts into a thesis I could write, and has been very honest and helpful in her approach to advising me. Without her help I would not have been able to write this thesis, thus I am very grateful for the time she has spent advising me. I would also like to thank Kevin Rask, as he helped to remind me that the data does not necessarily have the dependent variable I am looking for, but rather I can draw empirical and quantitative conclusions by using duration as a proxy to substitute for the dependent variable I wanted, but was not available. Aside from Ester and Kevin I would like to thank everyone listed in my sources cited at the end of my thesis. My work has been made possible by these people and sources, and without their help and informative articles I would not have been able to understand the reverse mortgage market like I do now. 4 TABLE OF CONTENTS I. INTRODUCTION……………………………………………….. 7 II. AGING AMERICA ……………………………………............... 12 a. Cost Burden………………………………………………...... 14 III. LITERATURE REVIEW………………………………………... 16 IV. Barriers to Entry………………………………………………...... 25 V. PRODUCTS…………………………………………………........ 26 a. Lifetime Mortgage…………………………………………...... 26 b. Reverse Mortgage……………………………………………... 27 c. Home Reversion……………………………………………...... 28 d. Shared Appreciation Mortgage..……………………………..... 30 e. Drawdown Mortgage……..………………………………….... 30 VI. Product Risks……………………………………………………... 30 a. Risks to Lifetime Mortgage…….........……………………...... 30 b. Risks to Reverse Mortgage………………………………........ 33 c. Risks to Home Reversion …………………………………..... 34 d. Risks to Shared Appreciation ………………………………... 35 e. Risks to drawdown mortgage ……………………………....... 35 VII. Other Risks……………………………………………………...... 35 a. Aging Risk…………………………………………………..... 35 b. Borrower Risk……………………………………………….... 36 c. Lender Risk…………………………………………………… 37 VIII. Loan Payment………….…………………………………………. 37 IX. Data……………………………………………………………….. 38 X. HECM……………………………………………………………... 40 5 XI. Model………………………………………………………........... 41 XII. Data Analysis and Stata tables…………………………………..... 42 a. Co-Borrower vs. No Co-Borrower…………………………..... 42 b. Gender……………………………………………………….... 44 c. Continued Analysis……………………………………………. 46 d. Model Part II, Explanatory Variables…………………………. 46 XIII. Conclusion………………………………………………………… 48 XIV. References………………………………………………………….. 50 6 Introduction As we get older we run the risk of having unforeseen expenses arise. As a whole, our population is aging, which means people are living longer and that medical expenses are more likely happen. There are many side effects to an aging population including aging the labor force, putting a burden on the people taking care of the aging family members as well as taxpayers who become more responsible for them, as well as diminishing pensions. (ILO, 2009) All in all, our aging population has left many elderlies in unstable financial states. For this thesis, I will be investigating how reverse mortgage products can counteract the financial effects of an aging population, one of which being they can offer the elderly an income-smoothing product that will allow them to maintain their quality of life while at the same time allowing them to continue to contribute to our consumption-driven economy. The goal of this thesis is to qualitatively research the reverse mortgage market in order to get a better understanding of what the products are and what risks accompany the benefits they provide. Once the qualitative research is finished, I will be analyzing a subset of the reverse mortgage market to identify what might cause a contract to terminate early,, which burdens the consumer of the product and benefits the seller. For the quantitative analysis, my subset will be FHA HECM contracts in Virginia that have been terminated. That stands for the Home Equity Conversion Mortgage that is insured by a U.S Federal Housing Administration approved lender. (U.S. Department of Urban Development and Housing, 2017) In doing so I hope to gain an understanding of the affect the independent variables I am analyzing have on my dependent variable. The 7 dependent variable being the duration of the contract. When reading the data analysis section, it is imperative to note that contract duration is a proxy for what I am looking for. Duration serves as a proxy, meaning that I will be analyzing what IVs affect the duration; a short contract being more harmful to the consumer, and a longer one being for the most part (to an extent) better for the consumer. The proxy variable of duration, called Contract Length, comes from subtracting the mortgage start date from the termination date. Shortness of contract is how I am measuring the harmful affect the independent variables are having, which I why I am using duration as the proxy. A consequence of an aging population is that pensions aren’t taking people through their retirement. This results from our ability to extend life past what was predicted when the pensions were made. Extending life is a good thing, but has made taxpayers more burdened and has put many elderlies out of their homes as they have had to rearrange assets to pay for unexpected costs that arise over time. We need to feed our consumption driven economy to keep growing out GDP by spending a lot of the money we make, and a result of this is people who have been spending money according to what expected costs would be in their future. Like aforementioned these costs have gone up as improved quality and accessibility of healthcare occurs. We trust in the markets and in our pensions, but when we live longer than expected, or pensions don’t pay out, people get hurt. (Henley, 2008) It is not always external forces however that leave people lacking financial safety. Many people spend too much money paying off houses they cannot afford and eventually find themselves in positions where finances have to be rearranged if they want to remain in their homes. The 8 result of these irresponsible financial decisions and not planning for possible future health implications is that people and families buy things with money that should be going into savings. When are not able to pay for their own expenses, they more often than not become a burden to the tax payer. In response to this crisis, a market has been developed that allows people who are eligible to exchange some of their illiquid home value for liquid currency, letting them maintain their quality of life by not having to move out. This market is the reverse mortgage market. It is a byproduct of the lifetime mortgage market, which allowed people to sell their homes but still remains in the homes as long as they could cover the cost of maintenance. These contracts usually ended with the borrower dying, or having to move into assisted living. Products have been made that offer people and families a chance to part with some of the equity or future appreciation in their home. Some private lenders offer products that encompasses both of those. Unlike a normal mortgage this is not just a loan that has to be repaid by installments, but rather, for the most part, is a income smoothing product that allows the consumer to repay the loan upon sale of their home. (Moneysupermarket.com, 2016) They offer the consumer a lump sum, installment of payments, or line of credit in exchange for equity in their home. Unfortunately, these products can be used irresponsibly, and often the consumer of the product might not understand the possibility of the loan financially burdening them. 9 The benefactors of these products are mostly people who no longer have monthly incomes and are not in a position to finance a forward mortgage that requires monthly installments to be repaid to the lender, secured on the home. The lenders in our U.S. reverse mortgage market have developed many different types of home equity release products that can be helpful to different people in different situations. Unfortunately, the same products that can help different people often end up in the hands of someone who might have benefitted from doing something, like simply selling their home and moving.
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