So how does using home equity “feel” to seniors who use the HECM (reverse mortgage) program? And what about the objective results? This week we look at some research that compares using home equity through a refinance, a traditional HELOC (Home Equity Line of Credit) or the government’s HECM program. Aside from requiring no monthly payments, the HECM is much easier to qualify for and cannot be restricted or “called” like a HELOC due to property value issues. Plus the HECM line of credit actually grows over time. In over 30 years in the financial services arena I have never encountered anything like it. Frankly it is counterintuitive and therefore hard to wrap your head around! You should know about it, so call me!
Senior homeowners can tap into their home equity in a variety of ways, whether that means taking a reverse mortgage, a home equity line of credit (HELOC) or cash-out refinance. But when it comes to deciding between these different extraction methods, reverse mortgages can have a positive impact on financial well-being of borrowers, according to the results of a recent study.
Extracting home equity through borrowing allows households to smooth consumption access liquidity without the substantial costs of selling the home. It also may allow seniors to pay-off higher cost debt and diversify their asset portfolio, says the study from Ohio State University titled, “How Home Equity Extraction and Reverse Mortgages Affect the Financial Well-Being of Senior Households.”
But unlike more common methods of equity extraction, such as HELOCs, Home Equity Conversion Mortgages (HECMs) provide distinct advantages to borrowers in that they cannot be reset in future periods with declines in home values or borrower credit quality, noted the study researchers, who include frequent reverse mortgage researcher Stephanie Moulton from Ohio State’s John Glenn College of Public Affairs; and Donald Haurin from Ohio State’s Department of Economics.
“Establishing a HECM may provide a buffer against financial shocks, thereby increasing liquidity and reducing default,” the researchers write.
With the participation of Samuel Dodini and Maximillian Schmeiser of the Federal Reserve Board, Moulton and Haurin analyzed equity extraction via reverse mortgages and how this impacts the financial well-being of senior households in regards to credit trends, both pre- and post-extraction.
Seniors extracting home equity through HECMs are more likely to undergo a credit shock within the two years prior to extraction, according to the findings.
“These consumers appear to have the most improvement in credit outcomes after extraction,” researchers write. “Compared to non-extractors, borrowers using other channels of extraction not more likely to have had a prior credit shock.”
Researchers also found that cash-out and second lien borrowers had higher foreclosure risk, while HECM and HELOC borrowers were not significantly more likely to experience foreclosure post-extraction, relative to individuals who did not extract their home equity.
HECM borrowers were also found to have a spike in credit card balances before loan origination, and then a sharp decline in credit card balances that persists thereafter—a unique pattern not observed for other extraction channels.
Such a pattern, according to researchers, may indicate a need for liquidity that is met with credit cards in the short term, and then substituted with home equity borrowing through a HECM; to the extent that HECM borrowing is lower cost than credit card borrowing, this could lead to improved financial well-being.
Looking ahead, researchers note the importance of monitoring how seniors seeking HECMs are being affected by policy changes, namely the Financial Assessment implemented in April 2015.
“A policy challenge for the HECM program moving forward is to preserve access of the program to seniors who may be cut-off from other home equity borrowing channels, while minimizing the risk that borrowers will be unable to afford to maintain the home, including payment of property taxes and homeowners insurance,” researchers conclude.
Written by Jason Oliva