Do Reverse Mortgage Borrowers Use Credit Ruthlessly?

Abstract

Home Equity Conversion Mortgages ("HECMs") offer older US homeowners liquidity and implicit home price insurance. If borrowers' homes are worth less than their loan balance when they move or die, their liability is limited to collateral value. The Federal Housing Administration ("FHA") absorbs the lender's loss. FHA aims to break even on this insurance, but pricing does not reflect geographic or cyclical risk. HECMs were disproportionately originated near the recent home price cycle peak in markets with large subsequent busts. Many borrowers thus have credit lines with limits greater than their homes are worth, and FHA has lost money on HECM. Did borrowers adversely select into HECM intending to exploit mispriced insurance? This appears unlikely: borrowers whose loans terminated with credit limits greater than their homes are worth have been no likelier to exhaust credit than similar borrowers whose loans terminated with credit limits below collateral value.

Keywords: Mortgages, Housing Demand, Social Security and Pensions, Portfolio Choice, Insurance

JEL Classification: G21, R21, H55, G11, G22