Rising Mortgage Borrowing for Seniors

graphic by www.aag.com/retirement-reverse-mortgage-pictures

J. Michael Collins et al. have posted Exploring the Rise of Mortgage Borrowing Among Older Americans to SSRN. The abstract reads,

3.6 million more older American households have a mortgage than 2000, contributing to an increase in mortgage usage among the elderly of thirty-nine percent. Rather than collecting imputed rent, older households are borrowing against home equity, potentially with loan terms that exceed their expected life spans. This paper explores several possible explanations for the rise in mortgage borrowing among the elderly over the past 35 years and its consequences. A primary factor is an increase in homeownership rates, but tax policy, rent-to-price ratios, and increased housing consumption are also factors. We find little evidence that changes to household characteristics such as income, education, or bequest motives are driving increased mortgage borrowing trends. Rising mortgage borrowing provides older households with increased liquid saving, but it does not appear to be associated with decreases in non-housing consumption or increases in loan defaults.

The discussion in the paper raises a lot of issues that may be of interest to other researchers:

Changes to local housing markets tax laws, and housing consumption preferences also appear to contribute to differential changes in mortgage usage by age.

Examining sub-groups of households helps illuminate these patterns. Households with below-median assets and those without pensions account for most of the increase in borrowing. Yet there are no signs of rising defaults or financial hardship for these older households with mortgage debt.

Relatively older homeowners without other assets, especially non-retirement assets, may simply be borrowing to fund consumption in the present—there are some patterns of borrowing in response to local unemployment rates that are consistent with this concept. This could be direct consumption or to help family members.

Older homeowners are holding on to their homes, and their mortgages, longer and potentially smoothing consumption or preserving liquid savings. Low interest rates may have enticed many homeowners in their 50s and 60s into refinancing in the 2000s. Those loans had low rates, and given the decline in home equity and also other asset values in the recession, paying off these loans was less feasible. There is also some evidence that borrowing tends to be more common in areas where the relative costs of renting are higher–limiting other options. Whether these patterns are sustained as more current aging cohorts retire from work, housing prices appreciate, and interest rates increase remains ambiguous.

The increase in the use of mortgages by older households is a trend worthy of more study. This is also an important issue for financial planners, and policy makers, to monitor over the next few years as more cohorts of older households retire, and existing retirees either take on more debt or pay off their loans. Likewise, estate sales of property and probate courts may find more homes encumbered with a mortgage. Surviving widows and widowers may struggle to pay mortgage payments after the death of a spouse and face a reduction of pension or Social Security payments. This may be a form of default risk not currently priced into mortgage underwriting for older loan applicants. If more mortgage borrowing among the elderly results in more foreclosures, smaller inheritances, or even estates with negative values, this could have negative effects on extended families and communities.

The New Mortgage Disclosure Rules

President Barack Obama meets with Rep. Barney Frank, (D-Mass), Sen. Dick Durbin, (D-Ill), and Sen. Chris Dodd, (D-Conn) by White House (Pete Souza)

TheStreet.com quoted me in New Mortgage Rule Requires Disclosure Documents to Help Consumers Compare Costs. It reads, in part,

A new set of shorter and simpler mortgage documents will be disclosed to consumers before they close on a loan, making the costs more transparent and helping home buyers compare offers from multiple lenders easier.

Mortgage lenders are required to start giving loan applicants the new disclosure documents starting on October 3, a new government requirement imposed by the Dodd-Frank Act.

“The disclosures will be easier and shorter so that consumers understand the mortgage they are getting because it will be simpler to compare offers,” said Holden Lewis, a mortgage analyst for Bankrate.com, the Palm Beach Gardens, Fla.-based financial content company.

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Drawbacks of New Documents

Of course, it’s not all positive. You can now expect your closing to take longer than before while lenders and title companies adjust to the new procedures. Consumers should definitely lock in their interest rates “a little longer to be safe in case there are delays,” he said. The process might stretch to three days, so lock in your mortgage rates for 45 days instead of the traditional 30 days and “err on side of caution,” Lewis said.

 Major changes to the terms in a mortgage can push back the closing and this can present a serious problem if the current interest rate lock is “on the verge of expiring and interest rates are rising,” said David Reiss, a law professor at Brooklyn Law School. In a worst case scenario, a lender could withdraw an offer because the consumer cannot afford higher monthly payments due to an increase in interest rates.

Homebuyers can mitigate this issue by negotiating the terms of their interest rates cautiously and discussing them with their lender or real estate broker who can help determine “whether there is enough of a cushion to take into account all of the things that can delay a closing,” he said. “Borrowers should know that a rate lock without a sufficient cushion of time offers a false sense of security.”

Closing on a house might take longer, so consumers should make sure their timing meshes with the apartment or house they are renting or if they are selling their current home. This is more critical right now because of the transition to the new documents.

“Through the end of the year, homebuyers may want to build in a cushion as to when they have to close on the purchase,” Reiss said. “This could offer some protection if the mortgage application process takes longer than expected because of TRID-related issues.”

If tax reasons are prompting homeowners to close on a sale by a certain date, then it is even more vital to focus on documents a buyer, lender or tittle company might require during the process.

“As with many things, staying on top of everyone at each stage such as the contract negotiation, mortgage application and closing is the best bet for avoiding surprises and bad results,” he said.