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 Impact of Tax Reform on Real Estate

Cushman & Wakefield have posted The Great Tax Race: How the World’s Fastest Tax Reform Package Could Impact Commercial Real Estate. There is a lot of interesting insights in the report, notwithstanding the fact that ultimate fate of the Republicans’ tax reform is still a bit up in the air. Indeed, C&W estimates that there is a 1 in 5 chance that a bill will not pass this year.

Commercial Real Estate

C&W states that history

suggests that tax law changes by themselves are often not key drivers for transactions or for investment performance. However, there is likely to be a period of transition and market flux as investors restructure to optimize tax outcomes with implications for the underlying asset classes. Corporations are likely to separate the real estate aspects of their businesses. (2)

The commercial real estate industry is largely exempt from the biggest changes contained in the House and Senate bills. 1031 exchanges, for instance, have not been touched. C&W sees corporations being big beneficiaries, with a net tax cut of $400 billion over the next 10 years; however, they “anticipate that the tax cut will be preferentially used to return capital to shareholders or reduce debt, rather than to increase corporate spending.” (2)

Residential Real Estate

C&W sees a different effect in the residential real estate sector, with a short-term drag on home values in areas with high SALT (state and local tax) deductions, including California, NY and NJ:

The drag on home values is likely to be largest in areas with high property taxes and medium-to-high home values. There is also likely to be a larger impact in parts of the country where incomes are higher and where a disproportionate proportion of taxpayers itemize. Both versions of the tax reform limit property tax deductibility to $10,000. While only 9.2% of households nationally report property taxes above this threshold, this figure rises to as high as 46% in Long Island, 34% in Newark and 20% in San Francisco according to Trulia data.

The Mortgage Bankers Association (MBA) estimates that 22% of mortgages in the U.S. have balances over $500,000, with most of these concentrated in high costs areas such as Washington, DC and Hawaii—where more than 40% of home purchase loans originated last year exceeded $500,000. This is followed by California at 27%, and New York and Massachusetts at 16%. (6)

C&W also evaluated tax reform’s impact on housing market liquidity and buy v. rent economics:

The median length of time people had owned their homes was 8.7 years in 2016—more than double what it had been 10 years earlier. Now that interest rates have begun to tick upward from their historic lows, the housing market may face a problem called the “lock-in” effect, where homeowners are reluctant to move, since moving might entail taking out a new mortgage at a higher rate. This leads to the possibility of decreasing housing market liquidity in high-priced markets.

All things considered, the doubling of the standard deduction and the cap on the property tax deduction is likely to have the largest impact on the buy vs. rent incentive, especially as it seems likely that there will be minimal changes to the mortgage interest deduction in any final tax reform bill. (7-8)