Reverse Mortgages and the Economic Status of Elderly Women 1

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1 Copyright 7996 by The Cerontological Society of America The Cerontologist Vol. 36, No. 3, Data from the 1990 Census of Population and Housing are used to estimate the potential demand for reverse mortgages among elderly women householders. A reverse mortgage product is simulated using parameters based on the Home Equity Conversion Mortgage insurance demonstration, and its effect on poverty and income distribution among this group is calculated. Approximately 1.8 million women with low incomes and home equity of $40,000 and above could see a significant increase in income under such a program. Key Words: Elderly housing, Reverse mortgage, Women, Poverty Reverse Mortgages and the Economic Status of Elderly Women 1 Barbara A. Morgan, PhD, 2 Isaac F. Megbolugbe, PhD, 3 and David W. Rasmussen, PhD 4 Women approaching old age in our society must confront some harsh economic facts. In 1990, the poverty rate among women aged 65 and over was 15.4%, more than twice that of comparably aged men. The poverty rate increases as women age (19.5% at age 75) and is substantially higher for elderly women living alone (26.9%). More than 2.7 million elderly women currently live in poverty (U.S. Department of Commerce, 1991). "\ This high poverty rate exists partly because, compared to men, women have relatively few claims on public and private pension assets. Among the retired, women have substantially lower pension benefits and coverage rates than men, largely due to differences in labor market experience, tenure, and earnings (Even & Macpherson, 1994). Income from a husband's pension coverage is often considerably reduced or eliminated at his death, so that the risk of poverty jumps substantially for women when their husbands die (Holden, Burkhauser, & Feaster, 1988). Because women generally marry men older than themselves and their life expectancy exceeds that of men, they have a high probability of living alone on an insufficient income as they grow older. In addition, a husband's extended illness can deplete financial assets and leave the widow with few resources to offset her low income (Poterba, Venti, & Wise, 1994). The mean value of financial assets owned by single elderly women was only 60% of that of single elderly men in , and income derived from these assets was correspondingly low (Rubin & Nies- 1 The authors would like to thank Charles B. Nam, William Serow, and two anonymous referees for their comments. 2 Address correspondence to Dr. Barbara A. Morgan, Policy Sciences Center, Florida State University, Tallahassee, FL Senior Director, Office of Housing Research, Fannie Mae, Washington, DC. Director, Policy Sciences Center, Florida State University, Tallahassee, FL. wiadomy, 1994). Although this gender differential should diminish somewhat in the future as female labor force participation and earnings increase, elderly women will continue to be disproportionately represented at the low end of the income spectrum. Many elderly women do, however, have one valuable asset; their home. Housing assets are by far the most important component of personal wealth in elderly households after Social Security wealth, one whose national potential is far from being realized (Jacobs, 1986). In 1991 the median household headed by an individual aged 65 to 69 had housing equity of $50,000, which accounted for more than half of all wealth when Social Security and pension wealth are excluded (Poterba et al., 1994). Our estimates from the Public Use Microdata Samples indicate that female householders aged 65 and over held approximately $300 billion in housing equity in 1990 (U.S. Department of Commerce, 1993). Although women with low incomes typically have few assets as well, a significant proportion of women living on low incomes have considerable housing assets. How might this equity be accessed and used to improve the financial status of elderly women? Tapping Housing Equity Moving to a less expensive home is one obvious way to reduce housing equity and increase financial assets for the purpose of generating income. Indeed, the U.S. tax code, which permits a one-time exemption from capital gains taxation for householders over age 55, encourages such a move. Trading down to a smaller home to increase income is consistent with the life-cycle hypothesis that, in its simplest form, predicts that people accumulate assets prior to retirement and draw them down after retirement. Venti and Wise (1990a, 1990b) are skeptical that elderly individuals typically behave in this way: They argue that elderly householders exhibit relatively low 400 The Gerontologist

2 mobility rates and that, on average, housing equity is not reduced even when older householders move. In fact, survey data show that an overwhelming majority of elderly householders prefer to remain in their home for the rest of their lives. Gibler and Rabianski (1993) report that the desire to stay in the home is especially strong among female householders. If home equity is to reduce poverty among elderly females, previous research suggests that the equity must be tapped with financial instruments that do not require a change of residence. Home equity loans and lines of credit facilitate access to housing equity, an option used by over 16 million households in 1990 (U.S. General Accounting Office, 1993). These vehicles for tapping housing equity require householders to qualify for the loan, which involves demonstrating the capacity to repay the loan out of current income. Elderly women are compromised in this regard. Many cannot qualify for a home equity loan because they have insufficient current income to repay a loan collateralized by their homes. Failure to repay could mean loss of their home. A more promising vehicle for tapping housing equity is the emerging market for reverse mortgages. Reverse mortgages allow homeowners to use their housing equity to secure a loan that is made available to the borrower either as a line of credit or an annuity. The value of the house is the lender's guarantee against repayment of the accumulated debt, with repayment due only after the residents die or sell the house. The reverse mortgage is a non-recourse loan, so the lender may not attach other assets even if the outstanding loan eventually exceeds the dwelling's value. The borrower has the right to reside in the house until he or she decides to sell, or until death. The U.S. Department of Housing and Urban Development's (HUD) Home Equity Conversion Mortgage (HECM) insurance demonstration was set up to facilitate and encourage the use of reverse mortgages by elderly homeowners. Case and Schnare (1994) summarize the key features of this program and evaluate its success to date. After a relatively slow start, loans originating under this program have grown throughout the nation. Private sector Federal Housing Administration (FHA) insured mortgages were available in 48 states and the District of Columbia in 1994, the exceptions being South Dakota and Texas. Texas has a public program that offers reverse mortgages to finance a property tax deferral program, however. A few companies offer privately insured reverse mortgages, but these are available in only a few states and for relatively high valued homes (National Center for Home Equity Conversion, 1994). Participants in the HECM demonstration have a median age of 76.7 years compared to 73 years for all elderly homeowners; 56.5% are female, although females comprise only 28.7% of all elderly homeowners; and at $7,572, the median income of HECM borrowers is less than half that of all elderly homeowners (Case & Schnare, 1994). In so far as a demand for reverse mortgages currently exists, a significant portion of it appears to be among elderly women living alone on a meager income. In this article, we estimate the number of elderly female householders who, on the basis of certain asset and income characteristics, might be potentially interested in converting their home equity into a more liquid form by means of a reverse mortgage. The proceeds from a reverse mortgage may be taken as a lump sum, a line of credit, or an annuity. As a second step, we assess the effect that annuity payments from a reverse mortgage would have on the poverty status and income distribution of these elderly women. Data and Method Estimates are derived from the Public Use Microdata Samples (PUMS) from the 1990 Census of Population and Housing. PUMS contain records for a sample (in this case, 1%) of the housing units in the United States, with information on the characteristics of each unit and the persons in them. In addition, they include weights for each person and housing unit that, when applied to individual records, expand the sample to the total United States population. We first estimate the number of single female householders aged 65 and over in the United States who own their own home free and clear of any mortgage payment. The number of women with a mortgage outstanding is likely to be very small because about 97% of homeowners over age 69 with equity exceeding $30,000 do not have a mortgage (Rasmussen, Megbolugbe, & Morgan, 1995). To estimate the potential demand for reverse mortgages among this group, we categorize individuals in terms of their income and the value of their property, where property value refers to the value of the individual's home. Income as defined in the 1990 Census is the sum of wage and salary income; self-employment income; interest, dividend and net rental income; Social Security income; public assistance; retirement income; and all other income. On average, 58% of income in our sample is Social Security income; 18% is interest, dividend and net rental income; and 11% is retirement income. Throughout, we classify income by relating it to the poverty level of income, which in 1990 was $6,268 for an elderly single person, exclusive of noncash items such as food stamps and Medicaid (U.S. Department of Commerce, 1991). Property value in the Census is estimated by the respondent. Because only a small percentage of owners sell their homes in any given year, it is likely that most have imperfect information about the market value of their home. Evidence suggests that homeowners tend to underestimate the value of their home, but not by much. Follain and Malpezzi (1980) review this literature and use data from the Annual Housing Survey to show that the downward bias rises with length of residence in the home. They estimate that, on average, homeowners undervalue their homes but only by about 2%. Using self-reported property values will thus tend to bias downward our estimate of the impact of reverse mortgages on the financial well-being of elderly female householders. We next simulate a reverse mortgage program using the parameters of the HECM demonstration. Vol. 36, No. 3,

3 Income from a reverse mortgage can be taken either as a lump sum or an annuity. Here we assume it is taken as an annuity and estimate the effect of this additional income on the poverty rate among elderly women and on the size distribution of their income. Only householders with home values of $40,000 and above are included in our analysis on the assumption that, on the supply side, lenders would be unwilling to loan below this value, and on the demand side, the additional income generated from a reverse mortgage would be low. An individual's age, property value, and the expected interest rate are the key parameters determining how much income a reverse mortgage will generate. In the HECM program, borrowing limits are determined by the "principal limit factor," which is the highest initial loan-to-value ratio for which the premium collected will cover all HUD's expected costs resulting from mortgage insurance claims (Scholen, 1992). This ratio varies negatively with the assumed long-term interest rate and positively with the age of the youngest person in the household. For example, at an interest rate of 10%, the principal limit factor for an 85-year-old householder is.589, implying that 58.9% of home value will be available to the borrower. We assume an interest rate of 10%, the upper quartile expected interest rate used in the HECM demonstration (Case & Schnare, 1994). The expected interest rate is the most recent weekly average yield for U.S. Treasury bonds and notes adjusted to a constant maturity of 10 years, plus some margin (typically around 1.6 percentage points). A higher interest rate lowers the amount of money that can be borrowed from a given level of home equity. Hence, this conservative figure is relatively unfavorable to our central argument that reverse mortgages have a significant impact on the poverty status of elderly women. Under the HECM demonstration, the potential amount (the "principal limit") that could be borrowed by an individual of a given age and with a given property value is calculated by multiplying the value of a home owned free and clear by the principal limit factor. For example, the most that could be borrowed by our 85-year-old householder, assuming a principal limit factor of.589 and property valued at $75,000, is $44,175. We calculated this principal limit for every householder in the sample. Property values in the PUMS are not given precisely, but are classified into one of 25 categories (for example, $50,000 to $55,000). In calculating the principal limit, we assume that all properties in a given category are worth the lowest value of this range. Closing costs of 4% of total home value, the average for the HECM demonstration, are assumed and subtracted from the principal limit. This "net" principal limit is then converted into a stream of yearly income payments assuming a life expectancy of 100 years (a HECM stipulation) and an expected interest rate of 10.5%. The extra 0.5% added to the interest rate covers the insurance premium charged for all loans to protect the lender from "crossover risk," the possibility that the rising balance under reverse mortgage could exceed the value of the dwelling. In the HECM demonstration, although the risk on each mortgage is controlled by limiting the amount loaned (Syzmanoski, 1994), a uniform insurance premium is also charged for all loans to protect the lender from cross-over risk. This standard insurance premium is 2% of house value at closing (already accounted for in our analysis), plus 0.5% of the outstanding balance per year. Note that we have made relatively conservative assumptions about interest rates and property values in our simulation so that our estimates will tend to be lower bound estimates of the impact of these annuities on income. On the other hand, these estimates do not take account of inflation, which would erode the real value of any income stream from a reverse mortgage. Over time, the potential effect of reverse mortgages on poverty status and income distribution would diminish. Findings Approximately 5.1 million female householders aged 65 and over in the United States own their houses free and clear of any mortgage payment. Most elderly female householders are white (91.3%), widowed (80.6%), and live alone (75.3%). Over half of these women are aged 75 or over. We decided to eliminate from our analysis the small percentage of female householders who are married (6.9%) or separated (0.7%) because their benefit eligibility and poverty status classification differs significantly from that of single older women. This leaves approximately 4.7 million elderly female householders who are either widowed, divorced, or have never married. Table 1 classifies this population in terms of the number of elderly female householders who fall into different income/property value categories. Column totals in Table 1 indicate the distribution of income among the elderly female population for income categories related to poverty level income (categories are the poverty level of income for an elderly single person in 1990, $6,268; 125, 150 and 200% of the poverty level; and over 200% of the poverty level). Over one-quarter of all elderly female householders have incomes at or below the poverty level, while only one-third have annual incomes greater than $12,536, which is twice the poverty level. Row totals show the distribution of property values among the same population. Approximately onethird have property values below $40,000, and would most likely be ineligible for, or uninterested in, a reverse mortgage. Nevertheless, the other twothirds of the elderly female householding population (approximately 3 million women) have considerable home equity, with property values ranging from $40,000 to over $100,000. Cell numbers and percentages in Table 1 illustrate the degree to which low incomes and low property values are correlated among the elderly female population. Clearly, in many instances, individuals with low income also have low-valued housing assets. For example, of the 1.28 million householders who have 402 The Gerontologist

4 Table 1. Distribution of Income and Property Values Among Elderly Female Householders Property value *s = $6, ,395 (14.91 ) b 244,515 (5.22) 131,300 (2.80) 61,153 (1.31) 146,787 (3.13) 1,282,150 (27.37) $6,269-7, ,969 (5.61) 130,108 (2.78) 74,564 (1.59) 36,034 (0.77) 80,024 (1.71) 583,699 (12.46) $7,836-9, ,835 (3.90) 104,208 (2.22) 63,940 (1.36) 32,730 (0.70) 67,392 (1.44) 451,105 (9.63) Income 3 $9,402-12, ,479 (4.79) 157,847 (3.37) 109,295 (2.33) 54,785 (1.17) 116,765 (2.49) 663,171 (14.16) > $12, ,254 (6.96) 337,825 (7.21) 311,185 (6.65) 191,641 (4.09) 537,489 (11.47) 1,704,394 (36.38) Row Total <$40,000 $40,000-59,999 $60,000-79,999 $80,000-99,999 1,694,932 (36.18) 974,503 (20.80) 690,284 (14.74) 376,343 (8.03) 948,457 (20.25) 4,684,519 (100.0) >$100,000 Column total "Income categories are the poverty level of income for an elderly single person in 1990 ($6,268); 125,150, and 200% of the poverty level; and over 200% of the poverty level. Figures are estimates for the United States, based on applying weights provided in the PUMS database. b Cell numbers as a percent of the overall total are shown in parentheses. incomes at or below the poverty level, over 698,000 or 54.5% own homes valued below $40,000. Nevertheless, approximately 584,000 elderly women with home equity valued at $40,000 or more live in poverty. An additional 1 million more women with this same level of home equity live on incomes below 200% of the poverty level, still a very modest income. Assume the proceeds from a reverse mortgage are taken as an annuity. How would this annuity income affect the poverty status and income distribution of elderly female householders? Table 2 illustrates the effect of such a program, assuming the parameters used in the HECM demonstration. Supplementary income from a reverse annuity mortgage (RAM) would reduce the percent of elderly women living at or below the poverty level from 19.5% to 5.8%. Thus, 410,806 women would move out of poverty as officially defined. The number of women living below 125% of the poverty level falls by over 567,000. Similar shifts are noted throughout the income distribution so that the percent of women in the highest income category (over twice the poverty level) increases from 46.1% to 64.3%. The effect on individual incomes in percentage terms can also be substantial. Although in many cases the absolute value of the income increase is not large, neither are the incomes on which these individuals are living. Assume an elderly woman has a home valued at only $40,000 and is living on a poverty level income. If a reverse mortgage is taken out in the form of an annuity at age 65, her income would increase by 16%. The impact on income is much stronger among the "older" old because the principal limit varies with age. Under the same circumstances, a reverse mortgage taken out at age 75 will increase income by 27% and at age 85 by 46%. The HECM program was forced to adopt stringent parameters because of uncertainty about financial risks. For example, designers of the HECM program anticipated persons who expect to live a long time would be the most likely to enroll because they Income range <$6,268 $6,269-$7,835 $7,835-$9,402 $9,403-$12,536 >$12,536 Total Table 2. Changes in the Distribution of Income Under Reverse Mortgages Before RAM 583,755 (19.5) 320,730 (10.7) 268,270 (9.0) 438,692 (14.7) 1,378,140 (46.1) 2,989,587 (100.0)* After RAM 172,949 (5.8) 164,440 (5.5) 227,022 (7.6) 501,901 (16.8) 1,923,275 (64.3) 2,989,587 (100.0) Note. It is assumed that RAMs are available only to individuals who own housing of at least $40,000 value free and clear; the interest rate is 10%, the insurance premium 0.5% per year, closing costs are 4% of property value, and individuals have a life expectancy of 100 years. Figures are estimates for the United States, based on applying weights provided in the PUMS database. Percentages do not add to 100 due to rounding. would reap greater benefits from the program. Consequently, principal limits and annuities are currently calculated under the assumption that all individuals live to age 100. Actual experience with the program to date suggests the self-selection problem has been exaggerated. In general, HECM participants tend to be less healthy than the overall elderly population (Syzmanoski, 1994). A relaxation of the life expectancy assumption would have a substantial effect, particularly on the income of the "older" old. Life expectancy for women at age 75 is in fact about 12 years rather than the 25 years assumed by the program. Under this more realistic assumption, annuities would increase both because the principal limit factor increases and because the stream of yearly income payments is compressed into a smaller Vol.36, No. 3,

5 number of years. The effect could be substantial. For example, the annuity payment on a $50,000 home would increase by about 30%, from $2,112 to $2,738, even if the principal limit factor did not change. Using a more realistic assumption about life expectancy increases cross-over risk, and thus insurance costs. However, this would only partially offset the effect on annuity payments, with the overall impact being determined by program experience. Under the program as currently structured, reverse mortgages are a relatively expensive form of credit. In fact, this may be why they have proved attractive to householders with very low income and no other credit options. Elderly households with sufficient income to qualify for and repay a home equity loan will find the HECM instrument a much higher cost option for short-term loans. Continued experience with reverse mortgages will undoubtedly lead to a more accurate assessment of cross-over risk and a reduction in costs, thus widening their appeal. Discussion and Policy Implications Evidence from the HECM program indicates that individuals attracted to reverse mortgages include a high proportion of low-income elderly women living alone. In 1990, approximately 1.6 million elderly women with incomes below twice the poverty level and property values greater than $40,000 could have significantly increased their income by means of a reverse mortgage. This potential demand for reverse mortgages can be expected to increase in the future. The proportion of individuals aged 65 and over in the population is projected to grow from 12.5% in 1990 to 16.3% in the year 2020 and will become increasingly female (U.S. Department of Commerce, 1994). Because women's life expectancy is continuing to grow faster than men's, most of the very old will be widows, who have substantially higher poverty rates than elderly persons in general (Hurd, 1990). Reverse mortgages may provide a means of partially alleviating poverty and low incomes among some elderly women. Realizing the potential of reverse annuity mortgages to reduce poverty among elderly women requires the development of a secondary market for these instruments. This process is well underway with Fannie Mae's participation in the HECM demonstration. Reverse mortgages are also discussed with increasing frequency by financial advisers and the popular press, so potential consumers are increasingly likely to acquire adequate information about the product. Acceptance of reverse mortgages among elderly women should not be readily assumed, however. The strong desire of elderly persons to remain independent suggests a lively demand for reverse mortgage products, and the baby boom cohort, moving into retirement within the next 20 years, is generally more receptive to the idea of credit than its predecessors. However, the many financial uncertainties facing older adults, especially in the field of health services, may reduce the demand among elderly women who are not in abject poverty. For example, Medicare does not cover long-term care for chronic disabilities, and Medicaid is biased toward nursing home care (Weiner, 1994). Under these arrangements, some elderly women may be reluctant to draw down the housing equity that they see as their final financial buffer against adversity (Skinner, 1993). To some degree, the demand for reverse mortgages among elderly women in poverty will depend on future innovations in national health care policy. If poverty reduction among elderly women is a public priority, reverse mortgages offer an opportunity to unlock housing equity and increase current consumption without an increase in public spending. This is a distinct advantage in a policy environment that is dominated by efforts to control spending and reduce the federal budget deficit. HUD's HECM insurance demonstration, aimed at unlocking housing equity among elderly persons, appears to have been an exemplary one: It is a self-supporting public-private partnership that provided valuable support for the early expansion of the reverse mortgage market. As demand increases, and as the financial services industry continues to develop reverse mortgage products, the market for reverse mortgages among the elderly may well become self-sustaining. This would greatly enhance the financial options facing elderly women with significant housing equity but low income and would advance the public interest by reducing poverty among this group. More controversially, subsidization of reverse mortgage programs, for example to reduce upfront costs, might be considered as a relatively inexpensive policy option for further improving the economic status of this population. References Case, B., & Schnare, A. B. (1994). Preliminary evaluation of the HECM reverse mortgage program. Journal of the American Real Estate and Urban Economics Association, 22, Even, W. E., & Macpherson, D. A. (1994). Gender difference in pensions. journal of Human Resources, 29, Follain, J. R., Jr., & Malpezzi, S. (1980). Dissecting housing value and rent: Estimates of hedonic indexes for thirty-nine large SMSAs. Washington, DC: The Urban Institute. Gibler, K. M., & Rabianski, J. (1993). Elderly interest in home equity conversion. Housing Policy Debate, 4, Holden, K. C, Burkhauser, R. V., & Feaster, D. J. (1988). The timing of falls into poverty after retirement and widowhood. Demography, 25, Hurd, M. D. (1990). 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