Wednesday, April 14, 2010

Baby Boom Delusions and Solutions (Chap.3, Part 2)

Today's post was delayed as I researched the most current trends in using reverse mortgages as a strategy for aging at home, instead of in an institution. The housing catastrophe of the past 30 months changed much of what I had originally written in the early drafts of the book. I am still waiting on  Medicaid to provide some updates but decided to post this entry now, even if the final version of the book is somewhat different, based on those updates. Medicaid is currently overwhelmed with adopting changes related to the new healthcare legislation and my request for interviews and information are likely a low priority.


Chapter 3 (Part 2)

The Reverse Mortgage

In 2030 the youngest boomers will be 67, the oldest 84. The homeowners in this group--eight of every ten boomers are homeowners--will be perched atop a home equity money mountain worth $8.1 trillion. Unfortunately, unless current efforts and policies are improved, many of these house-rich and cash-poor seniors will struggle to find the money they need to pay for the help that would allow them to remain at home. Failing that, they will be forced to sell the house in order to pay for alternate living arrangements.

A reverse mortgage—and there is currently only one type available—can unlock much of a home’s equity value, putting cash in the homeowner’s pocket immediately, without putting the house at risk. The cash can be used to make staying at home possible.

A reverse mortgage is a relatively new, creative and promising financial service. Those seniors who need help at home but find themselves house-rich and cash poor deserve a reverse mortgage option that is affordable, well-designed, carefully monitored and delivered by trustworthy professionals. The roadblocks for making this happen on a large scale are apparent: (1) $8.1 trillion piled up in one place will attract a lot of additional flies and as seniors lose their mental acuity, advantage can be taken; (2) the lending industry has proven that it cannot effectively police its own; (3) policy-makers do not understand the service and its potential positive impact on lowering Medicaid costs; (4) seniors do not understand the service benefits and believe many negative myths and (5) the product could get expensive again.

First, let’s understand the service. Below are the basics of the one service currently available, the Home Equity Conversion Mortgage (HECM, “heck’um”). This service was co-designed by AARP and The Federal Home Administration (FHA) and is underwritten by The Department of Housing and Urban Development (HUD):

1.    Every HECM applicant receives mandatory professional information counseling to insure that they understand the service.
2.    Available to those 62 or older, the homeowner gets the equity advance (loan) but maintains title to the home.
3.    There is no time limit on how long the homeowner can then stay in the home.
4.    The loan is not due until the home is sold by the homeowner or his or her heirs.
5.    The homeowner’s heirs will never be responsible for paying any part of the loan. Any negative gap in home sale price to loan value is insured by HUD. A positive gap goes to the estate.
6.    The loan proceeds can be used for any purpose.
7.    Loan proceeds are not income and therefore, not taxed.
8.    The homeowner must keep the home maintained, pay the real estate taxes and keep the    home insured.
9.    A homeowner’s other assets, income or credit score play no role in qualifying for the loan.
10.    The amount of the loan is based on a formula that includes the appraised value of the home, the homeowner’s age and current interest rates.
11.     Currently, there is a cap of $625,500 on the appraised value of the home, an amount that includes the vast majority of American homeowners.
12.    Interest on the loan is a tax deduction expense in the year the loan is repaid.
13.    The older the borrower, the greater the percentage of equity value he or she can free up.

Here are three simplified examples:

Borrower A
Age: 65
Home Value: $200,000
Mortgage Owed: $0
Cash to homeowner: $101,600
Interest Rate (2010): 5.7%

Borrower B
Age: 75
Home Value: $200,000
Mortgage Owed: $0
Cash to homeowner: $117,000
Interest Rate (2010): 5.7%

Borrower C
Age: 85
Home Value: $200,000
Mortgager Owed: $0
Cash to homeowner: $134,000
Interest Rate (2010): 5.7%

In the past, based on the $200,000 appraised value, each borrower would have paid $4,000 in mortgage insurance, $4,000 in origination fees plus title, closing and appraisal costs; likely about $10,000 in all. However, due to recent changes in the value of HECM-backed securities, the prices from some lenders have dropped dramatically, by as much as 70%. The actual out-of-pocket costs are relatively small because most of the fees are incorporated into the loan. The borrower could choose to take the loan proceeds in one of several ways: a lump sum, as a set monthly distribution, set up as a line of credit or some combination of those three.

So, in a country where several million retirees could benefit from this service, why are there only about half a million of these loans in force? More importantly for baby boomers, how can the percentage of users increase dramatically over the next 20 years?

In 2005, the National Council On Aging (NCOA), with the support of the Robert Wood Johnson Foundation and the Centers for Medicare and Medicaid Services, published a study entitled “Use Your Home to Stay at Home: Expanding the Use of Reverse Mortgages for Long-Term Care: A Blueprint for Action”. The study pointed out that one of the ironies of our current situation is that at a time when millions of impaired older Americans are financially struggling to maintain their independence at home, their homes could be the source of the money needed to stay in their homes.

Currently, there are four major barriers to a more robust and successful use of home equity to help seniors remain at home and pay for appropriate support services: (1) The uncertainty of reverse mortgage costs and features, (2) consumers’ negative attitudes, (3) government policy and (4) the fraud potential.

Historically, compared to other home mortgage products, the HECM has not been cost efficient. Interest rates, servicing and origination fees and mortgage insurance were markedly higher than conventional mortgages. Recently, however, these cost differentials have begun to moderate, making the costs of a HECM much more attractive. There is a role for federal government regulations to play in encouraging the mortgage industry to keep these costs competitive. Doing so would encourage millions of retirees to include reverse mortgages in their long-term financial planning.

Even among seniors who are familiar with reverse mortgages (and most are not) many are reluctant to consider one because they think that they are putting their home at risk; in fact, they are not.  Many believe that this type of loan is only appropriate for the financially desperate. 

One of the biggest negative perceptions is caused by semantics. The term “reverse mortgage” immediately brings to mind the 30-year mortgage debt of which most homeowners could not wait to be rid. The notion of taking on substantial debt late in life, using the home as collateral, seems an anathema.  But--and this is key--as long as the borrower is alive and able to live in the home (and this provision extends to the borrower’s spouse and certain other qualified dependents while they remain alive), they can remain in their home. This financial product should probably have been initially labeled something like “cash leverage service” or “liquidity generator account” so that consumers would perceive it in a more positive light. Maybe it’s not too late to re-think the label that providers put on this service.

Yet another perception problem is tied to the desire to “leave something to the kids”. This often means the home. Nearly 80% of home owning seniors view their home as a primary asset for bequest. Many children, however, have a decidedly different view. Fewer than 15% express any interest in retaining their parent’s home, either as a residence for themselves or as a rental asset. Adult children are much more amenable to seeing the equity value of their parents’ home used for their parents’ long term care needs, especially when the money helps the parents stay in their home.

Currently, some state Medicaid policies work at odds against the broader use of reverse mortgages. For instance, because reverse mortgages are required to be first mortgages, if the state has placed a lien against a home when one of the residents goes on Medicaid, and this is often the case, the spouse who is not on Medicaid is not qualified to get a reverse mortgage to help pay for any at-home care as long as the state lien is in the primary position. This policy increases the likelihood of one or both of the elders being forced into a nursing home where Medicaid picks up the entire cost of their care.

There is also a problem when states define reverse mortgage proceeds as “income or assets” in their calculations for Medicaid eligibility for poorer citizens. Reverse mortgage proceeds are loan proceeds, not income and should have no impact on determining eligibility just as the value of the home plays no role in eligibility. Unfortunately, many states have failed to see that this policy is working against the best interests of the state’s taxpayers. It discourages poorer homeowners from obtaining a HECM for fear of losing their Medicaid eligibility. Thus, cash strapped for private pay help at home, they end up, at state expense, in the local nursing home.

For elders who qualify for Medicaid nursing home services, several states have developed waiver programs that pay for some in-home services; that’s good. However, the current limitations of these programs still make it difficult for many elders to remain at home.  One such benefit exclusion is “room and board” or the cost of maintaining a home, groceries and utilities. In addition to excluding these day-to-day expenses, there is a limited set of authorized in-home medical and support services for which Medicaid will pay. This limited set does not include home modifications, companion care, house keeping, shopping services, meal preparation or most transportation. By requiring that homeowners pay out-of-pocket for these in-home services, while not encouraging the use of reverse mortgages—indeed, even discouraging their use by threatening the loss of Medicaid eligibility—Medicaid prematurely funnels millions of elders into the more costly nursing home alternative. Sometimes the government’s left hand needs to have a conversation with the government’s right hand.

The increased use of reverse mortgages is not a cure-all for what ails the Medicaid funding crisis but it can be an important part of the overall fix. Reverse mortgages hold the realistic potential to increase private sector (homeowner) funding for in-home support services which could save Medicaid about $4 billion each year, or roughly 10% of its annual budget for long-term care for the elderly. As the baby boom closes in on its dependence years, the comparable illiquid housing wealth will escalate because we have been better educated and more financially successful than our parent’s generation and much of our wealth has been poured into housing stock.

Medicaid policy change will also have to address the issue of reverse mortgage proceeds use, which currently has no restriction. For those who would otherwise be destined for a nursing home at Medicaid’s expense, reverse mortgage money must be dedicated to in-home care expenses meant to replace the nursing home alternative. This requirement likely means that a specific HECM product be developed for those homeowners who are already—or soon to be--Medicaid qualified, to insure that HECM proceeds don’t end up paying for things unrelated to in-home care.

Finally, and also related to the current issue of “no restrictions on HECM proceeds use”, is the specter of fraud. The immense liquidity value of baby boomers' home equity coupled with rules that put no restraint on what the HECM money can be used for and the mental deterioration that will be visited on too many as they age, is a recipe for fraud on a massive scale. The flies aren’t just circling; they are already feeding on the exposed cash. The current fraud activity associated with reverse mortgages is, in a major way, tarring the HECM service with the brush meant solely for the unscrupulous and outright dishonest. Once again, government policy and oversight are required to address this issue.

If, as a nation, we truly intend to resolve the cost challenges associated with the long-term-care of the country’s largest ever generation, then creatively using the generation’s own wealth as a foundation is a necessary (but not sufficient) prerequisite. 



Observoid of the Day: Bikers who wear a helmet look silly. Bikers without a helmet look like organ donors.