The Future of Reverse Mortgages in Retirement Planning

There is demand for new retirement income solutions
John Melinte

Pension actuaries often talk about the “three pillars” of retirement income: government-sponsored plans, employer-sponsored plans and individual personal savings. The amount of retirement income that each of these pillars represents has changed—and will continue to change—over time, resulting in various impacts on pensioners’ financial security and standards of living.

During the last few decades, the future of government-sponsored plans in both the United States and Canada has become less certain due in part to ongoing mortality improvements. Analysis of many programs in the United States has cast doubt on their long-term ability to sustain current levels of promised benefits. For example, the average funded ratio (the ratio of assets to present value of liabilities) for state-run pension plans in the United States has decreased from 96% in 2001 to 81% in 2021.

Likewise, the Canada Pension Plan (the major component of Canada’s government-sponsored retirement programs) was running an $885B CAD deficit as of 2018. While its funded ratio has increased over the years, it was still less than 30% as of 2018, despite mandatory employee and employer contributions now totaling roughly 11% of earnings (more than double the rate from 25 years ago).

At the same time, employer-sponsored defined benefit plans also have struggled with funding issues due to mortality improvements and overly optimistic future asset return assumptions. These challenges, combined with increasing solvency funding requirements, due to decreasing solvency discount rates and an ever more onerous regulatory burden, have resulted in a gradual but steady trend of plan freezes and closures, wind-ups and conversion to 401(k) or defined contribution plans. While providing retirement income, the latter has more in common with individual personal savings than traditionally defined benefit plans (sharing none of their longevity and investment risk-pooling characteristics).

Lastly, the third pillar (individual personal savings) also had diminished from highs in the 1970s and 1980s, when personal savings rates averaged 13.2% and 11.4% respectively. More recently, for the 10 years prior to the global COVID-19 pandemic, personal savings rates in the United States averaged only 7.8%. The historical pattern in Canada is similar. Should these trends continue, it is not difficult to see a future where many retirees are forced to search for additional sources of income to not become a financial burden to their children.

Coincidentally, as “traditional” personal savings rates have languished, residential real estate values have been doing the exact opposite. Despite the housing market crash of 2008–2009, the average value of a home in the United States has increased by almost 5% per year over the last 25 years. At the same time, home ownership in the United States is near all-time highs (at approximately 65%), and the story in Canada is comparable.

Ultimately, the continued intersection of these phenomena will generate increased demand for new retirement income solutions over the next few decades that will open the door for reverse mortgages to become a key part of retirement planning.

What Is a Reverse Mortgage?

A reverse mortgage is essentially a loan product geared toward older homeowners who have significant equity in their home (usually at least 50%) and are looking to borrow against it. In the United States, these products usually are offered to those aged 62 or older, while in Canada, they can be offered to homeowners as young as 55. Typically, the homeowner receives funds either as a lump sum, fixed monthly payment or line of credit. The homeowner is not required to make any loan payments—rather, the loan is paid back (with interest) when the borrower dies, moves out or sells the home. Upon death, the homeowner’s heir (or estate) may choose to pay off the loan to keep the home, or sell the home and keep the balance of the proceeds of the sale.

As financial vehicles go, reverse mortgages are relatively young (first arriving on the scene in the United States in the 1960s). During their first few decades, they generated their fair share of reports about scams and predatory practices. Now, there are federal regulations in place to protect consumers. For example, in the United States, lenders must structure the transaction so the loan amount won’t ever exceed the home’s value. Even if it does (through a drop in market value or if the borrower lives longer than expected), the borrower won’t be held responsible for paying the lender the difference (and in most cases, the lender will be made whole through a government-sponsored mandatory insurance program).

Today, reverse mortgages can represent a reliable source of accessible (and nontaxable) home equity without needing to sell or downsize. When the loan is structured via fixed monthly payments, this also helps the homeowner reduce the investment risk of otherwise selling the home and needing to invest the entire proceeds themselves.

Furthermore, many issuers also offer the opportunity to reduce longevity risk—an important consideration for pensioners without substantial defined benefit pensions. This is typically done via a “tenure plan,” which includes annuity-like features such as monthly payments (sometimes indexed) that will continue for the life of the borrower. Naturally, transfers of risk come at a premium, so care must be taken when comparing offerings.

Historical Size and Future Growth of the Market

While the size of the U.S. reverse mortgage market has shrunk over the last five years, longer-term trends are clearly on the rise. For example, over the last 10 years, the U.S. market has increased from $4.5 billion to $5.5 billion (an increase of roughly 2% per year). However, in trying to project the growth of reverse mortgages over the next few decades, one could argue that even the last 10 years have been abnormal and thus not likely to be indicative of future trends due to the following events:

  • In 2011, formerly dominant industry players such as Wells Fargo and Bank of America stopped issuing new reverse mortgages due to a combination of increased regulation and fear of home price volatility that plagued them during the 2008–2009 housing crisis. However, this has since created opportunities for other players (such as American Advisors Group) to fill the gap and find ways to manage risk and achieve profitably under the new regulations.
  • A new batch of more stringent regulations implemented in 2017 caused another temporary slowdown. However, these regulations included additional protections for borrowers, such as mandatory counseling prior to signing and the ability for the borrower to roll over the loan at maturity, that will help set the stage for the long-term sustainability of the market.
  • Over the last two years, the global COVID-19 pandemic temporarily has decreased demand for new reverse mortgages due to lower levels of consumer spending and higher levels of personal savings.

Going back further, over the last 30 years, the total amount of loans issued under the Home Equity Conversion Mortgage program (HECM), a federally insured program that now accounts for nearly all reverse mortgages issued in the United States, has increased significantly. Figure 1 illustrates the cumulative number of HECM loans since the program began in 1990.

Figure 1: Cumulative Number of HECM Loans

Hover Over Image for Specific Data

It is also worth noting that there is significant room for growth. As of Q2 2020, homeowners aged 62 and older owned roughly $7.8 trillion in home equity across the United States. Comparably, as of 2020, the total size of the U.S. reverse mortgage market was just over $4.5 billion, which represented less than 0.1% of total senior homeowner equity at that time.

In Canada, the growth of the industry is even more pronounced. While overall industry statistics are not readily available, earlier this year, HomeEquity Bank (the leader of the nation’s reverse mortgage industry) announced that it had surpassed $1 billion CAD in originations for 2021. This represents a first for them, as well as a 28% annual increase over 2020. The total value of the bank’s reverse mortgage portfolio under management now stands at $5.4 billion CAD.

At the same time, according to Statistics Canada, “principal residence” home equity for people aged 55+ in Canada totaled roughly $2.4 trillion CAD in 2019. From these metrics, we can estimate the penetration ratio of reverse mortgages in Canada to be more than 0.2%. Therefore, should the United States catch up to Canada in terms of reverse mortgage utilization, the market in the United States could grow by a factor of two to three times.

Canada, in turn, has a bit of catching up to do with other parts of the world (the United Kingdom in particular). Ben McCabe, CEO of Toronto-based FinTech Bloom (the newest entrant to the reverse mortgage industry in Canada), was recently quoted as saying: “[The reverse mortgage] is viewed much more as a mainstream retirement plan in the [United Kingdom] than it is here, and as a result, based on our math, it looks like the equity release market is roughly five times as penetrated in the [United Kingdom] as it is in Canada.”

Recent metrics and historical growth aside, there is little doubt that general demographic trends alone slowly but surely will increase the popularity of reverse mortgages in both Canada and the United States.

This raises some interesting considerations for the future. In recent years, economists and the media often have discussed the financial legacy that baby boomers will leave behind as “the largest transfer of assets in human history.” Naturally, real estate values drove much of this wealth accumulation. What will higher utilization of reverse mortgages mean for younger generations that are counting on their inheritance, and what will this, in turn, mean for social programs and the North American economy in general?

One thing we know for sure is that reverse mortgages are here to stay, and as such, we should prepare for their impact on various stakeholders and different areas of the economy. This should include consumer education efforts as well as the ongoing review and improvement of regulations to continue making the industry less predatory and more accessible. Regulators also can help by setting up a framework that does the following:

  • Allows more financial organizations to enter the market (thus increasing competition and ultimately benefiting the consumer)
  • Encourages transparency and consumer education (which in turn will help shed the industry’s negative reputation)
  • Supports product standardization to simplify and streamline the process for consumers (and make it easier to compare offerings on an “apples-to-apples” basis)

If used prudently, reverse mortgages can be a valuable financial tool to help fill the income gap left by insufficient government and employer pensions. However, no amount of regulation will change the fact that reverse mortgages will reduce inheritances. Pensioners who utilize these products will need to prepare for this, and having a serious discussion with their children or grandchildren would be a good first step toward that.

John Melinte, FSA, ACIA, is a pension & benefits actuary and the managing partner of Baartman Melinte Consulting in Toronto.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.

Copyright © 2022 by the Society of Actuaries, Schaumburg, Illinois.