Tag Archives: pension

Rising Mortgage Borrowing for Seniors

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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.

Should Seniors Pay Off Their Mortgages?

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photo by Andreas Lehner

TheStreet.com quoted me in Should Seniors Pay Off Their Mortgages? It opens,

Increasingly, seniors are going against the conventional retirement wisdom about mortgages which, always before, preached that a cornerstone of a good retirement was to enter it debt free. That meant without a mortgage.

And yet about one-third of homeowners 65 and older have a mortgage now. That’s up from 22% in 2001. Among seniors 75 and older, the rate jumped from 8.4% to 21.2%.

The appeal, of course, is that home mortgages are cheap; 30-year fixed-rate loans are going out under 3.7%, and 15-year fixed rates can be had for 3.1%.

That puts the question in sharp focus: is this good financial planning or is it reckless?

Understand: age discrimination is flatly illegal in home loans. But law does not dictate financial prudence and the question is: is it wiser to pay off a home mortgage if at all possible – which used to be the prevailing wisdom? That still brings a sense of relief, too. Tim Shanahan of Compass Securities Corporation in Braintree, Mass. said: “It’s a great feeling to have no debt and a significant accomplishment to be able to tear up the mortgage.”

True.

But is this still the smartest planning? As more seniors take on home mortgages, experts are re-opening the analysis.

“The short answer to the question is it depends,” said certified financial planner Kevin O’Brien of Peak Financial Services in Northborough, Mass. O’Brien is not being cute. So much of this is individual-centric.  O’Brien continued: “It depends on how strong the person’s cash flow is or not. It depends on how much liquid savings and investments they have after they might pay it off. It also depends on the balance they need to pay off in relation to their sources of cash flow, and liquid assets.”

Keep in mind, too: today’s retirement is not yesteryear’s. About one senior in four has told researchers he plans to work past 70 years of age. That means they have income. Also, at age 70, a person has every reason to claim Social Security – there are no benefits in delaying – so that means many 70+ year-olds now have two checks coming in, plus what retirement savings and pensions they have accrued.

That complexity is why Pedro Silva of Provo Financial Services in Shrewsbury, Mass offered nuanced advice: “We like to see clients go into retirement without mortgage debt. This monthly payment can be troublesome in retirement if people are using pre-tax money, such as IRAs, to pay monthly mortgage. That means that they pay tax on every dollar coming from these accounts and use the net amount to pay the mortgage.”

“If clients will carry a mortgage, then the low rates are a great opportunity to lock in a low payment,” Silva continued. “We encourage those folks who don’t foresee paying off their home in retirement, to stretch the payments as long as possible for as low a rate as possible.”

David Reiss, a professor at Brooklyn Law and a housing expert, offered what may be the key question: “I think the right question is – what would you do with your money if you did not pay off the mortgage? Would it sit in a savings account earning 0.01% interest — and taxable interest, at that? Paying off your mortgage could give you a guaranteed rate that is equal to your mortgage’s interest rate. So if you are paying 4.5% on your mortgage and you take money from your savings account that is not spoken for — like your emergency fund — you would do way better than the 0.01% you are getting in that savings account, even after taxes are taken into account.”

 

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Retiring with a Mortgage

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MassMutual quoted me in Is it OK to Retire with a Mortgage? It opens,

The conventional wisdom is that you should pay off your mortgage before you retire. Yet, about 4.4 million retired homeowners still had a mortgage in 2011, according to an analysis of American Community Survey data by the Consumer Financial Protection Bureau (CFPB). More than half of them spend 30 percent or more of their income on housing and related expenses, a percentage that may be uncomfortably high even for working homeowners.

Not having to put such a large percentage — or any percentage — of your retirement income toward a monthly mortgage payment in retirement will certainly make it easier to meet your other expenses. But is it really so bad to have a mortgage payment during retirement?

“The logic behind the rule of thumb is that your income will go down in retirement, so it would be helpful if your monthly expenses went down significantly as well,” said David Reiss, a law professor who specializes in real estate and consumer financial services at Brooklyn Law School in New York. But if your income from Social Security and a pension (if you have one), and to some extent your assets (the nest egg you plan to draw on for additional retirement income), will be sufficient to make your monthly mortgage payment and meet your other expenses in retirement, there is no real reason that you have to get rid of the mortgage, he said. The key is that keeping your mortgage during retirement should be part of a plan and not a response to a crisis.

More Homeowners are Retiring with a Mortgage

More homeowners retired with a mortgage in 2011 than a decade earlier, according to the CFPB’s analysis of U.S. census data.1 They’re less likely to have their homes paid off because they’re purchasing later in life, making smaller down payments and tapping equity for other purchases.1 In fact, 36.6 percent of homeowners ages 65 to 74 and 21.2 percent homeowners age 75 and older (some of whom may not be retired yet) had mortgages or home equity loans in 2010, according to the Federal Reserve. The median balance was $79,000 for the 65 to 74 age group, and $58,000 for the 75 and up age group.

The CFPB points out two problems with carrying a mortgage during retirement: less accumulated net wealth and the possibility of foreclosure if retirees can’t make their mortgage payments. Foreclosure is harder to recover from when you’re older because you may not be able to return to the workforce to compensate for the loss and because you’re more likely to have health problems or cognitive impairments, the CFPB said.1

Having less accumulated net wealth is a problem, especially if most of your wealth consists of your home equity, which is less liquid than stocks, bonds and cash. Foreclosure is a serious problem if it happens to you, but the odds are slim: even in the aftermath of the housing crisis, in 2011, foreclosure rates were only 2.55 percent for homeowners 65 to 74 and 3.19 percent for homeowners 75 and older.

Some retirement-age homeowners who haven’t paid off their mortgages undoubtedly would rather be debt free but couldn’t afford to retire their home loan sooner. But others might be putting the money that could have gone toward extra mortgage payments to a better use. (footnotes omitted)

Who Knows The ABCs of Finance?

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Annamaria Lusardi recently posted a working paper, Financial Literacy: Do People Know the ABCs of FInance? to SSRN. The abstract reads,

Increasingly, individuals are in charge of their own financial security and are confronted with ever more complex financial instruments. However, there is evidence that many individuals are not well-equipped to make sound saving decisions. This paper looks at financial literacy, which is defined as the ability to process economic information and make informed decisions about financial planning, wealth accumulation, debt, and pensions. Failure to plan for retirement, lack of participation in the stock market, and poor borrowing behavior can all be linked to ignorance of basic financial concepts. Financial literacy impacts financial decision-making, with implications that apply to individuals, communities, countries, and society as a whole. Given the lack of financial literacy among the population, it may be important to remedy it by adding financial literacy to the school curriculum.

As I have stated previously, not only is financial literacy in bad shape, but efforts to improve it have not proven to be very effective. Lusardi’s paper has some sobering findings:

most individuals in the United States and in other countries cannot
perform simple calculations and do not understand basic financial concepts such as interest compounding, the difference between nominal and real values, and risk diversification. Knowledge of more complex concepts, such as the difference between bonds and stocks, the workings of mutual funds, and basic asset pricing, is even scarcer. Financial illiteracy is widespread among the general population and particularly acute among specific demographic groups, such as women, the young and the old, and those with low educational attainment. (3)

Because evidence does not demonstrate that additional financial education is all that effective, I take a different lesson from Lusardi’s review of survey results. The government should take an active role in regulating financial markets to protect consumers from abusive behavior and to encourage them to make good financial decisions. Financial education is no replacement for consumer protection.