Reverse Mortgages: Supplementary Retirement Income from Homeownership

Abstract

A large proportion of the elderly have very low incomes. Nevertheless, they often have a considerable investment in their houses. A reverse mortgage is a method of dissaving which allows these individuals to convert some of the equity in their homes into a steady income stream while retaining their residence in these homes. Unlike conventional mortgage loans, which require mortgaging future income to acquire a real asset, reverse mortgages involve obtaining a mortgage loan on the house to provide a future stream of income, thereby liquidating wealth already accumulated. Upon retirement, many elderly homeowners are faced with the following dilemma: If they wish to remain in the house in which they have spent most of their lives and to which they may have an emotional attachment, they must accept what is often an inadequate retirement income while eventually leaving a sizeable bequest to their heirs. Alternatively, they can sell their home, which many are reluctant to do, and move to rented accommodation. In so doing, they generate for themselves a higher retirement income from the proceeds realized upon the sale of their house. However, uncertainty as to their life expectancy tends to deter them from selling. As long as they retain ownership of and continue to live in their house, they are provided with a rent-free service. If they sell their house, the capital derived from the sale and the income it generates could be depleted before their death. The objective of a reverse mortgage is to allow individuals to convert some of the equity they have in their homes into a steady income stream, without giving up residence in them. It is the reverse of a conventional mortgage in the sense that the individual receives a monthly payment rather than making one. Two methods of arranging for such a scheme are available. One method is the straightforward reverse mortgage (RM) in which the monthly payment received accumulates over time as a lien against the house. The other method is the RAM or reverse annuity mortgage, which involves the explicit purchase of an annuity with the proceeds of the mortgage loan. If the individual puts a Henry Bartel, Michael Daly, and Peter Wrage are on the staff of the Economic Council of Canada. The views expressed in this paper are solely those of the authors and, as such, have not been endorsed by members of the Economic Council of Canada. They wish to thank C. Hawtin of the Save and Prosper Group, and J.M. Selwyn of Hambro Provident Assurance Limited, both of London, England, for providing helpful material on alternative reverse mortgage schemes now in operation in Great Britain. Furthermore, the authors are grateful to A. Leduc of the Economic Council of Canada for this help in setting up the computer programming required for the examples in the text.