The Real Debt Crisis

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BankruptcyBy Christy Rogers, PhD, Director of Outreach,

More and more older adults, particularly adults of color, face a future of financial instability. Studies on retirement insecurity are indicating that debt, unemployment and poverty are rising, incomes are falling, pensions are flat, and wealth is declining for older adults, while they are living longer and their health care costs are rising.[1] All of these factors may exert more pressure on households to try to manage debt any way they can – even if, the Consumer Financial Protection Bureau (“CFPB”) warns, they are simply “prolonging an unsustainable financial situation.”[2]

With all the current political talk about the “national debt crisis,” family debt goes largely unchallenged. Although there have been small declines in mortgage and credit card debt since their peaks in 2008,[3]families’ assets have also declined. As a result, the leverage ratio (the ratio of the total amount of your debt compared to your total assets; the higher the ratio, the more indebted you are) actually rose from 2007 to 2010, and has been steadily rising for all age groups over the last decade.[4] Most of this debt is in mortgage debt, although student loan debt is increasingly significant. In fact, student loan debt surpassed car loan debt for the first time, in 2010.[5]  The steadily rising leverage ratios are worrisome for everyone, although they are of particular concern for people of color.

 

Figure 1: Rising debt for all age groups

Source: author’s analysis of SCF 2010 and SCF 2007 data.

 

 

Figure 2: Nonwhite or Hispanic leverage ratios are double those of Whites – and rising

Source: author’s analysis of SCF 2010 and SCF 2007 data.

 

As the charts show, leverage ratios are rising for all age groups, with some surprising upticks in the older age groups since 2007. We expect higher leverage ratios for younger folks – families are just taking out mortgages, starting to pay down student loan and auto loans, etc. But ideally, older adults should not be leveraged at all – the “golden years” should be one of financial security. Yet a study of older adults that were close to retirement revealed that their median debt increased from $44,000 in 2004 to $61,000 in 2007.[6]  We at the Kirwan Institute plan to take a deeper dive into the causes and consequences of this growing burden.

How are older adults going to manage this rising debt? It’s an open question, but the growth of one particular product might signal a new, and potentially troubling, consumer response. The CFPB and the AARP Public Policy Institute have recently focused their attention on reverse mortgages. While they are currently a small part of the market, their recent growth has been extraordinary.[7]  (Today, the majority of reverse mortgages are insured by the FHA as part of its Home Equity Conversion Mortgage or “HECM” program, so I will use “HECM” and “reverse mortgage” interchangeably.)

The idea behind the reverse mortgage is that an older borrower (reverse mortgages are limited to individuals 62 and older) can draw down her home equity over time, to access a monthly cash stream while remaining in the home indefinitely.  Interest is added to the loan every month, but the borrower makes no payments. The borrower is not liable for the difference if the loan ultimately exceeds the value of the home (FHA insurance provides that guarantee). When the borrower dies or moves, the estate sells the property and the proceeds go to the lender.

However, today’s borrowers are not using the reverse mortgage for the purpose of a long-term, reliable monthly cash stream.  In 2010, 70 percent of HECM borrowers took a lump sum at closing. Three quarters of all HECM borrowers take at least 90 percent at closing, up from less than half in 2008.[8]

The primary reason for taking out a reverse mortgage shifted from “improve quality of life and/or plan for emergencies” in 2006 to “manage debt” in 2010. [9]  Borrowers are increasingly younger, more likely to be married, and more likely to have traditional mortgage debt and other debt. [10]  And while one might reasonably guess that people use a reverse mortgage when they have a lot of equity to extract, in fact, reverse mortgage borrowers are less likely to have significant equity built up than other homeowners, and tend to be lower income. [11]   In essence, the CFPB found that people are increasingly using their loans as a method of refinancing traditional mortgages. And, ironically and tragically, “a surprisingly large proportion of reverse mortgage borrowers are at risk of foreclosure due to nonpayment of taxes and insurance.”[12]

In fact, this response – attempting to refinance an existing mortgage – was at the heart of the subprime lending and foreclosure crisis. Many people do not know that during 1998 – 2006, only 9 percent of all subprime loans went to first time homebuyers.[13] The majority were refinance loans, loans that were initially disproportionately marketed to African American neighborhoods. Subprime brokers targeted these communities not out of personal racial animosity, but because these neighborhoods lacked prime refinancing outlets, or because families had paid-off homes but unmet credit needs, such as college tuition or medical expenses.[14]  As the CFPB study notes, by 2006, non-whites were overrepresented in the reverse mortgage market. [15]

 

While only about 2-3 percent of eligible homeowners currently have a reverse mortgage, that number has the potential to increase dramatically. The CFPB report notes that “In 2008, the first baby boomers became eligible for reverse mortgages. The baby boom generation (48- to 66-year-olds in 2012) includes more than 43 million households, of which about 32 million are homeowners.”[16] The reverse mortgage is not in and of itself the problem. The increasing need for the reverse mortgage to manage debt is the problem. Over the next two decades, the percentage of older Americans will rise sharply, to a projected 16 percent in 2020 and 19 percent in 2030.[17]  And by 2050, the older population will be 42 percent minority.[18]  If growth of reverse mortgages continues and the potential market expands, we could see a lot more equity draw-down, and could see a disproportionate loss of home equity from families of color. This could further widen the already huge, and growing, racial wealth gap. The wealth gap between Whites and African-Americans has more than quadrupled over the course of a generation.[19]    Census Bureau figures show that in 2010 the median household net worth for White Americans was $110,729; for African Americans it was $4,995.

Lump sum equity extraction reverses the traditional ways that people slowly and faithfully build wealth. Without wealth to pass on, families become less able to help their children economically. The careful stewardship, retention, and passing on of home equity was foundational to building the middle class in this country, and the historical exclusion of families of color from homebuying and lending often prevented those families from joining the ranks of the middle class. Home equity is still the major component of family wealth, and we need to be careful how we treat it. It is a critical part of the bigger picture, of providing fair access to financial opportunity for all.

 

References


[1] See, for example, Alicia H. Munnell, Center for Retirement Research at Boston College, 2010 SCF Suggests Even Greater Retirement Risks (August 2012: No. 12-15).  Retrieved from:http://crr.bc.edu/briefs/2010-scf-suggests-even-greater-retirement-risks/

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