LTVs Rising for New Retirees

The report, Emerging Cohort Trends in Housing Debt and Home Equity, written by Joint Center researchers George Masnick, Zhu Xiao Di and Eric Belsky, analyzed such trends for different generations of borrowers nearing retirement and found that the amount of mortgage debt carried later in life has been increasing, while the share of borrowers having completely paid off their mortgage debt has been declining.

“What was widely perceived by previous generations as an illiquid asset is increasingly being viewed as relatively liquid,” the authors wrote. “More than before — and later in life — homeowners are now tapping into their home equity by borrowing against home equity or reinvesting less than was gained on the home sold when buying another home.”

Borrowers reaching retirement age in the 1970s and earlier typically had paid off their mortgages as they reached mid-life. Many viewed their home equity as a nest egg to be used for emergencies or as inheritance to their family. A satisfied mortgage dropped monthly housing costs significantly for the long-run.

In the 1980s and 1990s, however, the pattern of having mortgages paid off by late mid-life began to change. In 1989, more than half, or 54 percent, of owners age 55 to 64 owned their home debt free, compared to only 39 percent ten years later and an even smaller percentage is expected in the future, the report said.

The emergence of higher mortgage debt late in life in part results from significant intergenerational demographic and economic shifts such as the Tax Reform Act of 1986, which retained the deduction for mortgage interest, marriage at a later age, divorce and remarriage, the rise of the two-earner household, increasing life expectancies and returns to labor supplied by older people, changes in the way retirement is funded, and increased costs of education and health care.

The trend also results from mortgage market shifts affecting the liquidity of housing equity. The cost of borrowing against home equity has been reduced during the past decade and a half. Mortgage origination costs have also been trimmed due to declines in interest rates, the rise of secondary mortgage markets and improvements in information technologies. Additionally, legal impediments that discouraged lenders from offering home equity products were removed in the late 1980s, the report said.

By 2000, the oldest half of the baby boom generation, the 45 to 54 age group, reportedly had median housing debt of about $50,000. For the youngest of baby boomers, which was the 35 to 44 age group in 2000, it is likely that when they become 45 to 54 year olds in 2010, their median housing debt will be over $70,000, based on analyzing their debt levels a decade earlier and the likely changes in debt as they age.

The driving force behind rising mortgage debt for middle age cohorts are married couple owners, according to the report. Married couples have larger mortgage debt increases, than unmarried borrowers, due to multiple earners in the household and higher incomes to purchase more expensive housing. When comparing the older generation of married baby boomers (ages 45 to 54 in 2000) to the cohort of married 45-to 54-year olds in 1990, the difference in median mortgage debt is $62,000 versus $26,700, respectively. Already on an even higher debt trajectory are the younger married baby boomers, who at age 35 to 44 in 2000 had a median debt of $79,900, and the baby bust generation of married owners, who at ages 25 to 34 at that time had over $81,000 in mortgage debt.

Unmarried borrowers, however, lag married couples in home equity accumulation so their option to use such wealth may be limited when they face a downturn in their annual income later in life.

But, “the actual level of housing debt each cohort will carry ten years hence is intimately tied to how much house values grow,” the authors said.

While “serious problems” could be created for those with high debt later in life “if housing values were to suddenly fall, or if interest rates were to spike up in the future making the equity in homes less liquid,” the authors said data confirms that the values of owner housing occupied by the different cohorts increased for both married and unmarried owners between 1990 and 2000. “Every successively younger cohort of married owners is on a higher value trajectory than the cohort that preceded it in the age structure.”

Additionally, the value increases for married couples are larger than for unmarried owners. The authors indicated this can be linked to a larger household income for married borrowers and that a higher percentage, compared to the unmarried, purchase newer housing.

Among married owners, the largest home equity increases occurred for the oldest cohorts, who have the least mortgage debt. While housing values have increased most for younger married cohorts, their growing housing debt has cut into their growth in home equity. Younger cohorts will eventually gain additional equity as their mortgages are paid off, but it will come at a later age and depend on the present differences in cohort housing values being sustained.

Rising mortgage debt as cohorts approach retirement is likely to reinforce the recent trend of more people working beyond the age of eligibility for social security.

Downsizing would be another option. The four keys to successful downsizing at a later age are: sufficient home equity built up in the current home; a demand for this housing; affordable mortgage interest rates; and more affordable alternative housing for the down sizers. A majority of baby boomers, especially married couples, moving toward retirement over the next two decades appear to meet the first two requirements. The third and fourth requirements provide areas of uncertainty due to the difficulty in predicting future mortgage interest rates and nearby affordable living spaces.

Problems arise when neither of those two options is practical. Elderly with high mortgage balances are especially vulnerable if their health deteriorates or if income declines, especially if their housing is already of low value. Such unmarried adult or poor households are also less likely to undertake long-distance moves to retirement communities or lower-cost housing.

Home equity borrowing through cashout refinances have surged several times since 1990, and soared after 2001 due to strong house price appreciation paired with 40-year low mortgage rates, the authors wrote. Freddie Mac estimates that the amount of home equity cashed out, net of paying off second mortgages as part of the refinance process, was about $139 billion on primary conventional loans in 2003. About $65 billion in second mortgages were paid off in refinance transactions in which the second mortgages were rolled into the new first mortgage. Also skyrocketing, was the debt outstanding on home equity loans and lines of credit — roughly tripling to $1.0 trillion by the fourth quarter of 2003.

Paying off other higher cost debt is found to be the primary use of the proceeds of home equity borrowing and though the downside of doing so leaves borrowers’ homes more reachable to creditors, no secular upturn in the rate of mortgage loan delinquencies and defaults has resulted since more consumers began substituting mortgage debt for consumer debt, the authors said.

The authors also suggested that baby boomers might be more comfortable with high housing debt at a time when incomes have declined because their parents’ generation has attained record levels of home equity and household wealth and are estimated to pass down as much as $7.2 trillion in inheritance.

However, “carrying high housing debt in old age is surely based on wishful thinking across a whole range of issues — joint high and appreciating housing values, continued labor force attachment, continued ease at tapping accumulated home equity, and ease of selling the house when needed are the primary bets,” the authors wrote. “A windfall inheritance might only be the hoped for icing on the cake.”