Using Reverse Mortgages to Manage the Financial Risk of Long-Term Care

Abstract

A penny saved is a penny earned. Poor Richards Almanack (1737)

This sage advice of Benjamin Franklin highlights the fact that the basic strategy for ensuring retirement security has changed little over the past 200 years. The traditional formula is simple—accumulate assets during one’s working years and systematically draw down these assets after retirement. In recent years, however, more and more Americans are finding it difficult to save enough for retirement from earnings. The dramatic fall of the stock market between March 2000 and March 2001 exacerbated the problem, reducing personal wealth by an estimated $3.5 trillion in just one year (Weller 2003).

These trends are troubling at a time when rising longevity places seniors at greater financial risk due to a chronic illness or disability. There is one bright spot, however—housing wealth has continued to rise. Average home equity in the United States increased more than 10 percent between 2003 and 2004 (Joint Center for Housing Studies 2005). Many older families have substantial amounts of untapped housing wealth, including households whose other retirement resources may be very modest. With more than $2 trillion tied up in home equity, this financial asset has the potential to dramatically increase the ability of seniors to pay for the services and supports that can help them to stay at home.

Unlocking illiquid assets such as housing wealth requires us to look more closely at asset decumulation in retirement. Typically, elders sell their home to access the equity they have built up over time. When they move to a more appropriate living situation, the sale of a house can be very beneficial. Those elders with a chronic health condition, who are forced to sell their home to pay for long-term care, however, could face serious problems. Relocating often entails the loss of familiar activities along with support from family and friends. This can reduce quality of life and accelerate cognitive decline (Bassuk 1999). For physically or mentally impaired elders, a better approach would be to use the equity in the home to purchase services and devices that could enable them to stay at home. A new type of financial tool—the reverse mortgage—can help older Americans achieve this goal.

Little work has been done to examine the role of reverse mortgages in managing the financial risk of long-term care among older households. Here we address this issue by examining the use of reverse mortgages to help impaired elders continue to live at home (termed “aging in place”). The article also identifies the potential links between reverse mortgages and long-term care insurance. The research presented here is part of a study conducted by the National Council on the Aging, which was funded by grants from the Robert Wood Johnson Foundation and the Centers for Medicare and Medicaid Services (Stucki 2005). The analysis is based on the 2000 Health and Retirement Study and data from the housing and mortgage industries. This study focuses specifically on households where the youngest homeowner is at least age 62, since this is the minimum age to qualify for a reverse mortgage. Because home values have increased substantially since 2000, the numbers presented here will likely underrepresent the potential of this financing option for long-term care.

The results of this research suggest that liquidating housing wealth through reverse mortgages can play an important role in improving the way we pay for long-term care in this country. Elders who need assistance with activities of daily living or instrumental activities of daily living have, on average, substantial amounts of home equity that could be used to support informal caregivers and purchase a meaningful amount of services to promote aging in place.