The Plight of the "Move-down Buyer"

Stuck in Place

A healthy housing market functions like a gigantic escalator.

The bottom rungs are occupied by first-time Buyers. As they purchase entry-level homes, the Sellers of those homes ("Move-up Buyers") typically buy larger homes, enabling Sellers of those homes to buy even bigger homes.

And so on, and so on.

One of the most remarked consequences of the housing bear market the last three(?) years is that falling real estate prices have clobbered the equity of move-up Buyers.

So, the money they need for a downpayment to buy a bigger home is either diminished -- or gone.

In the most distressed housing markets -- places like Florida and Las Vegas -- many people who bought at the peak are now "underwater" (they owe more than their home is worth) to the tune of tens (or hundreds) of thousands of dollars.

Voila! No more moving escalator.

Stranded at the "Top of the Food Chain"

All of the foregoing is now very-well documented.

Less remarked is the plight of the "move-down Buyer" -- the owner of a bigger home, typically close to retirement age, who is ready for a smaller dwelling, but is unable to sell (also known as a "down-sizer").

If move-down Buyers are lucky, they bought decades ago, and have so much equity that even a 30% drop in housing prices still leaves them able to sell (and they've been prudent enough -- and financially secure enough -- to leave that equity untapped through the years).

It's also true that financial products like reverse mortgages can help move-down Buyers (at least the ones over 62 years old) transition to a smaller home.

However, the flip side of buying a bigger home decades ago is that the same home today could easily require hundreds of thousands of dollars of updating and remodeling to appeal to today's (financially hamstrung) Buyers.

Even if those Buyers can still muster a six-figure downpayment and qualify for a jumbo mortgage, coming up with a couple hundred grand for remodeling, out-of-pocket is (often) the kiss of death.

So what happens?

Nothing.

Move-down Buyers can't sell, which means that the owners of homes at lower price rungs can't sell -- and so on, and so on.

Public Policy Implications

The foregoing dynamic suggests that the best way to unfreeze the housing market isn't to buttress first-time Buyers, as policymakers have done so far.

Rather, the smarter approach is to help move-down Buyers.

That could be done by making a pot of cheap money available to Buyers undertaking major remodeling (cheap purchase money, courtesy of the Fed, doesn't do it); by giving tax credits to Buyers who tackle such projects; or even by giving incentives to investors to buy and remodel such homes.

Such a strategy not only would unlock the housing market's frozen upper brackets, but it would have a huge ripple (multiplier) effect as billions of dollars spent on labor and materials coursed through the economy.

Which all makes eminent, common sense.

After all, as everyone knows, a working escalator needs to go down as well as up.

Baby Boomers & Reverse Mortgages

Next Big Thing:
Reverse Mortgages

Take 80 million Baby Boomers fast closing in on retirement age, many of whom (still) have lots accumulated equity in their now too-big homes, and what do you get?

A vast potential market for something called a reverse mortgage.

Like its name suggests, in a reverse mortgage, the lender pays the borrower, instead of the other way around (it can either be a lump sum, or periodic payments).

The benefit to the borrower?

They get to tap their home equity without making payments -- and without qualifying for a new, conventionally amortizing loan (which could be difficult, given the now-retired borrower's lower income).

In fact, there are no income tests for reverse mortgages; to qualify, the borrow only has to: 1) be at least 62 years old; and 2) have sufficient equity in their home, as determined by an appraisal.

Reverse Mortgage Logistics

How big a reverse mortgage one qualifies for is then a(n actuarially determined) function of age: the younger you are, the less you can borrow.

Why no screening for pre-existing conditions, or other health issues that might affect the borrower's longevity?

Because someone in poor health is actually a better risk for the lender. If they die the day after taking out a reverse mortgage, the lender pockets the borrower's residual equity.

Conversely, it's the 62 year-old who's fit as a fiddle and lives to be 100 that causes lender losses (because the unpaid principal and interest keep accruing).

Fortunately for the reverse mortgagors, it's impossible to owe more than their home is worth (a condition called being "underwater").

For the 3% of (long-lived) borrowers where that would otherwise happen, insurance kicks in to cover the shortfall.

No More "No Doc" Loans? Think Again

Reverse Mortgages Gain in Popularity

So, after all the fiascoes with subprime mortgages and lax underwriting standards (if you can call them that), "no doc" loans are a thing of the past, right?

For the most part.

However, there's still a niche of the market where lenders are approving borrowers with virtually no paperwork: reverse mortgages.

The catch, of course, is that with a reverse mortgage, the bank is making monthly payments to the borrower, not the other way around.

Reverse mortgages are particularly suitable for older, long-time homeowners who have modest income, but a ton of equity in their existing home.

Lenders are more than happy to let such "borrowers" tap that equity to make a reverse mortgage on the purchase of a "downsized" property.

Even more than with traditional mortgages, fees and terms on a reverse mortgage are key.

In other words, do your homework!