Share

 

Investments begin at 60

Wealthier people and financial planners are embracing reverse mortgages as another tool for retirement investment portfolios

Reverse mortgages may be a ‘silver’ lining for cash-poor pensioners who own a property, particularly in developing countries where pension schemes are rare or non-existent. But how valuable are they for banks and will they reach scale in the near future?

A reverse mortgage (otherwise known as home equity conversion) is a financial arrangement between the real estate owner and the bank, which enables pension-age customers to convert their house equity into a loan in the form of cash advances demanding no repayment until a future date. Borrowers stay in their homes and interest accrues on these loans as on any other loans, but the final repayment is not expected until the owner sells the property or dies.

 

Features of a reverse mortgage

  1. Minimum age requirement. In most countries where reverse mortgages operate, borrowers should be at least 60 or older.
  2. Loan interest. Loan interest charged on the debt can be fixed or variable, depending mainly on the age of the borrower and the amount of the loan.
  3. Payment options. The borrower has the choice to receive a lump sum amount or a series of regular instalments.
  4. Repayment. No repayment is required on the reverse mortgage as long as the borrower resides in their principal residence on which the loan is secured. The full loan is payable only when borrower sells the house or permanently moves away or when the borrower dies. In the case of death, inheritors will repay the loan before reclaiming the property.
  5. Fees. Typical fees include origination, appraisal and mortgage insurance.

 

Current market status

Country

Property Stock, US $

Reverse Mortgage, US $

Market Penetration

INDIA

107 Billion

10 Million

1%

USA

85 Trillion

11.5 Billion

3%

UK

110 Trillion

23.5 Billion

7%

Sources: National Housing Bank (India), FHA Federal Housing Administration (USA), Office for National Statistics (UK), as of y/e 2014.

 

When reverse mortgages first entered the marketplace, they were largely aimed at people who had no other option for funding their retirement. This perception has changed, as wealthier people and financial planners embrace the concept as another tool for retirement investment portfolios.

In the US, government plays an important role within the reverse mortgage market. Home Equity Conversion Mortgage (HECM), a government-backed organisation, promotes a federal insured reverse mortgage product with a restricted loan limit. The Federal National Mortgage Association (Fannie Mae), a government-sponsored entity, offers a reverse mortgage programme with fewer restrictions on loan amounts.

In Canada, reverse mortgages are gaining popularity because they offer a tax-free stream of cash usually paid in the form of a monthly annuity.

 

The lender’s perspective

From the bank’s point of view, reverse mortgages offer a safe and profitable investment avenue because the property almost always appreciates. Of course, there is always a chance of depreciation which will then turn this mortgage into a risk exposure item.

Another advantage is that any increase in interest rates can be passed directly to the borrower, with a relatively low risk of probability of default. On the other hand, as it’s a non-recourse loan, there is no access to additional collateral / personal assets from the borrower in case of default.

Other risks associated with reverse mortgages are:

  • Cross-over risk – loan value being appreciated at a higher rate than the house value
  • Longevity risk – borrower exceeding the loan tenure
  • Anti-selection – house-value being overstated by the borrower’s intermediary
  • Moral risk – borrower neglecting property maintenance or not paying property tax / home insurance
  • Litigations – disputes with heirs over loan repayment / handing over the property to the lender

 

Going forward

There is a scope for public-private partnerships to provide reverse mortgages, educating consumers and ensuring transparency, which may act as a catalyst for a greater market share for this type of product.

At the macro-economic level, this could ease the pressure on governments to pay all pensions from the treasury, as the same money can be used for further economic development.

For the consumer, reverse mortgages could be the most dependable and secure retirement avenue, readily available to the asset-rich and income-poor or those wanting to diversify investments in later life. It is increasingly likely that their popularity will rise.