The future of retirement funding!
Over the past decade, reverse mortgages have typically been associated with mis-selling scandals and inheritance spats, and subsequently treated with caution. The housing crash and wider financial crisis threatened to wipe these loans off the map, with the likes of Wells Fargo and the Bank of America culling the product from their portfolio.
“The Older you are the more you can access”
Today’s ageing population needs to find new ways to finance their retirement however, and renewed regulatory efforts from the US government indicate the landscape may be shifting towards a resurgence of these alternative products.
But is the potential really there for reverse mortgages to emerge as a high-growth industry and a mainstream product in the US and elsewhere?
DORCHESTER Magazine has conducted numerous interviews with real estate and reverse mortgage experts in the US and UK to shed the light on the future of this marketplace.
Reverse mortgage is a way for those who are “asset rich, but cash poor” to unlock extra money for a comfortable retirement by using their existing home equity. As the name suggests, the products allow borrowers of a certain age to take out a loan against the value of their home that is repayable, along with interest accrued, when the borrower dies or moves.
In America, home to the largest marketplace for these products, strict guidelines stipulate that the borrower must be at least 62 years old, continue to pay property taxes, and that the property must be the borrower’s primary residence. Interest will be set at either a fixed rate, or an adjustable rate based on the LIBOR index (London Interbank Offered Rate Index).
Nearly all US reverse mortgages are federally insured non-recourse loans known as Home Equity Conversion Mortgages (HECM). For a fee paid by the borrower, the Federal Housing Association (FHA) subsumes the risk of property prices falling on behalf of the lender, at the same time as guaranteeing the borrower will never owe more than his property is worth.
“Let’s say the housing market falls and the house is upside-down in value,” explains Mark Reeve, National Director of Reverse Mortgages at the wholesale mortgage bank, Plaza Home Mortgage. “As a bank, you could be left managing a depreciating asset – in this instance, the Department of Housing and Urban Development will pay off the lender for the extra losses.”
How much a borrower can receive depends on age, home value and current interest rates, working on a sliding scale as set by the FHA: the older you are, the more you can access, while the younger you are, the more restrictive it is. At today’s interest rate, a 65-year-old is able to take out up to 54 percent of their home value, but this might go up as high as 60 percent for older borrowers.
“It used to be more aggressive, but now conditions are more conservative in order to protect the bank and the monetary fund of the FHA,” says Reeve referring to this loan-to-value ratio.
Seniors who still have a mortgage can refinance to a reverse mortgage as a way of cancelling out their existing loan payments. But for those who have no mortgage, or only a small part of their mortgage left to pay, additional funds can be made available in a lump sum, as a line of credit, or in monthly payments.
“We are finding that more and more of the borrowers are using the reverse mortgage as another tool in their financial planning for retirement,” says Steve Irwin, Executive Vice President of the National Reverse Lenders Mortgage Association (NRLMA) based in the US. “It’s not necessarily just needs-based borrowers, but also those who are considering cash flows in their retirement years – for example as a reserve for medical emergencies.”
Case studies on the NRLMA website illustrate the point. One tells the story of John, 62-year-old, from Maine, who used a reverse mortgage to override his remaining monthly mortgage payments, pay off medical bills and buy his son a much-needed car. “I previously had a lung operation and am now working with four different doctors on various health issues,” says John. “We love living here and our reverse mortgage has helped us to get rid of our monthly payments and live more comfortably knowing our medical bills are paid.”
“Winners and losers”
So what does the industry in the US look like? And what profits are market participants set to make? “It’s a niche, but there are large banking institutions offering these products, as well as small community banks, credit unions, independent mortgage lenders and third-party originators,” explains Irwin.
“There is also an active secondary market for these products. Through Ginnie Mae securities (or Government National Mortgage Association security), reverse mortgages can be pooled and are sold as bonds,” adds Irwin, stating that this is ideal for investors anticipating consistent returns over a longer period of time. “The lender is not necessarily waiting for the life of the loan.”
For mortgages brokers, profits may include a percentage of the loan based on conditions of the secondary market or origination fees. “The loans are valuable right now on the secondary market. They are the highest quality loan out there today, with their FHA guarantee,” says Mehran Aram, CEO of The Aramco Group, a Californian real estate and mortgage company.
While the greatest risk for a borrower is that the reverse mortgage slowly gnaws away at their children’s inheritance, pitfalls remain for the complex network of industry players, namely the macroeconomic and business cycle risks associated with house prices.
“It is possible of course that another bubble may take place, but the government regulation of the financial industry will help to avoid that situation,” says Debra Penne, a Senior Real Estate Specialist at Allen Tate Realtors in Carolina. “Steady slow growth and appreciation of the properties along with stronger regulation of loans will be the best way to avoid another property bubble.”
Certainly, the US government announced last November that the process for applying for a reverse mortgage would include the introduction of credit. Indeed, new government regulations came in on March 2, 2015 introducing credit and income checks for those applying for a reverse mortgage. “This will not be a typical underwrite, it’s not looking for a credit score, but just the borrower’s past credit history and an indication of their willingness to keep current on their debt obligations,” explains Irwin.
Is the change part of a policy response to the recent housing crash, part of driving home how safe and secure these products are? “When you add up the impact that home values suffered, the tremendous risk that this posed to the insurance fund and a set of borrowers that were then defaulting because they were not able to meet their loan obligations, when you add all that up, it does become part of the risk consideration,” says Irwin.
The UK’s reverse mortgage market is second in size only to the US, but is markedly different, starting first and foremost with the name of the product. Termed ‘equity release mortgages’, these have a lower age threshold of 55 and don’t have any of the state guarantees built into the US system – thereby carrying a greater risk to the lender if house prices depreciate.
Before the financial crisis, banks such as Northern Rock and Bradford & Bingley led the marketplace. Today however it is insurers such as Aviva and LV that are making waves, funding loans through annuity sales at a time of rapid reform in the UK pensions system.
According to the latest figures from the UK’s Equity Release Council, there was a record £1.4 billion of equity release lending in 2014, an increase of 29 percent from 2013, marking a boost above pre-recession levels. Over 21,000 new customers used the products in 2014, the highest number since 2008, and the average age of borrowers was 71.
“This year, some major high street names have expressed an interest in equity release,” said Nigel Waterman, chairman of the Equity Release Council, highlighting plans by Legal & General and Santander to take a deeper look into the implications of offering the products.
“Nowadays, we are about the most regulated product on the planet. This means satisfaction among customers is very high while complaints are very low when compared with mainstream mortgages.” Says Waterman.
According to Craig Colton, the CEO for Equity Release at Aviva, the stringent processes for customers taking out an equity release mortgage – consulting a specially qualified adviser plus an independent solicitor – have been in place since 2000, well before the crisis.
But is it only now that people feel more comfortable about the value of their homes once more, in the wake of the subprime crisis that an upward trend has emerged again?
“The risks for providers are better understood following the crisis; the product and proposition are better understood. An increasing number of advisers are able to give guidance on equity release and more people are investing their savings in assets,” says Colton.
“Waiting for the US boom”
While UK equity release has experienced a surge, the US reverse mortgage market is lagging, with 51,642 new loans made in 2014, falling from 60,091 in 2013. 14 million homes have qualifying borrowers, but there is currently only 3 percent market penetration, according to Mr. Reeve of Plaza Home Mortgage. With fewer than 100 qualified experts in the field in the US, this is hardly a saturated market and opportunities may yet arise.
“The reverse mortgage industry has been waiting for a so-called boom for quite some time. We have a baby boomer generation here in the US that’s been turning 62 at the rate of 10,000 persons a day for almost two years,” said Mr. Reeve, pointing to the demographic trend prevalent across the US and Europe of an ageing population with longer life expectancy.
“We haven’t quite seen the volume increase that the industry was projecting. But I do believe that in time, whether it’s 2015, 2016 or 2017, it is going to come, primarily because the senior community has a lot of home equity and they don’t have a lot of cash savings. It’s mathematical.” Says Reeve.
With stability in the housing market increasing since the crash, Mr. Reeve also sees the reverse mortgages as a boon to the US government. “If they see little or no risk in lending money out and using the property as collateral, it’s actually a cheaper alternative for the government so that they don’t have to come up with government programmes to sustain their seniors.”
Whether the reverse mortgage market can be emulated elsewhere in the world is difficult to judge. If there is a property ownership and a good property market, it is theoretically possible. One key factor is the stability of the housing market. How do house prices move? Does the country have the data and resources to consistently and reliably predict future movements?
More than this, the broader mortgage and mortgage insurance industry of that particular country would need a strong underlying infrastructure, willing lenders and a network of specialist advisers and lawyers.
In the meantime, it is likely we will see uptake of reverse mortgages climb in this year across the two biggest markets, the US and the UK.
By Hannah Murphy