Reverse mortgagesBasic features, risks, and international experience

Luxmon Attapich, PhD

Senior Country Economist

Asian Development Bank

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Aging Society

What is a reverse mortgage?

• Borrow against equity in existing home

• Receive a series of payments (loan tranches)

• Borrower has lifetime tenure in home

• No repayments during lifetime (voluntary repayments may be allowed)

• Loan is non-recourse (surplus to borrower, shortfall for lender)

• Borrower must reside in property and maintain and pay property taxes

• Target customers: elderly (typical minimum age 55-65)

• Owner-occupied residential property

• Income, credit history not normally a factor

• Bullet repayment on specified events: death, permanent care, sale of home

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What are the benefits?

• Elderly may be asset-rich, cash-poor

• Life expectancy at age 65 is around 20 years & growing

• In many countries, elderly are main owners of home equity

– Australia: A$ 500 bn home equity held by over-65s

(Deloittes)

– Japan: Typical senior household has JPY 12m in

financial assets and JPY 18m in property assets, but

monthly income shortfall (Nomura)

• Provides independence, freedom from anxiety about future

income, opportunity to spend - holidays, healthcare, home

improvements ...

• Less financial reliance on family and State

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-1,500

-1,000

-500

0

500

1,000

1,500

1 2 3 4 5 6 7 8 9 10

Reverse mortgage cash flowsRegular annual payments

Lender's view

period cash flow end of period loan balance

-1,200

-1,000

-800

-600

-400

-200

0

200

1 2 3 4 5 6 7 8 9 10 11

Forward mortgage cash flowsAnnual repayments

Lender's view

period cash flow end of period loan balance

Reverse mortgage Forward mortgage

Regular repayments, loan steadily reduces

No repayments until end, loan steadily increases

IRR = 6.5%

Regular incomeLoan repaid

Cash flows

IRR = 6.5%

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Risks to the lender

• Longevity risk - how long before the borrower dies (or moves into long term care)?

• Interest rate risk - how fast will the loan grow?

• Property value risk - will it be enough to repay the loan?

• Crossover - when loan value exceeds property value

• Adverse selection and moral hazard

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Cross-over House price risk

Interest rate risk Longevity risk

Lender risks

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60

65

70

75

80

85

90

95

100

Birth age 60 age 65 age 70 age 75 age 80 age 85 age 90

Life expectancy at different ages

India Thailand US UK

S Korea Australia Singapore Japan

Life expectancy in selected countries (2015)

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Source: World Bank

Thailand 2015

Total Population75.068

Female78.953

Male71.368

Risks to the borrower

• Loan grows and consumes all the property value -maybe ok for borrower, but nothing left for children

• What happens if the lender fails (if regular payments)?

• Mis-selling (elderly borrowers + main family asset)

• "... due to the rising debt balance through time, accumulating drawdowns, and the ongoing accrual of interest, RMs can be expensive ... some retirees’ estates will be significantly diminished" 2003 study for Japan

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Forward mortgage Reverse mortgage

Loan drawdown One time (at start)May be multiple times through life of loan

Loan repayment Monthly repayments Single bullet repayment at end

Interest rate Fixed or floatingFixed or floating - normally higher than forward mortgage, but may be capped

Term Fixed (normally 10-30 years)Lifetime of borrowerPayment period can be fixed or for lifetime

Life expectancy factorLonger is better (more time to repay)

Shorter is better (loan will grow less)

Risk to lenderHighest at start, steady decrease as capital repaid

Exposure increases through life of loan

Lending criteriaBorrower’s income and credit history are key criteria

Borrower’s income and credit history not normally relevant

CollateralProperty value is protection in case of default

Future property value is all the lender can rely on

Negative equity Borrower's problem Lenders problem

Forward and reverse mortgages compared

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International case studies

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US: product featuresHome Equity Conversion Mortgage (HECM)

• Launched in 1989 by US Housing Dept (HUD) - now 95% of market

• FHA insurance against cross-over risk

• Minimum age 62

• Borrower’s income is not a factor

• Maximum loan amount set by law (rises annually)

• Lump sum, monthly payments (for fixed term or life), or line of credit (flexible drawdown)

• Variable interest rate (with restrictions)

• Non recourse guarantee

• Counselling mandatory

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US: market experience

• “HECM was intended to be a

demonstration program offered by

the government for only a limited

time. Loan value was capped to

target low-income elderly”

• Regarded as expensive - origination

fee, insurance premium 2% (+ 0.5%

of loan balance), monthly servicing

fee, legal costs etc

• Federal regulation is “confusing and

incomplete”

• In 2006 survey, 93% of borrowers

said effect was positive

• Most complaints concern information

and administration

• Regulations are being reviewed to

make product more effective

0

20000

40000

60000

80000

100000

120000

140000

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

US - new HECM loans each year

Take-up initially slowOnly 80,000 loans originated from 1989-2003Faster growth now but still a niche product

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UK: 2 types of equity release

Lifetime Mortgage (=RM)

'Loan' model (96% of market)

• Lump sum or regular payments (1/3

choose lump sum)

• Max agreed limit

• Right to repay interest (or not)

• Some lenders may lend more to

people with shorter life expectancy

• Rates fixed or variable with cap

• May be early repayment penalty

• Minimum age 55

Home Reversion Plan

'Sale' model (4% of market)

• Right to remain in the property rent

free for life

• No interest charged

• Lender purchases % of the equity

(may be 100%)

• When property is sold, lender gets

of proceeds - no more, no less

• Can repay early but will be based on

% of property value

• Minimum age 60

Both types carry a No Negative Equity Guarantee

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UK: regulation

• Advisers and providers of both types of plans are regulated by the Financial

Conduct Authority (FCA). Equity release is a ‘regulated activity’ with

required qualifications

• Equity Release Council is trade body, members voluntary sign up to

additional principles:

• No negative equity guarantee

• Borrower can remain in property for life or until long-term care

• Borrower can move to another property if acceptable to lender

• Lawyer prepares report explaining obligations and benefits, at least one

face to face meeting

• Professional property valuation

• Penalties such as early repayment charges must be clearly explained

• Interest rates fixed or variable (with a cap)

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Australia

• Provided by large banks

• Non recourse guarantee

• Mortgage insurance available

• Typical max borrowing (as % of property value): 15% (age 60), 45% (age 90)

• Rates fixed or variable, 1-2% above standard mortgage rate (pays for the NR guarantee)

• 50% of borrowers aged 70-79

• Industry body SEQUAL has Code of Conduct

• Home reversion product also available (1 provider)

0

100

200

300

400

500

600

700

800

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Australia: approvals and drawdowns ($m)

new approved facilities ($) new drawdowns ($)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Australia: outstanding market size ($bn)

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Japan• Several large banks and credit associations offer RMs

– 2013: Mizuho Bank launched, 55+, Tokyo area, “potential demand 230,000 loans

and JPY 5 trillion (US$ 50 bn)”, annual visits to check home and value

– 2014: BTMU launched, age 60-80, up to JPY 15m (US$ 150k), borrower makes

monthly interest payments, for home renovations only

– 2015: Sumitomo launched, age 60+, min home value JPY 60m, rate 150bp above

prime, revised 6-monthly, no restrictions on use of funds

• Limitations:

– Generally lend against land value only, so payments smaller

– Only fixed-term payments, not for lifetime

– Some products require monthly interest repayment

– Some products require some principal repayment if land values fall

– Non-recourse aspect not always clear

– Most products require use of a trust

• So key features of RMs do not really apply in Japan, product not popular

• It has been proposed that the Government should partner with the private sector to

underwrite the risk or to purchase the loans (Nomura 2013)

• Study suggests RMs in Japan may not generate enough income to cover shortfall for

most households outside Tokyo

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Korea - development

• Pre-2007

– RM offered without government support

– No lifetime payments

– Products not design specifically for elderly

– Products exposed to interest rate, home price, longevity risks

• JTYK implemented in 2007, government-guaranteed RM

– Has grown rapidly

Cumulative number of loans- Still less then 1% of potential

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Korea: JTYK product features (benchmarked on US HECM)

• Guaranteed by KHFC

• Started slowly, modified, now growing steadily, 25000 loans by 2015

• Conventional RM product (lifetime tenure, no repayments, non-recourse)

income not needed

• Adjustable rate (2 options, chosen by borrower)

• Payment options (constant, increasing 3%pa, decreasing 3%pa, stepdown)

• Lifetime (tenure) payments or fixed term (10-30 years)

• Fully or partially repayable at any time

• Mortgage guarantee provide by KHFC (one-time 2% of property value + 0.5%pa

of loan balance) based on US premium structure

• 30-day cancellation period

• Age 60+, KRW 900 million cap on property value

• Mandatory counselling, no fee

• Borrower may get tax exemptions

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Korea: market experience

• KHFC announced in 2016 they would issue new policies to promote RMs - more flexible ages, more subsidy to lower income elderly

• In 2011, Government also launched a RM program for farmers who are ‘farmland rich, cash poor’

Growth of RM product in Korea

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Hong Kong: product features

• HKMC did market survey among 1000 elderly, launched pilot in July

2011, then fine-tuned

• Further enhancements in 2015

• Slow start, now business growing, applications up 80% in 2015, now

1,200 loans per month

• Age 55+

• Monthly payments for 10, 15, 20 years or life

• Lump sum option

• Commercial banks write the business

• No negative equity, lenders covered by HKMC mortgage insurance

• Counselling is mandatory

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Hong Kong: pricing and payments

• Interest: HK Prime minus 2.5%

• Mortgage insurance added to loan (1.25% pa of outstanding loan, plus 0.28% pa for 7 years)

• Can get higher payments by assigning life policy

• Steady growth - lifetime payments most popular option

Payment

term

1

borrower

2

borrowers

1

borrower

2

borrowers

1

borrower

2

borrowers

10-year $3,200 $2,800 $3,700 $3,300 $5,100 $4,600

15-year $2,400 $2,150 $2,800 $2,500 $3,800 $3,500

20-year $2,050 $1,800 $2,400 $2,100 $3,300 $3,000

Life $1,650 $1,450 $2,000 $1,800 $3,100 $2,800

age 55 age 60 age 70

Monthly payments (per $1 million property value)

0

200

400

600

800

1,000

1,200

1,400

Dec11

Mar12

Jun12

Sep12

Dec12

Mar13

Jun13

Sep13

Dec13

Mar14

Jun14

Sep14

Dec14

Mar15

Jun15

Sep15

Dec15

Mar16

HKMC: Applications per month

0%

20%

40%

60%

80%

100%

120%

Dec11

Mar12

Jun12

Sep12

Dec12

Mar13

Jun13

Sep13

Dec13

Mar14

Jun14

Sep14

Dec14

Mar15

Jun15

Sep15

Dec15

Mar16

HKMC: Payment terms

10-year 15-year 20-year Life

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Lessons learned

• Clear and effective regulation is key

• Need to create product understanding - consumers and

providers and opinion formers

• Need flexible product (e.g. age, payment frequency)

• Takes time - the market is not created overnight

• Importance of a pilot and fine-tuning

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Market features which help RM

• Ageing population with less reliance on family self-help

• Elderly owner occupation in saleable homes

• Historically rising property values

• Liquid and transparent property market

• Robust legal system - confidence in future property rights

• Well-developed (forward) mortgage market

• Well-developed annuity market

• Reliable life expectancy data (for likely borrowers)

• Ability of lenders to hedge interest rates (e.g. bond market)

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Market features that can be managed

• Clear and transparent legal framework and regulation

• Effective regulation - e.g. mandatory counselling

• Insurance - to protect lenders from crossover risk

• Insurance - to protect borrowers if a lender fails

• Public education

• Willingness of lenders to innovate and be flexible and patient

• “mortgage insurance and mandatory counselling could be the two critical

product features if Hong Kong is to consider implementing RM in the

near future” 2010 report for HKMC

• “there must be safeguards for borrowers; there must be insurance

available for lenders, who otherwise might not involve themselves with

what are inherently risky contracts; and there must be a secondary

market for reverse mortgages so that lenders have the option of selling

some proportion of their RMs to other parties” 2003 report on Japan

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Some issues

• Can compound interest be charged?

• Tax treatment of borrowers and lenders

• Effect of RM payments on social security entitlements

• How to ensure effective regulation?

• Should RMs be subsidised and in what way?

• How big is the target group? Do they live in the type of

property that will be eligible?

• Who will provide the insurance / guarantees?

• Can a secondary market be created?

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More on Hong Kong Experience

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www.adb.org

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