Reverse mortgages are a way to unlock home equity, and for many Australians, it is an important part of wealth.
The Financial System Inquiry (Financial System Inquiry) proposed this mortgage to support retirees to diversify their wealth and improve the efficiency of Australia’s financial system.
The relative growth rate of reverse mortgages corresponds to this, but is still marginal, with a total exposure of A$2.9 billion (see the line at the bottom of the chart), which is much lower than standard mortgages and higher-risk loans such as net interest rates And low interest rate document loans. Although the transaction volume has increased, the number of lenders has decreased over time. According to the financial system, before the global financial crisis, there were more than 15 lenders, but today there are only 5 lenders.
Although the population is aging and billions of home equity are waiting to be released, why are mortgages so popular and reverse mortgages not so popular?
How reverse mortgages work
A reverse mortgage allows homeowners to use the house as collateral to obtain a lump sum or annuity. The advantage of reverse mortgages is that the borrower usually continues to live in real estate until death. The decision to sell a house is usually an exciting decision. Using this product can be avoided because the house can be sold to repay the loan after death.
Reverse mortgages can also be used for expenditures, or in aged care, which usually requires hundreds of thousands of dollars in accommodation deposits.
There are other options: Australians who want to get home equity usually prefer to sell their homes and buy or rent smaller ones. This decision may trigger costs such as capital taxes and other expenses, but it may also make a difference as retirees move into the space and standard residences they need. The free cash can then be converted into an annuity, for example to fund monthly income.
How is reverse mortgage different from standard mortgage?
In reverse mortgages, as the borrower uses the credit line, the loan amount will increase over time until it reaches the upper limit. As interest is added to the outstanding amount, the loan amount further increases. Since borrowers can usually only use limited other assets and income to repay loans, and if they have a long life, the loan amount may quickly increase to unexpected levels.
In order to protect consumers (protected by the National Consumer Credit Protection Act), customers of these products must be provided with legal and financial advice through standardized calculators. In addition, banks provide “no negative equity” guarantees, which means that the loan amount cannot exceed the value of the property.
Finally, because the sector has less competition and higher risk for lenders, interest rates are usually higher than those of standard housing loan products. In this part of the market, the property value provided by the lender usually does not exceed 50% of the real estate value, while the value of a standard mortgage loan is usually around 80% of the property value-even higher if mortgage insurance is used.
What are the risks for the lender?
If the loan amount exceeds the value of the property, no negative equity guarantee may result in losses. Despite the large amount of incidental buffering, this can happen in many ways. First, house prices may fall. It is not unreasonable to see that the decline in the financial market equals the previous rise.
In addition, the homeowner has the right to live in the property and can only repay the loan after death. If the borrower enjoys a long life after obtaining a reverse mortgage, or if the cumulative interest rate on the loan amount is higher than the house price, the lender can use a non-negative equity guarantee. Longevity risk is difficult to assess because it requires predicting life expectancy.
Longevity risks are also affected by adverse choices. Unlike life insurance, healthy consumers may be keen on reverse mortgages.
In addition, the limited number of reverse mortgages makes it difficult for banks to conduct risk analysis. The lender determines the loan amount based on the age of the lender (the older the age, the larger the possible loan amount).
Borrowers can also choose to repay the loan early. If they find a cheaper lender, they can refinance and prepay for the reverse mortgage, which exposes the original lender to further risks.
Another aspect is that once the negative equity threshold is reached, the borrower has no further financial incentives to maintain the property, which may lead to further depreciation of the property value.
The release of home equity is positive for the efficiency of the Australian economy and is in line with our retirement philosophy. In the United States, the government provides non-negative equity guarantees to reduce the risk of lenders and support the market.
The Australian government may not be prepared to compensate for industry risks. However, more general measures can be adopted to support the development of such markets.
First, the housing can be further confirmed in the means test for determining the age pension. Such measures may better meet people’s needs.
Second, the industry’s biggest concern is the limited availability of risk transfer solutions (such as derivatives and securitization structures), which will enable banks to reduce housing price risks and life risks at a reasonable cost. It is difficult for banks to hedge or transfer life and housing price risks. This is a trap for the industry22-only more equity release may lead to more risk transfer solutions, and vice versa.
