Magazine article Journal of Banking and Financial Services

Unlocking Equity with Reverse Mortgages: Australia's Rapidly Ageing Population Suggests There's Room for Reverse Mortgage Products, Even Though They've Been Tried before without Much Success. (Mortgages)

Magazine article Journal of Banking and Financial Services

Unlocking Equity with Reverse Mortgages: Australia's Rapidly Ageing Population Suggests There's Room for Reverse Mortgage Products, Even Though They've Been Tried before without Much Success. (Mortgages)

Article excerpt

Demographic trends in Australia mirror those in the developed economies. As a result, the time may be ripe for innovative products that benefit older Australians who have built up considerable home equity, but who are cash poor.

As its name implies, a reverse mortgage involves a reversal of the cash flow pattern associated with a traditional mortgage. The borrower (home owner) typically receives a monthly cash payment until either his or her death, or the house is sold and the lender receives a balloon repayment of the loan out of the proceeds of the property sale.

Such an arrangement would appeal to individuals (or families) who are no longer earning a regular income, have considerable equity built up in a residential property, but who are unwilling to sell out and move to a smaller unit in order to unlock and access the home equity. Arguably, this profile fits an increasing number of elderly retired Australians.

According to Australian Bureau of Statistics data, in 1995-96 there were 1.11 million households -- out of a total of 4.79 million owner-occupier households -- where the home owner was 65 years or older. The mean equity in the home -- the value of the dwelling less outstanding mortgages -- was $155,000. For the age 65 and over home owner category, the mean loan outstanding was just over $1000.

The Australian population is growing older, tracking demographic trends in the rest of the developed world. In 1998, 12.2 per cent of the Australian population was aged 65 years or more. ABS projections suggest that this proportion will rise to 24.2 per cent by the year 2051.

Recent soaring property values mean that home equity can only have risen sharply since these statistics were prepared.

So why have reverse mortgages and similar home equity conversion mechanisms not caught on Australia? Reverse mortgage products were offered by St George Bank in the 1990s, but were withdrawn because of lack of consumer demand.

However, the demographic statistics show that a big potential market exists, so why has it not been tapped more widely?

Some of the risk characteristics and other impediments associated with reverse mortgages are discussed below.

Lender risks

The lender faces the risk that the accumulated loan balance may exceed the value of the house -- sometimes referred to as crossover risk. The sources of crossover risk are:

* tenure risk, or the risk that the borrower lives longer than the period assumed when the contract is drawn up; and

* value risk, or the risk that the value of the house appreciates at a rate lower than the rate assumed by the lender. Value risk may arise exogenously through fluctuations in the property markets, or through a moral hazard problem. The latter refers to the fact that the borrower now has less incentive to spend money on home maintenance and hence the quality and value of the home suffers.

Other risks for lenders include interest rate risk in the case of fixed-rate reverse mortgages and prepayment risk. These are similar to risks faced with traditional mortgages, but some researchers have argued that these risks are somewhat higher with reverse mortgages.

It seems to me that the financial services sector is quite capable of estimating the risk parameters involved and introducing an appropriately priced product.

In fact, the reverse mortgage seems particularly suited to the insurance industry, with its long experience in actuarial matters and the cash flow pattern serving as a natural hedge against risks associated with life insurance policies. It is therefore an ideal offering for bancassurance providers such as the Commonwealth Bank of Australia and Suncorp Metway.

Most of the risks identified are likely to be minimised once a diversified portfolio of reverse mortgages is developed. …

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