While reverse mortgages have notable potential to increase in demand across the planet due to the aging of the global population, constraints on the sides of both supply and demand, along with a relatively limited number of providers even in well-developed economies, have kept reverse mortgages in the realm of “last resort” products as opposed to viable considerations of good retirement planning.
This is according to a newly-published policy paper authored by researchers Peter Knaak, Margaret Miller and Fiona Stewart on behalf of the World Bank’s Finance, Competitiveness and Innovation Global Practice.
“The academic literature on the topic suggests that reverse mortgages (RM) can be a welfare-enhancing tool to supplement pension income, or as a form of insurance,” the paper reads. “In particular, low-income senior homeowners may tap into their accumulated housing wealth to smooth consumption and increase their resilience against financial shocks. The welfare-enhancing potential of this instrument has been modeled in academic studies using data from a variety of jurisdictions.”
This can allow reverse mortgages to be especially beneficial for very elderly people, as well as longer-living women who have lower pensions on average, the researchers say. Reverse mortgages could also serve to avoid the exclusion of seniors from the traditional mortgage market if they cannot meet the income requirements commonly associated with those loans.
‘Universal roadblocks’ for reverse mortgages
One of the aims of the paper is to provide a deeper understanding of impositions that could diminish the ability for reverse mortgages to catch on at a higher degree than current levels suggest they’re being used. This is according to researcher Fiona Stewart, one of the authors of the paper in an interview with RMD.
“The paper outlines issues which could be seen as ‘universal’ roadblocks for the greater spread of these products,” Stewart says. “These include the inevitably complex nature of the products, making them difficult to price and regulate – and consequently prone to mis-selling.”
Demand can also be limited by seniors who want to leave their homes to an heir, Stewart says.
“The ‘bequest motive’ – the desire to pass on property to one’s heirs – limits demands, which further pushes up costs,” she describes. “In many emerging markets the challenges are amplified by the already small share on home ownership (compounded by other issues such as challenges around land titling) and under-developed financial markets.”
One area that stands out as a generally unfulfilled need that reverse mortgages are uniquely equipped to address is elder care, Stewart says.
“Elderly care is the big gap which needs addressing in developed and developing countries alike – and which reverse mortgages are currently not designed to address,” she says.
In spite of the potential benefit of reverse mortgages, market failures and risk factors have acted as constraints on the supply side of the reverse mortgage market, the researchers contend. High insurance costs, an absence of risk pooling mechanisms reducing lenders’ viability in offering reverse mortgages, and a tough regulatory climate may all contribute to barriers to entering the reverse mortgage market in the economies of many nations.
“The combination of these factors may help explain why some banks, both in rich and developing countries, have exited the RM market in recent years, and why only a small subset of financial intermediaries chose to enter it in the first place,” the paper reads.
The issue of reverse mortgages being viewed as a product of “last resort” by many potential borrowers could be alleviated by a couple of key features, some of which are present in countries currently offering reverse mortgage products, Stewart says.
“The U.K. experience – and the U.S. to some extent – suggest that a strong regulatory framework (including some degree of financial education and/or advice) may be required, over and above market practice alone,” Stewart says. “That said, the introduction of credible, established providers, as well as relatively unknown, niche firms, may help.”
Supply-side and demand-side constraints
Combined risks and market failures of reverse mortgages on the supply and demand side have served to limit the full development of the reverse mortgage market, researchers say. On the supply side, these constraints come in the form of crossover risk, adverse selection and a lack of risk pooling options which can reduce the incentives for lenders to offer reverse mortgages, the researchers say.
On the demand side, issues related to elder care, regulatory uncertainty, risk of fraud and social insurance risk represent “significant constraints” on the ability of reverse mortgage products to flourish in the marketplace.
“Moral hazard is a more serious market failure that may constrain supply,” the paper reads. “Homeowners who sign a reverse mortgage have less incentive to keep up their house and pay property taxes. The borrower will never have to repay more than the house value, and thus may seek to avoid expensive house repairs.”
Additionally, this creates the potential risk of corruption in private home sales, since heirs who receive a house value at or below the amount of funds received have little incentive to maximize the price of home sales, the researchers write. Regulatory responses to this moral hazard are present, particularly in the United States, where the Federal Housing Administration (FHA) provides mandatory insurance against crossover risk. However, the cost for this insurance to borrowers is high, and its profitability to FHA diminished when the premium was raised in 2010 and again in 2017.
Research cited by the World Bank argues that abandoning the current insurance structure and passing the risk instead to lenders and heirs, “would make reverse mortgages cheaper and thus increase demand, but the authors dedicate little attention to discussing the clear downsides of this proposal.”
Read the World Bank policy research paper.