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Risk inherent in the Reverse Mortgage Product Research Team | Posted On Wednesday, March 25,2009, 04:06 PM

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Risk inherent in the Reverse Mortgage Product



Any financial product will obviously involve some risk and reverse mortgage is no exception. The lender faces many type of risk for this product. Some of these risks are..

Longevity Risk

The lender has to provide the payment upfront either lump sum or installments as the case may be but gets his money back only when the borrowers dies or move into another residence. As we are aware that the life expectancy of people is increasing, the risk of late recovery of loans is a big risk for the lenders. The risk is aggravated by the fact that with the payments from reverse mortgage, the lifestyle of the borrower gets better which may become one of the contributors in the improvement of longevity. The longevity risk is higher for reverse mortgage where the payment is continued till the death of the borrower since not only the recovery gets delayed but also the lender has to make payments for a longer time.

Interest Rate Risk

The payments to the borrower in case of a reverse mortgage is fixed, either for a term or lifetime but the cash flows for the lender may not be fixed and are dependent on the interest rate market. Thus the lender runs the risk that the interest rates in the market may move in the opposite direction of that the lender anticipated.

Market Risk (Property Value Risk)

The lender in a reverse mortgage canclaim back his loan only from the property on which the loan has been granted. He does not have recourse to any other asset of the borrower. If the sales proceeds of the home are not sufficient, the lender cannot claim the balance from the heirs of the borrower. This gives rise to the risk of adverse movement in property market which affects the profitability of the product. Though this risk can be diversified with increasing the geographical reach of the operations of the lender but the risk still remains

Early Redemption Risk

Some of the reverse mortgages loans may give the borrower an option of repay the loan at any point of time. This leads to another risk for the lender of early redemption as the borrower will pay back the loan when it is most beneficial to him which in most cases does not coincide with the interests of the lender. In case the lender has securitized the loan, which in most of the cases it is, the risk becomes higher as the lender cannot close its position in this case.

Adverse selection and moral hazard risk

Aswith insurance products, reverse mortgage products also have the scope of adverse selection i.e. only people with expected higher longevity may go for such products. Also as the borrower has really no incentive for keeping the house in proper condition as the risk is borne by the lender, it may lead to depreciation of value of the property.

Condemnation/ Sovereign takeover of the property by a government agency

The asset available to the lender is the house and if there are changes like takeover of property by the government for development purposes etc, the lender is the looser.

But as spillover/multiplier effect of releasing the equity value of houses is very large as total household stock in a country ranges between 100% and 150% of GDP, it is good if home equity conversion products become a success in India as it can provide a strong dynamism to the economy by unlocking the illiquid wealth represented in India’s stock of owned houses. Therefore, this market must be looked at favorably both by the regulators and market participants.

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