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Risk Mitigation in Reverse Mortgage Research Team | Posted On Wednesday, March 25,2009, 04:17 PM

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Risk Mitigation in Reverse Mortgage



Risk mitigation is the key for the success of any financial product including reverse mortgage. Some of the risk mitigation techniques which the providers can apply to reduce the risk on their books

1. Proper eligibility criterions

The first mitigation of risk can be done at the time of providing loans. This can be done through proper verification of the title of the property, age of the borrower; his/her credit analysis etc. This reduces the risk of default by the borrower.

2. Variable interest rates loan as compared to fixed interest rate loan

To avoid interest rate risk, the lender can go for variable interest rates based on some market benchmark like MIBOR. This will also reduce the risk of Pre-payment as the borrower will not have interest arbitrage on prepayment of the loan.

3. Proper analysis of mortality trends

As the product has significant longevity risk, the lender can do a detailed mortality trend analysis on a macro level and also in the market where it is operating.

4. Geographical diversification

The lender can look at spreading the business across the country by promoting the product in secondary and tertiary cities also so that the law of large numbers may work properly and if the provider has a bad experience in one market; it can be compensated with good experience in other cities.

5. Develop the product for lower age groups

The lender can develop home equity conversion mortgages for all households and not just for elderly. This will significantly reduce loan to value ratio and that will take care of many of the risks inherent in the product.

6. Securitization

One of the most effective ways of mitigation risk is securitization It involves many other financial players and thus it spreads the risk of default/prepayment to many other participants. USA has a history of eight year of securitization of its Reverse Mortgage. In the Repayment schedule, some default conditions or changes that affect the security of the loan for the lender that can make reverse mortgages payable must also be added, like :

  • Declaration of bankruptcy
  • Donation or abandonment of the house
  • Condemnation/ Sovereign Takeover of the property by a government agency
  • Adding a new owner to the home’s title
  • Taking out new debt against the home etc.

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