Converting Brick and Mortar into Cash

Implications: 1.A useful product for Baby boomer retirees . 2.Proper advice should be taken before availing the mortgage. 3.Lenders should take into account the associated risks attached to the product before aggressively pushing the product.

Analysis:  An equity release loan, also known as reverse mortgage, may help reduce the gap between a consumer’s lifestyle expectations and their pension savings. Baby boomers who are asset rich i.e. owning a home but have little cash in hand, a home equity release product can be an attractive option. Reverse mortgages are expected to grow in popularity as more baby boom retirees seek access to their housing equity. However there are major risks for the lenders which revolve around the uncertainty about the duration of the loan and the value of the property at the time of sale. Risk increases if the housing prices hit a plateau .

There are three sources of risk for reverse mortgage lenders :

1.Longevity risk – the risk the borrowers live longer than expected.

2.Interest rate risk – higher than expected interest rates may result in the capitalisation of interest exceeding the value of the secured property.

3.Valuation risk – the risk that the value of the house property does not increase as fast as expected or enough to stay ahead of the capitalising of interest.

Apart from other benefits to the retirees, the lower income retirees can use the money so available to meet living and other expenses and wealthier retirees can borrow money and distribute it among the intended beneficiaries, when still alive.

There is a view, that because reverse mortgage lending takes on longevity risk, the product should be handled by the life insurers. However another view holds that reverse mortgages are lending products which can be provided only by lenders with longevity risk being the only reason why the mortgage may not be fully paid.

Recently, there has been a notable innovation in the reverse mortgage sector and that is the introduction of the ‘no negative equity guarantee’ or NNEG. On a broad note, NNEG assures the consumer that they will never owe more under the reverse mortgage than the proceeds of sale of their home provided they have fulfilled the contract.

Before extending any tax benefits/concessions to the borrowers a comprehensive investigation needs to be undertaken to work out modalities for the lending criteria and ensure appropriate risk management systems for these products are in place.

Though an equity release loan may help reduce the gap between a consumer’s lifestyle and their pension and savings, the one benefit that it provides is access to consumer of extra retirement funds so that they are able to live the way they want in retirement.

One fear is that it should not end up mimicking the subprime product.