by Brian Brady
Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL
If you’re considering a reverse mortgage, get it now. The reverse mortgage market is going to blow up as big as the sub-prime market did. This time, like last, it’s those “durned borrowers” acting differently than the rockets scientists predicted they would. In the sub-prime market, it was assumed that people would honor the old paradigm: mortgage payment, car payment, then consumer credit. Sub-prime borrowers sacrificed the house payment, in order to keep their credit cards active, and the world turned upside-down.
The reverse mortgage borrower is about to screw things up royally; he’s going to live longer than expected….and like sub-prime, that risk is not priced into the current market.
A reverse mortgage is basically a negative amortization, no-payment required loan. Actuaries consider the borrower’s life expectancy, discount a reasonable return on the future loan balance, and loan the borrower whatever is remaining. When the borrower dies, the loan balance can be paid off so that the heirs can “reclaim” the asset or the house is sold. The deal goes sour when the now 65-year old lives past his expected death date. Consider that baby-boomers are the healthiest (and largest) generation; they could add 4-5 years to that life expectancy.
The loans are still being underwritten as if the oldest baby-boomers were just 56 years old. Throw in the fact that a tremendous amount of home equity evaporated, since, 2007, and you have a recipe for disaster. While you remember the wreckage an uptick in defaults had, on a levered sub-prime secondary market, imagine how those measly four years could cause the Great Recession of 2030, complete with bailouts.
The warehouse lenders know it, too. Ask reverse mortgage originators why a seemingly healthy market turned ill this year and you’ll hear them blame the liquidity crisis. Reverse mortgage originators will cry that the sub-prime collapse caused warehouse lenders to adopt a bunker mentality, which is killing a healthy mortgage product. They’ll tell you that their product has NOTHING to do with sub-prime and they’re correct. Reverse mortgages and sub-prime loans have only one thing in common;
they were both priced on faulty risk models.
PS: A default (in the forward mortgage market) happens when the borrower misses a series of mortgage payments. A default (in the reverse mortgage market) happens when the borrower doesn’t die quickly enough. Forget the concept of moral compunction. How are we gonna foreclose on these future octagenarians, kill them?
PPS: There is nothing wrong with this product if you’re a borrower, over 62 years old. In fact, this may be the cheapest money you’ll ever borrow. Get it while you can.
Thomas Johnson says:
How are we gonna foreclose on these future octagenarians, kill them?
Relax, Brian! All is well in the reverse mortgage market. All the reverse mortgage liens will soon be owned by the US Treasury or the FED and when Obama care passes, Tim Geithner will become the euthanasia czar. If you outlive the risk model, they will be pulling the plug.
August 2, 2009 — 1:15 am
Robert Kerr says:
Good points, Brian. Good post.
August 2, 2009 — 9:57 pm
Dave Shafer says:
Brian, educate me. Aren’t they using current actuarial tables? The life insurance actuarial tables are very accurate and are based on a couple hundred of years of data. They are updated annually.
As to the loss of equity, point taken!
By the way, reverse mortgages have another point of connection to the sub-prime market. These companies make their money by origination fees and pass the risk on down the line.
August 8, 2009 — 3:36 pm
Robert Worthington says:
Brian, you must be an evil capitalist like me. Well written and I totally agree you. Tell me; is it now true that some reverse mortgage citizens are worth more dead than alive like we’ve all heard before?
August 9, 2009 — 4:30 pm
The Mortgage Cicerone says:
Brian – As always, you provoke thought and foresight in area’s well ahead of the media or main stream analyst. Just like you investigated the fundamental accounting numbers or bowels of the Countrywide financials eighteen full months before Countrywide collapsed, you bring to fore a possible segment of the market that warrants watch. I would recommend one watches the actions of the warehouse lenders…they are also watching this closely. Fortunately, it does not currently reach the same proportion of market share nor reach that the sub-prime and Alt-A market did and property values have dropped substantially in that decreased values alone have slowed the exponential HECM funding train, however this product will be interesting to watch in the upcoming future.
August 9, 2009 — 4:30 pm
Brian Brady says:
“Aren’t they using current actuarial tables? The life insurance actuarial tables are very accurate and are based on a couple hundred of years of data. They are updated annually.”
The actuarial tables they’re using are outdated like the life insurance insutry’s of the late 1980s. The life insurance industry started updating them in the early 90s. The fatal mistake I see is that underwriters aren’t accounting for the SIZE of this soon-to-be-62-year-old market.
In 1940, there were around 2.5 million births in the US. By 1950, that number climbed to close to 4 million. With so much at stake, the reverse mortgage industry can’t afford to make even a smidgeon of a mistake lest it bankrupt FHA.
One possible solution is to raise the insurance premium. That, combined with (a) slower expected appreciation rates, (b) scientific breakthroughs for life extension, and (c) rising interst rates, could make this product VERY expensive in the near-term future.
I’ll reiterate my advice; get the reverse mortagge money now.
August 9, 2009 — 5:36 pm
Dave Shafer says:
Brian: The average life expectancy for a 65 year old is currently 18.5 years. In 1980 is was 16.4 years. Complicating this is the fact is the time seniors spend at the end of life totally disabled has increased. In other words although folks are living longer, the last years are not usually independent. What this all means to the reverse mortgage actuarial tables is a little complicated to parse out. However, we can say that even though 2.1 years have been added, that is not 2.1 years that the average reverse mortgagee will be able to spend in the house. This does not spell disaster to me, but we will see it played out.
Question, last time I looked the maximum LTV was around 60% with 55% being more likely. Has that number been adjusted down?
Reverse mortgages were always a dubious strategy to me as the interest rates and the compounding nature tended to eat through equity fairly fast. It always make more sense to me to sell the house when you can and turn your equity into guaranteed income via an immediate annuity which you can use to rent. The numbers always made more sense to me doing it this way. In fact over 60% of seniors age 70 and over do rent. The percentage takes another jump at 75.
Perhaps that is because I live in a senior heavy area and see what happens when seniors try to hang on to that home with moderate amounts of personal income [it isn’t pretty!].
August 10, 2009 — 10:41 am
K says:
I know very little about the houseing market, but after searching for a house in southern California since October I’ve seemed to have learned quite a bit. Mainly about how “crooked” the banks are with their lending.
I found a home in an area I liked, which was listed as for “sale” or option of “lease”. I contacted the realtors to find out the cost of the home and was surprised to find out the home was no longer up for sale and that someone has decided to lease it for awhile. The home is in really bad shape (a fixer upper)etc. and I couldn’t understand why someone would want to rent it for the asking lease price of 2,800 a month?? Hmmm. I found the mortage information at the county office.. and found that the home was assessed in 08 for only 189K and that during the “home booming years” of 06 and 07 two mortages were taken out on the home (from same bank). One for 400,000 in 06 and another for 200,000 in 07. I looked on zillow and found out that home was worth around 800K during the “boom” years in comparison to homes around it. I was furhter informed by the realtor that the 400k mortgage was a “reverse mortgage”.
Currently the primary residence owner doesn’t live there and has been placed in a nursing home due to an unexpected illness. Not one family member lives there.
What’s sad here, is the bank who issued these mortages, has to know that the place is being rented out and there happy getting the 30,000 a year from the rentable income. I know the realtor got a bid for $500K when the house was for sale, which would still be under what is owed on the house… 600,000 dollars.
I’ve been in this house and if the bank who loaned the family the monies had been in the house recently they should of taken the 500K offer. In a year part of the roof will most likely fall down based on it’s appearance and lack of care and then it’s just going to devalue again and the bank is going to lose out one of these days. I agree with everyone who thinks the reverse mortage will be the next sub-prime and not only that, I work with several people who somehow received regular home mortgages from local banks, who can’t realistically afford what they received. I even know several people who took out interest only loans (can’t afford to pay the principal and will never be able to pay on the principl) but somehow got these loans. I don’t get it.
August 11, 2009 — 9:14 pm