Yahoo Finance Reverse mortgage market has plenty of room to grow, but risks abound
Canada’s reverse mortgage market has plenty of room to grow, but lenders should be wary of risks that are tied to its unique structure — such as longevity risk and appraisal risk — according to an analysis released this week by credit rating agency DBRS Morningstar.
In a July 11 report, analysts at the ratings agency noted that the penetration of the Canadian reverse mortgage market is lagging behind other developed economies (most notably the United Kingdom and Australia) with less than 0.5 per cent of more than six million senior households holding a reverse mortgage.
However, a rapidly aging population could bring significant growth to the segment and more risks with it.
Reverse mortgages are loans secured by a borrower’s home that give the owner access to its equity. Unlike a traditional mortgage, there is no defined time period or amortization schedule and no monthly principal or interest payments. The loan does not need to be paid back until the borrower moves out of the home, sells the property or passes away.
That structure brings longevity risk, in which it takes longer than expected to recover the money loaned, into play. The report said longevity risk was greatly influenced by the borrower’s age.
Shokhrukh Temurov, vice-president of North American financial institutions at DBRS Morningstar, said that overheated housing markets, which have predominated in recent years, can also lead to more of the risk being shouldered by lenders rather than borrowers.
That’s because newer vintages are more exposed to a correction, though older ones become more secured by the higher home values.
“As long as the market corrects itself (as we’re starting to see now), the property values move in a more reasonable range, the risks should be managed by the banks,” Temurov said.
The potential for prices to swing dramatically makes the valuation process important, said Temurov, noting “appraisal is really critical for this product.
DBRS Morningstar estimates the reverse mortgage market at less than $6 billion as of the first quarter of this year, with two lenders shouldering most of the load: HomeEquity Bank and Equitable Bank Inc. HomeEquity Bank holds the largest reverse mortgage loan book with approximately $5.4 billion as of the first quarter in 2022 and accounts for more than 90 per cent of the estimated reverse mortgage loans in the country. Last September, the Ontario Teachers’ Pension Plan acquired the company’s parent from Birch Hill Equity Partners Management Inc. Equitable Bank, while a smaller player in the market, saw its loan book grow to $304 million at the end of this year’s first quarter.
The Office of the Superintendent of Financial Institutions is keeping its eye on the growing risks and has already moved on tightening rules around some lending products over financial system risk concerns, expecting financial institutions to limit maximum authorized loan-to-value (LTV) ratio of less than or equal to 65 per cent.
The institution also called on lenders to exercise more due diligence on issues like collateral management, property appraisal, and longevity risk for reverse mortgages and uninsured mortgages.
BRS expects lending institutions offering reverse mortgages to tighten their underwriting standards and become more conservative in their lending policies to avoid risks to their business.
Property valuations and appraisals are a critical part in determining mortgage amounts, keeping asset qualities strong, and setting aside a sufficient buffer to shoulder losses in a stressed environment.
Mortgage expert Rob McLister believes reverse mortgages are among the safest products for lenders on the market.
Net net, reverse mortgages will continue to fly off the shelves
Rob McLister
“The loan-to-values are set by actuaries and regulated closely by OSFI,” McLister said in an e-mail. “If more than one in 100 reverse mortgage balances exceeded the property value at the time of discharge, I’d be surprised. Sure, property values are diving but that’s all factored into the lender’s loan amount formula.”
McLister added that for a borrower aged 65 with a $1-million home in Toronto, the largest reverse mortgage range they could get is between $316,000 to $360,000. Even if home prices crashed in Canada over 30 per cent like they had during the U.S. financial crisis (which he notes is unlikely to happen), the lender would still have a 30 per cent buffer or greater.
DBRS Morningstar also noted that repayment risks rise in the event of a housing market downturn, though these challenges would be somewhat mitigated with lower loan-to-values in the reverse mortgage space.
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McLister appeared unfazed by market downturn risks, pointing to the fact that there has yet to be a 10-year timespan in modern history where Canada’s nationwide average home value did not appreciate.
With soaring inflation and higher borrowing costs, McLister expects reverse mortgages to become more popular for seniors on fixed incomes needing more cash infusions to fund their life and stay in their home.
“Ultimately, however, most borrowers get a reverse mortgage because they need one, not because they want one,” McLister said. “That, and the fact it’s easy to qualify, make reverse mortgage borrowers more rate tolerant than your average mortgagor.”
“Net net, reverse mortgages will continue to fly off the shelves,” he said.
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