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Tuesday, April 20, 2010

Baby Boomers & Reverse Mortgages

Next Big Thing:
Reverse Mortgages

Take 80 million Baby Boomers fast closing in on retirement age, many of whom (still) have lots accumulated equity in their now too-big homes, and what do you get?

A vast potential market for something called a reverse mortgage.

Like its name suggests, in a reverse mortgage, the lender pays the borrower, instead of the other way around (it can either be a lump sum, or periodic payments).

The benefit to the borrower?

They get to tap their home equity without making payments -- and without qualifying for a new, conventionally amortizing loan (which could be difficult, given the now-retired borrower's lower income).

In fact, there are no income tests for reverse mortgages; to qualify, the borrow only has to: 1) be at least 62 years old; and 2) have sufficient equity in their home, as determined by an appraisal.

Reverse Mortgage Logistics

How big a reverse mortgage one qualifies for is then a(n actuarially determined) function of age: the younger you are, the less you can borrow.

Why no screening for pre-existing conditions, or other health issues that might affect the borrower's longevity?

Because someone in poor health is actually a better risk for the lender. If they die the day after taking out a reverse mortgage, the lender pockets the borrower's residual equity.

Conversely, it's the 62 year-old who's fit as a fiddle and lives to be 100 that causes lender losses (because the unpaid principal and interest keep accruing).

Fortunately for the reverse mortgagors, it's impossible to owe more than their home is worth (a condition called being "underwater").

For the 3% of (long-lived) borrowers where that would otherwise happen, insurance kicks in to cover the shortfall.

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