For many people around the world, buying a home is the biggest financial decision of their lives. A house to live in, and an asset to leave for descendants.
But the gradual increase in life expectancy is changing people’s saving and consumption patterns in many developed countries. We live longer, and therefore need more money to live on in the years after retirement. Oscar Arce, Director General for Economics, Statistics and Research at the Bank of Spain, recently said “living longer is expensive, it involves additional costs.”
As a result of all this, nowadays many people are house rich, cash poor. An alternative may be to sell the house, and liquidate the equity, but this requires new expenses at a later date, because after all, you have to live somewhere.
Another alternative, which is increasingly being explored, is the reverse mortgage, a financial transaction specially designed for people over 65 and dependents that makes it possible to convert the equity value of homeownership into money.
In this case, unlike in a conventional mortgage, it is the homeowner who receives an amount from the bank in exchange for the home (usually in the form of monthly income). The main advantage is that you can continue to use it until your death and at no time lose ownership of your home.
Ricardo González, Director of Analysis, Sectorial Research and Regulation at MAPFRE Economics, explains that there are three major reverse mortgage modalities:
- a) Single payment or lump sum, where the client receives the total amount of the loan in a single payment.
- b) Temporary with monthly payments, where the beneficiary receives monthly payments over a specific period of time.
- c) Whole life with monthly payments, where the client has taken out Life insurance in addition to the reverse mortgage (deferred annuity insurance). As with the temporary modality, the client receives monthly income from the mortgage for a specified time, determined in the contract, and if the beneficiary is still alive after that period ends, the annuity insurance is triggered and the client receives that until their death.
After the owner’s death, the heirs are responsible for both the home ownership and the debt accumulated with the financial institution, and they have two options:
- Keep the home: To do this, they must settle the debt with the institution, returning the borrowed money.
- Sell it: In this case, the amount of the sale is used to pay off the debt contracted by the holders of the reverse mortgage.
The latest report by Economics on the global development of Life Insurance addresses the emerging phenomenon of reverse mortgages in several countries. Let’s briefly look at how this product is managed in some of them:
In Spain, the reverse mortgage regulations are contained in Law 41/2007, as amended by Article 5 of Law 1/2013, on measures to reinforce the protection of mortgage debtors, debt restructuring and social housing rental. The recipients of this mortgage must be over 65 years of age, people with a degree of disability equal to or greater than 33 percent, and people with severe or great dependence.
In Spain, there are more than six million people currently collecting a retirement pension, based on social security data at the end of 2019. Of these, more than half, some 3.1 million people, collect less than 900 euros per month as their pension. And, in this same country—where there are pensioners who have problems making it to the end of the month—almost 90 percent of those over 65 own their own homes, according to the European Central Bank’s Household Finance and Consumption Survey. These two data points, combined, lead many to believe that the Spanish market could be fertile ground for this type of financial transaction.
It should be noted that this product is eligible for tax exemptions. As this is a loan, this additional monthly income is not taxed for IRPF (Impuesto sobre la Renta de Personas Físicas — Spanish personal income tax).
There are basically three types of reverse mortgage in the US market:
- A) Single use. This type of mortgage is offered by state or local governments, or non-profit agencies. They have very favorable financial terms and conditions for borrowers (they do not require insurance and have low interest rates).
- b) HECM3 reverse mortgages. These are backed by the Federal Housing Administration (FHA), where the Federal Government guarantees that the companies offering this product will make the agreed payments. Likewise, if the price obtained from the sale is less than the sum of the total mortgage debt, the government is responsible for the loss and, if the price obtained is higher than the debt, the borrower or heirs receive the profit.
- c) Private reverse mortgages (Jumbo, Proprietary Reverse Mortgages). These reverse mortgages are offered by authorized financial institutions and do not have FHA-related insurance or a limit on the amount borrowed.
Known as hipoteca pensionaria (mortgage for retirees), the future evolution of pension replacement rates and the high percentage of people over the age of 60 who own their homes would seem to predict some potential for these reverse mortgages in the coming years. Current Mexican legislation on this product states that the minimum age of policy contracting is 60 years old, and that the loan may not be less than 70 percent of the property value.
Although in Brazil reverse mortgages are not yet regulated by federal law, since 2018, there have been several legislative proposals for their development and introduction.
There are two main types of equity release in the British market:
- a) Lifetime mortgages. This is the most popular option. The consumer retains ownership of their home and takes out a loan guaranteed by this home. The loan can be received as a single payment, regular income, line of credit or a combination of all three.
- b) Home reversion plans. With this type of product, the consumer wholly or partially sells their home to the provider, but retains the right to live in it until their death or until they are moved into a nursing home.
Two methods are used: direct, in which the local government provides the loans, and indirect, in which the local government teams up with a financial institution to grant the mortgage.
Perhaps the reason why this product has not taken off until now is because it does not come without certain risks.
It is estimated that the initial costs for contracting this product (opening fees, notaries, appraisal, taxes, plus annuity insurance) can reach almost 10 percent of the home’s appraised value. It is worth considering whether the monthly amounts received will compensate for this expense.
For this reason, it is very important that the companies that market the product are transparent and offer their clients an appropriate risk assessment, as it affects the elderly, who are a vulnerable group.