Experts anticipate reverse mortgages will gain popularity among seniors due to rising borrowing costs and soaring inflation
The market for reverse mortgages in Canada has a lot of room to grow, but according to a report from credit rating company DBRS Morningstar, lenders need to be aware of the risks associated with its special structure, including longevity risk and appraisal risk.
Fewer than 0.5% of Canada's more than six million senior households have a reverse mortgage, according to research from DBRS Morningstar analysts. This percentage is lower than that of other developed nations, most notably the United Kingdom and Australia.
A rapidly aging population, however, may result in both huge growth for the sector and an increase in risks.
Reverse mortgages are home-based loans that allow the homeowner access to the equity in their property.
In contrast to a conventional mortgage, they don’t have fixed time horizons, amortization schedules, or regular principal and interest payments. The loan is not due until the borrower vacates the residence, sells the house, or passes away.
But the structure also carries longevity risk, which occurs when it takes longer than anticipated to recoup the loaned money. The borrower's age has a significant impact on longevity risk, the analysis said.
The recent trend of overheated housing markets, according to Shokhrukh Temurov, vice-president of North American financial institutions at DBRS Morningstar, can also result in a greater share of the risk being borne by lenders as opposed to borrowers.
The reason for this is that younger vintages are more susceptible to a correction, whilst older ones are more secure due to rising property 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.”
Temurov noted that “appraisal is really critical for this product.”
As of the first quarter of this year, the reverse mortgage market was estimated by DBRS Morningstar to be less than $6 billion, mostly shouldered by HomeEquity Bank and Equitable Bank Inc. With a $5.4-billion loan book as of the first quarter of this year, HomeEquity Bank holds the lion’s share.
The Office of the Superintendent of Financial Institutions is monitoring the rising risks and has already tightened regulations around some lending products due to concerns about financial system risk. Financial institutions are expected to set a maximum authorized loan-to-value (LTV) ratio of less than or equal to 65%.
The organization also urged lenders to exercise greater caution when it came to managing collateral, appraising real estate, and assessing longevity risk for reverse mortgages and uninsured mortgages.
Property valuations and appraisals play a crucial role in setting mortgage amounts, maintaining the asset quality of assets, and allocating enough buffer to absorb losses in a stressful situation.
Although these difficulties would be slightly lessened by lower loan-to-values in the reverse mortgage area, DBRS Morningstar also stated that repayment risks increase in the case of a home market slump.
