Risk Analysis for Reverse Mortgages with Different Payout Designs

AbstractWe analyze the risk and profitability of reverse mortgages with lump-sum or income stream payments from the lender’s perspective. Reverse mortgage cash flows and loan balances are modeled in a multi-period stochastic framework that allows for house price risk, interest rate risk and risk of delayed loan termination. A vector autoregressive (VAR) model is used to simulate economic scenarios and to derive stochastic discount factors for pricing the no negative equity guarantee embedded in reverse mortgage contracts. Our results show that lump-sum reverse mortgages are more profitable and require less risk-based capital than income stream reverse mortgages, which explains why this product design dominates in most markets. The loan-to-value ratio, the borrower’s age, mortality improvements and the lender’s financing structure are shown to be important drivers of the profitability and riskiness of reverse mortgages, but changes in these parameters do not change the main conclusions.

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Multivariate Risk-Neutral Pricing of Reverse Mortgages under the Bayesian Framework

Risks ◽

10.3390/risks7010011 ◽

2019 ◽

Vol 7 (1) ◽

pp. 11

Author(s):

Jackie Li ◽

Atsuyuki Kogure ◽

Jia Liu

Keyword(s):

House Price ◽

Interest Rate Risk ◽

Price Risk ◽

Multivariate Approach ◽

Reverse Mortgage ◽

Principle Of Maximum Entropy ◽

Multivariate Risk ◽

Reverse Mortgages ◽

Principle Of Maximum ◽

Financial Environment

In this paper, we suggest a Bayesian multivariate approach for pricing a reverse mortgage, allowing for house price risk, interest rate risk and longevity risk. We adopt the principle of maximum entropy in risk-neutralisation of these three risk components simultaneously. Our numerical results based on Australian data suggest that a reverse mortgage would be financially sustainable under the current financial environment and the model settings and assumptions.

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Reverse Mortgage Risks. Time Evolution of VaR in Lump-Sum Solutions

Mathematics ◽

10.3390/math8112043 ◽

2020 ◽

Vol 8 (11) ◽

pp. 2043

Author(s):

Iván de la Fuente ◽

Eliseo Navarro ◽

Gregorio Serna

Keyword(s):

At Risk ◽

Value At Risk ◽

House Price ◽

Policy Decision ◽

Simulation Method ◽

Capital Requirements ◽

Reverse Mortgage ◽

Female Population ◽

Lump Sum ◽

Reverse Mortgages

In this study, we analyzed the risk faced by the reverse mortgage provider in the case of the lump-sum solution, which is increasingly becoming one of the most popular types of reverse mortgages. The risk faced by the mortgage provider was estimated by means of a value at risk (VaR) procedure that involves a Monte Carlo simulation method and an ARMA-EGARCH assumption for modeling house price returns in the United Kingdom from 1952 to 2019. The results showed that the reverse mortgage provider faced higher risk and consequently needed to allocate more funds to meet its regulatory capital requirements in the case of relatively young borrowers, especially when they reached their life expectancy and had high roll-up rates. The risk was even higher in the case of the female population. Furthermore, care must be taken when the rental yield rate is higher than the risk-free rate, as is currently the case, as the value of the no-negative-equity guarantee (NNEG) is relatively high and results in higher value at risk (VaR) and expected shortfall (ES) values. These results have important implications in terms of policy decision making when determining the countercyclical buffer for reverse mortgages in Basel III, as well as from a managerial perspective when determining the economic capital needed to support the risk taken by the lender.

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Evaluation of the Reverse Mortgage Option in Korea: A Long Straddle Perspective

International Journal of Financial Studies ◽

10.3390/ijfs8030055 ◽

2020 ◽

Vol 8 (3) ◽

pp. 55

Author(s):

Kyung Jin Choi ◽

Byungkwon Lim ◽

Jaehwan Park

Keyword(s):

Option Pricing ◽

House Price ◽

Analytical Models ◽

Call Option ◽

Option Value ◽

Pricing Model ◽

Reverse Mortgage ◽

Option Pricing Model ◽

Reverse Mortgages ◽

Key Variables

This study explored the option value embedded in a reverse mortgage in Korea through an empirical analysis, using the Black–Scholes option-pricing model. The value of a reverse mortgage is affected by the variation in house prices. However, older homeowners using reverse mortgages are able to choose this option due to the unique characteristics of reverse mortgages, such as non-recourse clauses or being able to redeem the loan. This paper found the following results. First, the call option value is 5.8% of the house price at the age of 60, under the assumption of a KRW three hundred million house value, while the put option value is only 2.0%. Contrary to what it is at sixty years of age, only the call option value will remain when the homeowner reaches the age of 80. Second, this article analyzed the sensitivity of the key variables of real-option analytical models, such as the change of the exercise price, the change of the risk-free rate, volatility, and maturity, on the option value of a reverse mortgage. The sensitivity results of the key variables supported economic rationales for the option pricing model.

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A Numerical Analysis to Study Whether the Early Termination of Reverse Mortgages is Rational

Sustainability ◽

10.3390/su11236820 ◽

2019 ◽

Vol 11 (23) ◽

pp. 6820

Author(s):

Hyung-Suk Choi

Keyword(s):

Growth Rate ◽

Numerical Solutions ◽

House Price ◽

Developed Countries ◽

Cash Flows ◽

Mortgage Market ◽

Early Termination ◽

Pricing Model ◽

Reverse Mortgage ◽

Mortality Improvement

A reverse mortgage supports the aging society more sustainably by providing stable cash flows to elderly retirees. Although the reverse mortgage market has successfully grown in many developed countries, we have observed significantly increased early terminations due to the recent housing market boom in Korea. In this study, we provide the numerical solutions for the monthly payment from the actuarial pricing model of the reverse mortgage, reflecting the house price growth and mortality improvement to examine whether the early-termination-and-repurchase strategy is profitable. Findings suggest that in order for the strategy to be profitable, the realized growth rate of the house price should be significantly greater than the expected growth rate in the actuarial pricing model. Furthermore, for the older borrower, the greater growth rate of the house price is required for the strategy to be profitable.

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The Exposure of Mortgage Borrowers to Interest Rate Risk, Income Risk and House Price Risk Evidence from Swiss Loan Application Data

SSRN Electronic Journal ◽

10.2139/ssrn.2608823 ◽

2014 ◽

Author(s):

Martin Brown ◽

Benjamin Guin

Keyword(s):

Interest Rate ◽

House Price ◽

Interest Rate Risk ◽

Price Risk ◽

Income Risk ◽

Rate Risk ◽

Application Data ◽

House Price Risk

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Merchant cash advances: investigating the taxation consequences in South Africa

Journal of Economic and Financial Sciences ◽

10.4102/jef.v8i2.101 ◽

2015 ◽

Vol 8 (2) ◽

pp. 415-431

Author(s):

Eduard Kilian ◽

Rudie Nel

Keyword(s):

South Africa ◽

Service Provider ◽

Income Tax ◽

Cash Flows ◽

Financial Service ◽

Debit Card ◽

Lump Sum ◽

Gross Income

The merchant cash advance is an emerging lending product designed to address the need to maintain cash flows and is essentially the business equivalent of a “payday” loan. A lump-sum advance is made by the merchant cash advance service provider to a business (the merchant) in exchange for an agreed upon percentage of future credit and/or debit card receivables. This article investigates the taxation consequences of merchant cash advance transactions in South Africa, in an attempt to provide guidance which is currently lacking. Although it is posited that a merchant cash advance is a form of debt factoring, the income tax treatment of the initial advance and the resulting discount reflect that of a loan. Through the investigation it was determined that merchants will be able to deduct the discount and processing fees from income. The merchant cash advance service provider will include such discount and processing fee in ‘gross income’. The initial advance and any resulting discount are held to be a ‘financial service’ and therefore an exempt supply for VAT purposes, with the processing fee constituting a taxable supply.

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International Real Estate Review

International Real Estate Review ◽

10.53383/100112 ◽

2009 ◽

Vol 12 (3) ◽

pp. 193-220

Author(s):

Karol Jan Borowiecki ◽

Keyword(s):

Real Estate ◽

Positive Impact ◽

House Prices ◽

House Price ◽

Housing Price ◽

Quality Improvements ◽

Vector Autoregressive ◽

Price Growth ◽

Price Determinants ◽

A Minor

This paper studies the Swiss housing price determinants. The Swiss housing economy is reproduced by employing a macro- series from the last seventeen years and constructing a vector-autoregressive model. Conditional on a comparatively broad set of fundamental determinants considered, i.e. wealth, banking, demographic and real estate specific variables, the following findings are made: 1) real house price growth and construction activity dynamics are most sensitive to changes in population and construction prices, whereas real GDP, in contrary to common empirical findings in other countries, turns out to have only a minor impact in the short-term, 2) exogenous house price shocks have no long-term impacts on housing supply and vice versa, and 3) despite the recent substantial price increases, worries of overvaluation are unfounded. Furthermore, based on a self-constructed quality index, evidence is provided for a positive impact of quality improvements in supplied dwellings on house prices.

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Aging in Place, Housing Maintenance, and Reverse Mortgages

The Review of Economic Studies ◽

10.1093/restud/rdz047 ◽

2019 ◽

Vol 87 (4) ◽

pp. 1799-1836 ◽

Cited By ~ 3

Author(s):

João F Cocco ◽

Paula Lopes

Keyword(s):

Aging In Place ◽

The Elderly ◽

Cash Flows ◽

Housing Wealth ◽

Reverse Mortgages ◽

The Government ◽

Saving Decisions ◽

Pareto Improving ◽

The Impact

Abstract We study the role of housing wealth in financing retirement consumption. In our model retirees: 1. derive utility benefits from remaining in their home (aging in place); and 2. choose in each period whether to maintain their house. The evidence that we present shows that these features are important in explaining the saving decisions of the elderly. The costs and the maintenance requirement of reverse mortgages (RMs) reduce (or eliminate) the benefits of the loans for retirees who wish to do less maintenance. We evaluate the impact of different loan features on retirees’ utility, cash-flows to lenders, and to the government agency that provides mortgage insurance. We show that combining RMs with insurance against a forced home sale (e.g. due to a move to a nursing home) is Pareto improving and can lead to increased demand for the loans due to product complementarities.

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