The reverse mortgage can be a useful financial product that allows elderly homeowners to stay in their dwellings while they tap the equity that they built up through the years. Typically, older homeowners have limited income, which necessitates the (sometimes partial or slow) liquidation of assets such as homes. Low birth rates and an aging baby boomer generation are causing many regions around the world to see an increasing proportion of seniors in their population distributions. This demographic trend could drive demand for reverse mortgages and related products as retirees eventually seek income from the equity in homes that have been paid off. In this article, S&P Global Ratings explains the main features of reverse mortgages, examines regional trends, analyzes the age distributions of select countries, and contemplates the risks to borrowers that could influence the popularity of reverse mortgages. We also compare some of the features and uncertainties of reverse mortgage securitizations to securitizations of similar home loan offerings.

What Is A Reverse Mortgage?

A reverse mortgage (also called an equity release mortgage or a lifetime mortgage) is a loan secured by a residential property that is typically repaid via the eventual proceeds from the sale of the home. The timing of the sale is inherently uncertain in that it transpires once the homeowner moves out or dies--so called "maturity events". Reverse mortgages are often marketed to older homeowners and retirees who have assets (including the home) but lack sufficient financial liquidity and income. The initial loan amount is based on (and always less than) the current market value of the home and can be delivered as a lump sum or disbursed in regular payments over the course of a fixed term.

One key feature of a reverse mortgage is that the interest (which can be either fixed or floating rate) accrues over time and adds to the principal owed. Subsequent interest payments are based on this growing value; therefore, the remaining borrower equity is eroded over time unless the home price appreciation (HPA) is sufficient to outpace the compounding interest. In general, reverse mortgages are legally considered fully repaid once the lender receives the net sales proceeds of the property upon liquidation, regardless of the outstanding loan balance plus accrued interest. Depending on the jurisdiction, this can be achieved through "no negative equity guaranty" mechanisms or third-party guarantees, such as those offered by the Federal Housing Authority (FHA) in the U.S.

Reverse mortgages and related products in different regional markets

The basic mechanics, described above, are common to all reverse mortgages. However, there is some degree of regional variation in the terms and conditions. (For example, in European markets, see "Reverse Mortgages In Europe: Product Growth Has Yet To Spur Securitization," published July 26, 2023.) There also exist related home financing products that are often marketed to the same demographic group, and their popularity may vary by region. Two of these include the retirement interest-only (RIO) mortgage and the home reversion plan (HRP). Chart 1 below compares the structures of reverse mortgages, RIOs, and HRPs. The main difference between a reverse mortgage and an HRP is that with the former, the borrower retains 100% ownership of their property, whereas with the latter, a share of the property is sold up front at a discount to the property value. HRPs allow the borrower to retain a guaranteed lifetime lease, while the provider recovers its share in the property after the sale following the death of the borrower (or some other maturity event). Because HRPs grant the provider only an equity interest in the home, there is no mortgage, and hence, no interest due from the borrower. In the case of an RIO mortgage, the borrower must pay interest (based on a fixed loan balance) on a regular and ongoing basis. The borrower's ability to make regular payments beyond working age is assessed by the lender at the outset. An attractive feature of the RIO mortgage is that the loan doesn't need to be repaid until the last remaining borrower dies or permanently moves to a long-term care facility. (For further details, see "Help The Aged: The Changing Landscape For U.K. Borrowers In Retirement Creates Risks And Opportunities For Lenders," published June 1, 2018.) We will return to these alternative products in the final section when we present considerations for our ratings analysis.

Chart 1

Crossover points

One of the fundamental features of the reverse mortgage is the concept of the crossover point; that is, the point in time after which the remaining home equity is depleted. This occurs when the accrued interest (which is compounded over time) plus original debt exceeds the appreciated value of the home. While the homeowner is rarely on the hook for the negative equity, being "under water" means that paying off the loan and/or bequeathing the property (or proceeds from its sale) to a relative becomes more challenging financially. From the lender's standpoint, reaching the crossover point means a loss will likely be incurred on the mortgage, depending on the source of financing and the initial mortgage loan-to-value (LTV) ratio.

Forecasting the crossover point at mortgage inception involves an expectation of future paths of home prices and interest rates. As an illustration, we present several plausible scenarios in charts 2A and 2B. In both graphs, we assume a mortgage LTV ratio of 50%, a baseline HPA of 5% per annum, and a baseline mortgage rate of 8% per annum. In chart 2A, we examine the effect of deviations from the baseline interest rate over time (this assumes a variable rate reverse mortgage). In chart 2B, we examine the effect of a period of home price depreciation prior to a reversion to baseline HPA.

Chart 2A

Chart 2B

Chart 2A shows that under the baseline interest rate, crossover is achieved after about 25 years. In a rising rate environment, this drops to 18 years, while in a falling rate environment, the crossover point is not achieved within the time frame considered. The baseline case in chart 2B matches that of chart 2A: the crossover occurs after about 25 years. However, a period of mild home price deprecation followed by reversion to baseline HPA can advance the cross-over point dramatically: under the downside scenario in chart 2B, it occurs after about 12 years.

Many Countries Have Aging Populations, So Demand Could Grow

With certain regions experiencing a shift in distributional mass of age in their populations, demand for reverse mortgages could grow.

Shifting distributional mass of age for eight developed nations

The age distribution of a country will typically change over time due to several different factors, such as immigration policies and birth/mortality rates. Specifically, for the eight developed nations shown in chart 3, there is a shift in the distributional mass of age progressing from 1982 to 2022, as these countries' populations start to skew toward the middle-aged or elderly. Japan stands out as currently having the greatest relative weight of seniors (aged 60 years or older) and the most pronounced rightward shift in its population distribution--seniors made up 35% of Japan's population in 2022, up from only 14% just 40 years prior. In 2022, the Netherlands, Spain, and Sweden each had 26%-27% of their populations in the over-60 years bucket, and the remaining countries ranged between 25% in the U.K. down to 20% in Ireland.

Chart 3

One of the reasons for this phenomenon is the fact that people are generally living longer. In fact, life expectancies for all countries considered in chart 3 have drifted up roughly seven years on average over the past 40 years. It is reasonable to expect that as living conditions improve globally and medical technology advances and becomes more widely available, the heavy right tails of the age distributions could persist for years, especially if the low birth rates in many developed nations continue. Note that the high elderly population figures in chart 3 are hallmarks of developed nations, with strong medical care, high life expectancy, and low birth rates. For reference, elderly people (over 60 years of age) account for less than 15% of the global population.

Financial situations for aging population segments imply reverse mortgages could be attractive

All of this has a direct bearing on the housing needs of the elderly and the potential demand for products like reverse mortgages. It's generally the case that household financial circumstances evolve according to a reasonably predictable pattern. The "horseshoe plots" in charts 4A and 4B (for select, but representative, regions) illustrate how, as people age beyond their mid-50s, net worth tends to increase while income tends to decrease. This phenomenon suggests that, regardless of location, post-retirement households are often asset-rich and cash-poor.

Chart 4A

Chart 4B

While this implies that reverse mortgages could be attractive to these population segments, there are other regional factors that also play a role. For example, local regulations may restrict this type of funding, which could act as a headwind. Also, local cultural norms could have an impact. For instance, Germany has a low homeownership rate of 48%, suggesting that many people there may be more comfortable "letting go" of family homes and downsizing into a rental unit. In contrast, the Italian homeownership rate is 74%, so there may be some reluctance to relinquish full control of homeownership. Moreover, Italian homes sometimes house extended family and are passed on to the next generation. This implies that reverse mortgages may not be as attractive in Italy, despite its aging population (about 30% of Italy's population was aged over 60 years in 2022).

Drivers Of Reverse Mortgage Demand: Benefits And Risks To The Homeowner

As many countries face a shift in age distribution, it is reasonable to expect increased demand for retirement funding considering the benefits reverse mortgages offer--especially where living expenses are on the rise and public pensions may not adequately fund the desired lifestyles of retirees. Indeed, one of the main advantages of the reverse mortgage is that an individual can stay in their house indefinitely, provided essential payments are made on time. (If there are two occupants in the home, liquidation doesn't take place until both are out--this is a boon to the homeowners/borrowers but a risk to the lender.) In other words, the homeowner can't be removed from the home in the case of a reverse mortgage; however, there is the risk that they simply run out of cash and are unable to pay taxes, insurance, and maintenance. For a retiree not ready to downsize or to relocate to a new area, a reverse mortgage offers an alternative funding source that allows them to stay in the current property. Many regions have enjoyed substantial home price growth over the past decade, which adds to the allure of the product as additional equity is available to the borrower. Moreover, reverse mortgages can provide early inheritance or assist with tax planning in the sense that reverse mortgage proceeds are generally tax-free.

It is worth noting that this type of home financing can offer a repayment solution for the interest-only legacy mortgage loans originated prior to the global financial crisis in several European countries, such as the U.K., Ireland, and the Netherlands. Borrowers facing looming maturity dates as they enter retirement may lack a viable repayment strategy for their maturing interest-only loans. While traditional lending may prove challenging in these cases, equity release products and interest-only retirement loans can provide the necessary capital to repay these outstanding debts. However, the benefits may be muted in the currently high interest rate environment, especially with weak home price growth expected in these countries.

Cost-benefit analysis of the decision to take on a reverse mortgage

From the homeowner's point of view, much of a reverse mortgage's benefit derives from the utility of staying in the same home, and not moving to a rental unit and/or "downsizing". From a purely financial economic perspective, the cost-benefit analysis should be assessed on a case-by-case basis. Assume that the borrower is indifferent to whether they live in their current home or are willing to become a renter of an equivalent home. A suitable counterfactual world to consider is one in which the homeowner sells the dwelling at fair market value and invests the cash in a safe, low volatility investment.

To assess the value of the utility of being in the same physical dwelling, and not moving to a rental unit and/or "downsizing", one may compare the economic situation of a homeowner (A) that takes on a reverse mortgage (say, at a 50% LTV ratio) to a homeowner (B), identical in all respects but for the assumption that homeowner B will sell the home at fair market value, invest all the proceeds (perhaps in a liquid fixed income fund or an annuity) less capital gains taxes, and rent an equivalent home. Assume for this comparison that homeowner A invests the loan (by construction, more than half the value that homeowner B receives from the sale because of homeowner B's capital gains tax) in the same financial instruments. In this way, homeowners A and B have similar living accommodations, and, at the start of the analysis, they have roughly equal finances--the difference being that much of homeowner A's cash is locked up in his home and will start eroding as interest accrues. The test of which of the two is economically better off is driven by (1) the periodic costs they each incur; and (2) the rate at which homeowner A's home equity erodes, which depends on the interest rate of the reverse mortgage and the appreciation of the home.

The analysis relies heavily on assumptions, and we will not carry it out here. However, it's important to understand that while homeowner A must pay taxes, insurance, and maintenance on a regular basis, homeowner B must pay rent on an equivalent home (which is based on the owner's periodic taxes, insurance, maintenance, and mortgage costs). A preliminary review of typical ownership costs and rental costs in the U.S. suggests that homeowner B's expenses are substantially greater if homeowner A owes no mortgage payments (as would be the case here). This means that homeowner B might very quickly deplete the invested capital from the sale of the home and eventually have trouble paying the rent. On the other hand, homeowner A might soon lose all equity in the home. The main difference is that homeowner A can dwell in the home indefinitely provided the (much lower) monthly maintenance costs are kept up with the help of the loan and any other sources of capital.

Among factors to consider in such an analysis are life expectancy, sources of income (including savings and pensions), investment options and interest rate expectations, HPA trends, tax rates, owner's equivalent rent, terms of the reverse mortgage (e.g., maximum allowable LTV ratio), and whether instead of renting an equivalent home one downsizes to a rental or purchase unit. Certainly, the decision as to whether a reverse mortgage makes sense economically boils down to assessing the value of the homeowner's utility, making reasonable assumptions regarding the variables described above. Also worth considering is the value of the liquidity one obtains by becoming a renter of an equivalent or smaller property.

Securitization Of Reverse Mortgages

We have observed a renewed and growing interest from lenders and investors in the equity release securitization sector across various regions. This interest extends beyond typical reverse mortgages to include RIOs and other products similar to the HRPs discussed above. Such growing interest suggests potential for market expansion, which could (1) be vital in meeting the escalating financial needs of aging populations; and (2) enhance competition among lenders, potentially resulting in more favorable conditions for elderly homeowners.

Securitization varies across regions

The global securitization of reverse mortgages exhibits notable variation across regions. The U.S. displays the most developed market for these products, primarily due to a well-established and mature reverse mortgage sector. This maturity is supported by broad consumer acceptance and comprehensive financial institution engagement. Further bolstering the U.S. market is the Home Equity Conversion Mortgage (HECM) program, backed by the FHA, which provides a standardized framework and government guarantees for these financial products.

Internationally, securitization of reverse mortgages remains limited, with only a handful of transactions backed by the U.K., Swedish, Australian, and more recently, Irish and Spanish cross-jurisdictional assets. Factors such as limited available collateral and a scarcity of issuers with established track records restrict securitization activities outside the U.S., although the U.K. and Australia stand out as the most progressive in the reverse mortgage sector within the European and Asia-Pacific regions, respectively. Additionally, the complex nature and stringent regulations of reverse mortgages hinder new market entrants and suppress the volume of loan origination necessary for regular securitization transactions.

Key rating analysis considerations for rating reverse mortgage transactions

Understanding our principal analytical considerations for rating reverse mortgage transactions involves highlighting ways in which they differ from traditional residential mortgages. The following are features that make reverse mortgage transactions unlike traditional ones:

• Reverse mortgages don't involve the conventional concept of loan default due to the absence of periodic mortgage payments.
• The loan underwriting methodology is predominately asset-based, meaning there is greater emphasis placed on the asset value of the underlying property and on borrower longevity risks rather than the credit quality of the homeowner (i.e., affordability assessment is less of a consideration).
• Loss severity is primarily influenced by the amount of proceeds upon property liquidation at the time of a maturity event rather than at the time of default, with less correlation to economic stress compared to a traditional mortgage pool.
• Reverse mortgages are typically subject to different or supplementary prudential/conduct regulations.

The table below compares our main considerations for rating reverse mortgage securitizations to those of traditional mortgages, HRPs, and RIOs. It's important to note that this list of features is not exhaustive and that these products may carry additional risks and attributes (influenced by country-specific regulatory frameworks and market underwriting practices) that would warrant further assessment.

Monitoring Market For Reverse Mortgage Securitizations

In some instances, S&P Global Ratings may be able to rate and surveille reverse mortgage securitizations. However, whether new or existing transactions can be rated and/or surveilled depends on established criteria, which is region-specific. In countries where we have not previously rated transactions, or where we see different types of late-life funding products (such as RIOs and HRPs), we would need to create new methodologies and assumptions. Typically, this process would start with a request for comment before the publication of new criteria. Alternatively, we could develop a tailored approach guided by our "Principles Of Credit Ratings" (refer to "Related Criteria" for more details). We will continue to monitor the growing demand, origination, and securitization of reverse mortgages in countries around the globe.