Over the last couple years, reverse mortgage lending has exploded, such that the product can no longer be considered a niche offering. Now, it looks as if the industry will get another boost, as Wall Street introduces the practice of securitization, which has long since been commonplace in conventional mortgage lending.

For those of you aren’t familiar with this concept, securitization involves the bundling of individual assets (mortgages in this case) into massive portfolios, so that they ca be sold to institutional investors. The idea is that by packaging many mortgages together, the risk declines, since a few defaults will presumably be offset by repayment by the majority of borrowers. By connecting capital markets (i.e. large investors) directly with mortgagers, it is believed that mortgage rates and terms are more attractive than they otherwise would be. (As an aside, it is also believed that securitzation played a large role in the fomenting of the housing bubble and the subsequent financial crisis).

With 110,000 reverse mortgages per year (and rising), Wall Street investment banks have discovered new potential for securitization. In fact, it is surprising that the practice wasn’t introduced earlier, since in some ways, reverse mortgages would seem to constitute the ideal candidate for securitization; due to mandatory FHA mortgage insurance, lenders already bear virtually zero risk in the reverse mortgages they originate. From an investor standpoint, meanwhile, the risk of default is also nil, since taxpayers (via the FHA) are ultimately on the hook for any mortgages that cannot be paid.

On the other hand, there are some inherent differences between reverse mortgages and conventional mortgages, which create a unique investment dynamic. Namely, the time horizon for repayment is typically much longer with a reverse mortgage, and in fact indefinite. Whereas a conventional mortgage borrower must repay the mortgage incrementally over a fixed time period (usually 15 or 30 years), it is impossible to predict when a reverse mortgage will be repaid since it usually only comes due when the borrower dies and/or the home is sold. In addition, whereas a conventional mortgage must be gradually repaid, a reverse mortgage is typically only repaid in full.

It would be difficult for investors, then, to judge how long the mortgage must be held before it will yield a profit. In some ways, then, it is akin to investing in an asset that doesn’t produce a stream of income payments, but only a lump-sum payout at the end of its life. Accordingly, it probably isn’t appropriate for the majority of investors.

How will this affect borrowers? Those with outstanding reverse mortgages won’t be affected in the slightest. For potential borrowers, it could lead to slightly lower interest rates, since a larger supply of capital will presumably drive down prices. Lending standards will probably also be relaxed, since lenders will have virtually zero incentive to ensure repayment. The FHA insurance premium guarantees that investors will ultimately be repaid, regardless of what happens to the value of one’s home (the main variable in a reverse mortgage) in the interim. Once again, it looks like taxpayers will get screwed, but everyone else will come out ahead.

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