Reverse Mortgage: Comparison of Spain,

Reverse Mortgage: Comparison of Spain, The United Kingdom, The United States and the Italy

The reverse mortgage is described as a "hot product" in the report of Fessler (2008) entitled: 'How Reverse Mortgages Could Help fund Your Retirement' since reverse mortgages "offer older investors a change to earn monthly income while they wait for the housing market to stabilize..." A reverse mortgage is defined as "...essentially a home quit loan that's paid out over time. Banks long ago recognized that some seniors approaching retirement were coming up short on monthly income, and the reverse mortgage was born...." (Fessler, 2008) Fessler states the following of the reverse mortgage: (1) it's a way to tap into a home's equity and receive a monthly check instead of making monthly payments; (2) the loan is paid back when the house is sold due to the owner moving or if the owner dies; (3) Most reverse mortgages have a minimum age requirement. In the case of Bank of America, it's 62 and older; (4) the upside to a reverse mortgage is that seniors can remain in their home, keep title to it and can continue to make improvements and basically do anything else one would do prior to getting a reverse mortgage." (Fessler, 2008)

The reverse mortgage, according to Fessler (2008) does not affect the various "entitlement programs such as Medicare, but Medicaid and other programs such as Supplemental Security Income (SSI) might be affected." The situation of a homeowner's tax may as well be affected by the reverse mortgage. In considering the reverse mortgage, the age of the individual is a factor and it is noted by Fessler (2008) that since people are living longer they should consider that the result would be that they would need "greater and greater sums to fund their retirement." Other factors to consider include whether the individual desires to stay in their home or sell and then buy another home or rent. Fessler does note that the reverse mortgage would be a good way "to receive additional monthly income while you wait for the market to recover." (Fessler, 2008) the downside is that the reverse mortgage "is - after all - debt dressed up as equity. And there's no free lunch: it eventually has to be paid back, either by you or your heirs." (Fessler, 2008)

I. OVERVIEW

The Peterson Institute for International Economics report entitled: "Germany and Italy: Mind the Accelerator!" states that Italy has a highly fragmented banking system "with extensive public-sector ownership, and limited alternative finance for companies and households" (Peterson Institute, 2007) the result is that "bank capital impairment is a very real risk and the supervisory system of Italy is "more centralized and likely will perform better than Germany's BarFin." (Peterson Institute, 2007) the property bubble in the United States is stated by the Peterson Institute to be nothing in comparison to the United Kingdom and Spain's and states additionally that "while direct property market spillovers are rare across borders, general liquidity reduction for real estate investment could hit these markets." (Peterson Institute, 2007) the Peterson Institute states that "Spain is at the greatest risk" and the United Kingdom is "at the least risk." (2007) the recovery in Italy are stated by the Peterson Institute to be unsustainable with Spanish real estate bubbles "significant" in nature. (2007)

II. POVERTY AMONG ELDERLY HOMEOWNERS

The following figure lists the poverty among elderly homeowners before and after home equity conversion in the countries of Spain and Italy.

Poverty among elderly homeowners before and after home equity conversion

Base income Imputed rent Moving Rev. Mortgage

Spain 32%

Italy 18%

Source: Lefebure, Mangeleer, and Bosch (2006)

Atkinson (0.5) inequality indices before and after home equity conversion

Base Imputed rent

Sale+Buy

Rev. mortgage

Spain 0.153 0.124* 0.138* 0.118*

Italy 0.165 0.152* 0.166 0.153*

Source: Lefebure, Mangeleer, and Bosch (2006)

The work of Lefebure, Mangeleer, and Bosch (2006) entitled: "Elderly Prosperity and Homeownership in the European Union: New Evidence from the Share Data" states that the "elderly population often combines low household income with high ownership rates" and additionally that the addition of a rate of return to home values "significantly reduces the poverty rates of the elderly, particularly in Southern and Central Europe." (Lefebure, Mangeleer, and Bosch. 2006)

The poverty rate is lower in the United States than in the UK where it is approximately 25%. In Italy the over 65 years of age poverty rate is lower as it is in the United States. The population in the country of Italy is reported as aging and it is stated that it is known from "basic life cycle theory (Modigliani) that saving and spending patterns change across the life cycle, with the propensity to borrow against future income in order to buy now declining significantly among the over 50s, and since it is increasing consumer credit that drives retail sales growth in the dynamic internal consumption economies, then it is highly likely that ageing will now act as a drag on sales growth in countries like Italy with very high median population ages (43, along with Germany and Japan). As we can see in the chart below (which comes from the U.S. Census Bureau database), Italy's median population age has been rising steadily, and at a very rapid rate (over 1 year's increase in median population age for each calendar year, of course historically this type of rapid ageing is quite unprecedented), with the only real substantial unknowns between now and 2020 being life expectancy, which may accelerate more than anticipated (in which case the population ageing will be even more rapid), and immigration, which will slow ageing down a bit." (Hugh, 2008)

Italy Median Ages

Source: Hugh (2008)

III. BANK of ITALY

In an address given by Ignazio Visco, member of the board, Bank of Italy at the 'Luxembourg Wealth Study: Enhancing Comparative Research on Household Finance' in Rome in July 2007 it is stated as follows: "As the assembling and standardization of national data sources is now complete, this LWS final conference marks the conclusion of the project. The next stage, as I understand it, will be the release of the LWS database to the research community. It contains a wealth of information on households' net worth and asset portfolio composition, as well as on demographic characteristics, consumption, expenditures and sources of income." (Luxembourg Wealth Study, 2007) Additionally stated is: "According to the Survey of Consumer Finances, the ratio of real assets to household disposable income in the United States rose from 3.7 in 1992 to 4.8 in 2004; in Italy, according to the SHIW, from 5.3 in 1993 to 6.3 in 2004. This is clearly a pattern shared by many other countries. On the other hand, net financial assets show a much more moderate trend. Overall, although time series of the aggregate level of household net worth still leave much to be desired (and the Bank of Italy is currently in the process of overhauling the estimation of Italian wealth figures, with results that will be presented in another conference later this year), there seems to be little question that over this long period wealth has increased at higher rates, for many countries much higher rates, than household disposable income." (Luxembourg Wealth Study, 2007)

Visco additionally states that there is the possibility that there: "...may be merit in considering the changes in shelter costs for owner-occupied housing as part of general consumer price changes. In this case, one should conclude that the prices of housing services have gone up substantially compared to other consumer goods and services. A part however, and possibly a significant part, of housing expenditures is clearly of capital-good nature. One should also then conclude that in these years house owners have been able to extract substantial rent from their accumulated real estate (and then the related questions would be: What determined the rent? Who has gained from the relative price changes? And at whose expense, at a country level and globally?).Anyway, in the first case we have an issue of relevance for monetary stability, in the second for financial stability, especially as house prices have been moving faster in relatively short periods of time and the larger house values have been used as collateral in financial deals. Clearly the LWS data could help substantially in answering some of these questions, comparing the experience of different countries and taking into account the presence of borrowing constraints as well as differences in house ownership. On the latter, it is striking to see how widely home ownership rates differ between countries: in 2000, while in the United States and in the United Kingdom about two households out of three owned their homes, in Germany, in the Netherlands and in Sweden the proportion was 40 to 60 per cent, in Italy about 75 per cent, in Greece and Spain 85 per cent." (Luxembourg Wealth Study, 2007) in summary, Visco states that homeowner statistics are as follows:

Country Homeowners

1) United States 33 1/3% of households

2) United Kingdom 33 1/3% of households

3) Spain 75% of households

4) Spain 85% of households

Visco relates that capital gains and losses on "on real and financial assets are also worth special attention from a macroeconomic perspective, however. This would be only natural for central bankers, as wealth effects may be a very relevant factor in determining fluctuations in aggregate demand. Studies on wealth effects have been conducted in recent years, also in the Bank of Italy, making use of household surveys. For a given level of net worth, the wealth effect may be defined as the extent to which household consumption changes in response to a change in asset prices relative to the general consumer price level. Conceptually, this is no different from the old Pigou effect, but while that worked through changes in consumer prices that reduced the "value" of money balances in real terms, we now have asset prices rather than consumer prices as the main factor. While consumer prices may be relatively stable, asset prices could move substantially, and the wealth effect could actually be a destabilizing rather than, as was once thought, a stabilizing factor." (2007) This results in a question of whether a "substantial drop in the relative price of houses might have a significant negative effect on aggregate demand." (Visco, 2007)

IV. GLOBAL CORPORATE TRUST REPORT

Reverse mortgages (RM) are stated to have once been considered "the sole province of poor retirees, a last resort for individuals without adequate retirement savings. How the market is shifting in a way that may portend bigger things to come. RMs are fast becoming the financial tool of choice for house-rich but cash-poor seniors. Prior to RMs, retirees could only access home equity by selling or by taking a home equity loan. With the recent real estate downturn, selling has become a less palatable option." (Global Corporate Trust, 2008) Over 300,000 reverse mortgages are stated to have been originated "during the past five years." (Global Corporate Trust, 2008) This only represents however, approximately "1% market penetration" and it is estimated by the National Reverse Mortgage Lenders Association (NRMLA) that "80% of seniors own their homes and hold about $4.3 trillion in untapped home equity." (Global Corporate Trust, 2008) it is predicted that reverse mortgages will grow substantially in the future because of "demographic trends..." illustrated in the "pending global retirement of the post-World War II baby boomer generation." (Global Corporate Trust, 2008) it is reported that the Bank of New York Mellon 'has been building a sophisticated end-to-end RM platform to support origination and securitization by government-sponsored entities (GSEs) and the private market. This platform, currently being developed in the United States, may eventually be rolled out worldwide as RM-type products take hold in other graying nations." (Global Corporate Trust, 2008) Specific demographic trends are stated among the world's population to be as shown in the following chart labeled figure 4 in this study.

Demographic Trends Among the World's Aging Population

Source: Global Corporate Trust, 2008

It is additionally reported that Italy's over-60 population is approximately 39% of the total population in Italy and by 2025 "more than a third of the U.K.'s population will be over age 55." (Global Corporate Trust, 2008) in fact it is held by experts that "such population shifts will severely strain social insurance programs at the very time seniors will be most dependent on them. McKinsey & Company predicts these trends will create significant downward pressure on household savings and financial wealth accumulation." (Global Corporate Trust, 2008) While presently legislation for reverse mortgages is under consideration in Spain, the United Kingdom has established "home reversion programs [that] allow a homeowner to sell an equity interest in the home in exchange for an equivalent percentage of cash." (Global Corporate Trust, 2008) in the case where the owner sells the full equity of the home the homeowner is allowed to "remain in the home rent free until relocation or death." (Global Corporate Trust, 2008) it is related that a report by Defaqto in "April 2007, "noted that a combination of underfunded pensions, low annuity rates, demographics and pensioner debt, along with high levels of equity in housing stock, will make equity release in the U.K. An important retirement planning alternative." (Global Corporate Trust, 2008) Facts stated concerning the nature of the reverse mortgage as having importance as a tool in financial and estate planning which "coincides with the services provided by many diversified financial institutions" include the following:

Long-term care (LTC). About 60% of people over age 65 will require LTC care during their lifetimes, according to the National Clearinghouse for Long-Term Care Information. RMs could fund a long-term care policy or be used to meet out-of pocket LTC expenses;

Medigap. A Medigap policy is health insurance sold by private insurance companies to fill gaps in the original Medicare Plan coverage. Some Medigap policies cover costs not included under Medicare; and Life insurance. Heirs expecting to inherit childhood homes may be disappointed to learn an outstanding RM will require the home to be sold. One solution: use RM cash flow to maintain payments on an existing life policy or to purchase additional coverage. At death, beneficiaries can use the proceeds to pay the RM loan balance or receive a tax-free equivalent that will pass free of probate. (Global Corporate Trust, 2008)

It is related that "a long list of third-party services are often required to support an RM custodial file as its moves from origination to securitization and beyond." (Global Corporate Trust, 2008) These services are stated to include:

1) Document Custodian. When an RM loan is originated, a document custodian is typically charged with holding a physical collateral file that contains the RM note, the title policy, the deed of trust (depending on the state of origination), the assignment form, as well as insurance and other documents. The document custodian is charged with safekeeping, document review, borrowing base calculations, and reporting. RM custodial duties appear similar to forward mortgages, but they are not. Each type of RM loan may require a different set of criteria and documentation. Some of these loans require holding 26 separate documents, including the credit file and HUD requirements, in addition to mortgage related documents. The Bank of New York Mellon has developed specialized RM loan-custody processes, reviewing, certifying, and warehousing the documents from locations in New York, Texas, and California.

2) Collateral Agent. As custodian, the Bank of New York Mellon safekeeps collateral in segregated accounts and marks-to-market daily to ensure prescribed collateral margins are maintained. The Bank's proprietary collateral management system can process a wide array of transaction types, including tri-party repurchase agreements (both equity and fixed income), portfolio swaps, collateralized loans, and swap collateralization deals.

3) Trustee. A trust indenture mandates the appointment of a trustee to provide a central point of contact and serve as the noteholder's representative. Divergent legal environments influence the role of the trustee and the extent of any administrative duties undertaken; however, the core administrative services remain largely the same. The Bank of New York Mellon's service platform and product suite offer a single source for all trustee needs. Choosing the right trustee could influence an issue's rating as well as its potential performance in the secondary market.

4) Master Servicer. The Bank of New York Mellon currently monitors primary servicing functions for public and private forward mortgages. These duties include monitoring primary and special servicers, acting as back-up servicer, managing payment flows, collecting monthly reports, aggregating and validating loan level data, and customizing investor reporting. As of May 31, 2007, the Bank of New York Mellon was master servicing more than 131,855 loans totaling $25.1 billion (Fitch Ratings, December 4, 2007).RM master services will be added in the near future. (Global Corporate Trust, 2008)

V. THEORY of MODIGLIANI

The work of Philippe Le Goff (2003) entitled: "The Reverse Mortgage: A Solution to Retirement Funding?" states that the theoretical basis of the reverse mortgage or the concept that underpins the reverse mortgage demand "is the consumption and savings lifecycle theory advanced by Modigliani in the 1950s." Or stated more simply the theory holds that "households accumulate a nest egg for retirement and use it to finance their retirement spending, thus cushioning the impact of the income drop that usually occurs at retirement. The theory involves two important assumptions concerning reverse mortgage demand:

1) Seniors living alone are more likely to participate in a reverse mortgage program; and 2) the appeal of a reverse mortgage program increases with age. (Le Goff, 2003)

Payment options are quite varied in the Reverse Mortgage plans and include:

1) lump-sum payments: The homeowner receives the full amount of the loan in a single payment;

2) Line of credit: The homeowner is given free access to funds up to a preset amount and can use them as he or she sees fit.;

3) Periodic payments: The homeowner receives payments for the duration of the reverse mortgage according to a schedule set out in the contract. (Le Goff, 2003)

Advantages of the reverse mortgage are stated to include:

1) Homeowners continue to live in their residence for the duration of the loan;

2) the property's value is likely to rise during the loan period, which reduces the actual cost of the loan;

3) the interest paid is tax-deductible if the reverse mortgage is used to earn investment income, such as interest or dividends. (Le Goff, 2003)

Primary disadvantages of reverse mortgages include:

1) Interest can accumulate quickly depending on the mortgage interest rate and the type of reverse mortgage chosen by the participant;

2) Due to associated fees, over and above the interest costs, the actual costs of the funds is higher than the cost of funds available from other instruments, such as a conventional line of credit;

3) if the property value does not increase much, the amount due upon disposition will be a large percentage of the selling price, which will reduce the net proceeds of the transaction; and 4) Heirs may end up with a much smaller inheritance. (Le Goff, 2003)

The work of Angus Deaton (2005) entitled: "Franco Modigliani and the Life Cycle Theory of Consumption" states that the theory of Modigliani was a theory of spending "based on the idea that people make intelligent choices about how much they want to spend at each age, limited only by the resources available over their lives." (Deaton, 2005) Modigliani is stated to have identified "one of the most important motives for putting money aside..." And that being "the need to provide for retirement." (Deaton, 2005) the life-cycle theory is one that holds that the "wealth of the national gets passed around: the very young have little wealth, middle aged people have more, and peak wealth is reached just before people retire. As they live through their golden years, retirees sell off their assets to provide for food, housing, and recreation in retirement. The assets shed by the old are taken up by the young who are still in the accumulation part of the cycle." (Deaton, 2005) Deaton states that the life-cycle hypothesis and its consistency with "the received theory of consumer choice is not only guaranteed its internal consistency, but also provided it with a generality that accounts for much of its durability." (2005) the theory in its original form provides a "specific account of consumption and saving, but it is derived from fundamental underlying principles that could be used to extend the model and to deal with a wide range of issues about consumption and saving, many of which had not been though about in 1950." (Deaton, 2005) Presently a key policy consideration is that of social security and while the role it plays is small "in the original formulation, the framework can be readily extended" to assist in the thinking about alternative policy consequences. While the methods and theories of economics have evolved over time and the enrichment and extension of the life cycle theory as have been witnessed were not "possible in the 1950s." (Deaton, 2005) Specifically, Deaton states: "Assumptions that were originally necessary for tractability have been relaxed. For example, Modigliani and Brumberg's original formulation recognized that life cycle planning requires people to look into an uncertain future, and that it is difficult to formulate theoretically satisfactory and tractable models of how people behave in the face of uncertainty. In the subsequent half-century, economists and others have developed methods for dealing with uncertainty, and economics has absorbed tools from the statistical analysis of time-series that enable us to handle expectations about the future in a more coherent way, and much recent work has been devoted to reworking life-cycle theory so as to rigorously incorporate an uncertain future. The tools were not available to undertake such a task in 1950." (Deaton, 2005)