Reverse mortgages have lots of room to grow in Canada, but bring risks

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According to the DBRS Morningstar report, lenders should be wary of unique risks such as longevity risk and valuation risk

Penetration of Canada's reverse mortgage market lags behind other developed economies, according to a report by DBRS Morningstar. Penetration of Canada’s reverse mortgage market lags behind other developed economies, according to a report by DBRS Morningstar. Photo by Getty Images/iStockphoto

Canada’s reverse mortgage market has plenty of room for growth, but lenders should be wary of risks associated with its unique structure — such as longevity risk and valuation risk — according to analysis released this week by ratings agency DBRS Morningstar.

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In a July 11 report, analysts at the rating agency found that Canada’s reverse mortgage market penetration lags behind other developed economies (particularly the United Kingdom and Australia) with less than 0.5 percent of more than six million senior households owning property a reverse mortgage.

However, a rapidly aging population could bring significant growth and risk to the segment.

Reverse mortgages are loans secured by a borrower’s home, giving the owner access to their equity. Unlike a traditional mortgage, there is no set period or repayment schedule, and no monthly principal or interest payments. The loan does not have to be repaid until the borrower moves out of the house, sells the property or dies.

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This structure brings with it longevity risk, where it takes longer than expected to recover the money borrowed. According to the report, longevity risk was strongly influenced by the age of the borrower.

Shokhrukh Temurov, vice president of North American financial institutions at DBRS Morningstar, said the overheated real estate markets that have prevailed in recent years may also result in more risk being borne by lenders than borrowers.

That’s because newer vintages are more vulnerable to a correction, while higher home values ​​make older generations more secure.

“As long as the market corrects itself (as we are seeing now) property values ​​are in a more reasonable range, the risks should be managed by the banks,” Temurov said.

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The potential for dramatic price swings makes the valuation process important, Temurov said, noting, “Valuation is really crucial for this product.

DBRS Morningstar estimates the reverse mortgage market at less than $6 billion in the first quarter of this year, with two lenders shouldering most of the burden: HomeEquity Bank and Equitable Bank Inc as of Q1 2022, accounting for more than 90 percent of the estimated reverse mortgage loans in the country. Last September, the Ontario Teachers’ Pension Plan acquired the company’s parent company from Birch Hill Equity Partners Management Inc. Equitable Bank, a smaller player in the market, saw its loan portfolio grow to $304 million at the end of the first quarter of this year .

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The logo of EQ Bank, a subsidiary of Equitable Group Inc., in Toronto. The logo of EQ Bank, a subsidiary of Equitable Group Inc., in Toronto. Photo by Chris Helgren/Reuters

The Office of the Superintendent of Financial Institutions is keeping a close eye on the growing risks and, due to concerns about financial system risk, has already tightened rules on some lending products in anticipation that financial institutions will limit the maximum approved loan-to-value ratio (LTV) to less than or equal to 65 percent.

The institution also urged lenders to exercise more due diligence on issues such as collateral management, property valuation and longevity risk for reverse and uninsured mortgages.

BRS expects lenders offering reverse mortgages to tighten their underwriting standards and become more conservative in their lending policies to avoid risk to their business.

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Property appraisals and appraisals are a crucial part of determining mortgage amounts, maintaining strong asset qualities and providing an adequate buffer to absorb losses in a stressed environment.

Mortgage expert Rob McLister believes reverse mortgages are among the safest lender products on the market.

Net net, reverse mortgages will continue to fly off the shelves

Rob McLister

“Loan-to-values ​​are set by actuaries and closely regulated by OSFI,” McLister said in an email. “If more than 1 in 100 reverse mortgage balances exceeded the home’s value at the time of discharge, I’d be surprised. Sure, property values ​​are going down, but that’s all accounted for in the lender’s loan amount formula.”

McLister added that for a 65-year-old borrower with a $1 million Toronto home, the largest reverse mortgage range is between $316,000 and $360,000. Even if home prices in Canada plummeted over 30 percent, as they did during the US financial crisis (which he says is unlikely), the lender would still have a buffer of 30 percent or more.

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DBRS Morningstar also noted that if the housing market downturns, repayment risks will increase, although lower LTVs in the reverse mortgage space mitigate these challenges somewhat.

  1. A home for sale in Toronto.

    OSFI tightens guidelines on compound lending plans to ‘reduce systemic risk’

  2. Reverse mortgages typically work like lines of credit for home equity loans, allowing Canadians to invest the equity in their home for a lump sum or constant cash flow.

    Reverse mortgages gain momentum in Canada as more seniors ‘age in place’

  3. Older Canadians worry about the impact of inflation on their finances.

    Canadians taking early retirement are finding it’s more expensive than they thought

  4. OSFI also sounded the alarm about an overheated housing market and over-indebted borrowers, which have heightened the financial system's sensitivity to a price correction.

    According to OSFI, the real estate crisis and cyber attacks are the greatest risks for the Canadian financial system

McLister was unperturbed by the risks of a market downturn, noting that there has never been a 10-year period in modern history when Canada’s national average home value has not increased.

With rising inflation and higher borrowing costs, McLister expects reverse mortgages to become more popular among fixed-income seniors who need more money to support their lives and stay in their homes.

“Ultimately, however, most borrowers get a reverse mortgage because they need one, not because they want one,” McLister said. “That, plus the fact that it’s easy to qualify, makes reverse mortgage borrowers more interest rate tolerant than the average mortgage lender.”

“Reverse mortgages net net will continue to fly off the shelves,” he said.

• Email: [email protected] | Twitter: StephHughes95

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