The next shoe to fall: Reverse Mortgages

Slowly but surely we are starting to see cracks in the reverse mortgage market. Like all the new mortgage finance innovations of the bubble years, having a lender give a lump sum payment to an elderly homeowner for the privilege of collecting upon the death of the borrower sounded like a good idea. Unfortunately, we are now starting to see that many of the underlying assumptions of reverse mortgages were flawed.

In particular, it is now evident that home prices have fallen so much that many reverse mortgage holders are under-water, finding that the current market price of their home is worth less than what they borrowed. As the New York Times points out, this impacts any surviving spouses who had hoped to wind up with a little inheritance with the passing of their loved one.

http://www.nytimes.com/2011/03/12/your-money/12money.html

Of bigger implications, however, is the fact that lenders are already starting to see situations where they are taking losses on reverse mortgages. The generous equity cushions lenders had thought they were leaving themselves have proven to be not so safe after all. When homes drop 40% or 60% in value even large equity cushions of 25% or 30% aren't sufficient to prevent losses.

Could losses from under-water reverse mortgages start to impact bank balance sheets?

I don't have a lot of sympathy for people who find their homes are being foreclosed upon when their spouse passes away. After all, these people managed to benefit from having the bank over-pay for the value of the home. At least the lender can't force anyone to make up the difference from the market sale price and the balance owed.

If the treatment of other distressed properties is anything to go by I wouldn't be surprised to see many lenders delay in the foreclosure, and sale, of reverse mortgaged properties as well. Banks have shown a great aversion to having to take write-downs on mortgages by selling for low market values and I doubt attitude will change with reverse mortgages.