"Upside-down" mortgages

Monday, 16 december 2019 | Redacción CEU

Spain is one of the countries in the world where people live the longest. This is why its inhabitants may be worried about whether they will be able to maintain a satisfactory standard of living during their retirement or not. Beyond the possible debates about the current and future pension system, today, on the CEU IAM Blog, we have decided to talk about one of the least known and most special financial formulas aimed at elderly people: reverse mortgages. They are a financial product that enables people to obtain a loan, by using their house as collateral and without having to take charge of the debt repayment at any time. What exactly are the particularities of this proposal?

Before delving into the details of this financial product, which can be quite complex, it is necessary to state properly what the meaning of "reverse mortgage" is. To this end, we make use of the definition which appears on The Access Guide to Reverse Mortgage written by the Bank of Spain: <<It is a credit or loan which is guaranteed with a mortgage that falls on the habitual housing (also on other properties, but, in that case, the potential tax advantages or benefits would be lower), and which can be receive as a lump-sum payment or in installments. It is granted to people who must be over a certain age - from 65 years old- or who accredit a degree of disability (equal to or greater than 33%) or dependency (severe or great dependency), not being required to return it until the time of their death [writer’s translation]>>.

One of the most characteristic features that we can point out about this product is the age of the people at whom it is aimed, which is generally people over 65 years old. Hence, there is a paradox. Interestingly enough, this product is little known in one of the countries with more long-lived population, which also has a high rate of home-ownership. In particular, in its VII Survey on the Savings among the Spanish Population, BBVA Institute of Pensions indicates that eight out of ten people born between 1957 and 1977 own a home (38% are still paying their mortgages). According to this study, if one day they needed more money to live, 61% of them would be willing to use their house as a source of financing.

The largest Spanish banks do not offer this financial instrument. This could be one of the main reasons why reverse mortgages are little known in Spain. However, this product has been regulated since 2007 (Law 41/2007), and there are some Spanish financial institutions that offer it.

The features of "upside-down" mortgages

When opting for this alternative, borrowers obtain liquidity, as well as maintaining the use of the housing. This is undoubtedly one of the great advantages of this formula. Regarding the money that they can receive, this will be influenced by the property’s appraised value and the signatory’s age. Depending on their interests, people may opt for different alternatives:

Lifetime reverse mortgages: their signatories receive a monthly income for life, which is less money than the temporary reverse mortgages.
Temporary reverse mortgages: their signatories receive an income during an agreed time, which also depends on the value of the home, when this period is over, they can continue living in the home.
One-time-payment reverse mortgages: their signatories receive a single amount according to their property’s value.

The most striking feature of this proposal is that the borrowers are not subject to the repayment of the loans, but their heirs at the moment they die. Their heirs will also be the ones who must decide whether they want to acknowledge this debt (and the interests which are generated) and keep the home or if they do not want (or cannot) deal with it. In the last case, the final owner of the house will be the borrowing entity. They can also choose to take out a new mortgage on the house and rent it in order to cover the debt. Furthermore, they can sell the home to meet the debt and its interest.

Although this financial product may seem attractive a priori, it is important to keep in mind that these types of products always have associated risks. Therefore, we proceed to list both its main advantages and disadvantages:

Advantages

The signatories of these mortgages can obtain profitability from their real estate assets without the need to sell or rent them.
Borrowers can live in their homes throughout their whole lives.
This financial product serves as a complement to pensions.
Reverse mortgages can be interesting for people who face unexpected economic setbacks.
This product has a favorable tax treatment.
Houses work as collateral, it is not necessary to provide other guarantors, demonstrate other incomes or justify what that money will be used for.
Heirs have priority when deciding how to proceed to cancel the debt.

Disadvantages

It is a complex product that may be difficult to understand for its target audience.
It entails a loss of inheritance for heirs.
The debt grows over time instead of diminishing.
It is very difficult to finance the total value of homes. In the most favorable cases, the percentage amounts to 80% (these cases are exceptional).
The interests that heirs must face may be high (generally, over 5%).
Fees are not updated with the CPI (unless it has been agreed on).
Due to their characteristics, these mortgages are usually granted to high-value houses in the market.
In case of opting for the lifetime reverse mortgage, the insurance is usually high.

The CEU IAM Business School offers different masters, management programs and training courses which are focused on the finance world so that professionals can choose which one fits them best. Among them, there are courses such as our Advanced Program on Certification in Real Estate Credit Counseling, our Program Focused on Certification in Information and Commercialization of Real Estate Credits or our Advanced Program in Corporate Finance. Ask for further information!