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insight

Mortgage Insurance is the Key to Success of Reverse Mortgage

There have been many debates since the Hong Kong Mortgage Corporation (HKMC) announced its plan to launch a reverse mortgage pilot scheme later this year. Issues like sufficiency of the annuity payment, level of insurance premium and associated fees, and degree of transparency have been raised in the community. We welcome these discussions, which help the public better understand the nature of the scheme.

Reverse mortgage enables the elderly to stay in their homes and, at the same time, obtain steady loan payments to help improve their quality of life.

I must say it upfront that the proposed reverse mortgage plan is not an elderly welfare scheme nor an investment arrangement. No government subsidies or investment gains or losses are involved.

One salient benefit that differentiates our scheme from some reverse mortgage programmes elsewhere in the world is that all residual value of the mortgaged properties will go to the inheritors of the elderly, not the banks. With this and other protections for the participants, elaborated below, a reverse mortgage plan is viable in Hong Kong only with the insurance to be offered by the HKMC.

In brief, a reverse mortgage is a residential mortgage product specifically designed for elderly people. Participants will use their self-occupied and non-mortgaged homes as collateral to apply for reverse mortgage loans with banks, and will receive a secure stream of monthly loan payments. At the same time, the elderly can remain in their homes for the rest of their lives. They do not need to repay the loan or pay any interest or mortgage insurance premiums during their lifetime. The banks will possess and dispose of the properties upon the death of the elderly to cover the accrued principal, interest and mortgage insurance premium. Any surplus will go to the inheritors.

Reverse mortgages have been available for years in many countries, including the UK and the US. However, in Hong Kong, no banks or insurance companies were willing to provide such a product, showing there are considerable complications in risk management and social acceptance here.

After an extensive study of overseas experience, the HKMC has come up with a framework for the pilot scheme, taking into account the merits of successful cases and lessons from the not-so-successful ones. We are encouraged by the positive feedback from the elderly respondents in our recent survey, which showed that 44% of the 1,005 respondents supported the introduction of reverse mortgage in Hong Kong and almost a quarter of the respondents would consider participating in such a scheme. However, market response will determine whether the scheme will operate in the long term.

Under the pilot scheme, the HKMC will play the role of insurer. To encourage banks to offer reverse mortgage loans, it will bear the risks of a shortfall in case the proceeds from disposal of the properties cannot cover the loan principal and interest. A significant drop in property prices, higher-than-expected interest rates, or exceptional longevity of the participating elderly person can all lead to a shortfall. As the tenor of reverse mortgage may last for over 20 years, these risks are very significant. Since property price volatility in Hong Kong is far greater than in many other places, the HKMC may have to bear huge shortfalls.

In addition to these risks, the design of the scheme and the amount of annuity payment would also affect the potential financial exposure and, in turn, the level of insurance premium. In some countries, the properties under reverse mortgage are sold to the lending institutions up front. This enables the institutions to make larger annuity payments because they will enjoy the full benefit of any property price appreciation.

However, according to our study, most of the elderly prefer to leave any surplus to their children and reserve their right to redeem the property. In light of this, the pilot scheme is designed so that the HKMC as the insurer, will bear the shortfall in case the realised value of the property cannot fully cover the outstanding loan balance of the reverse mortgage. And, if the value of the property remains stable or increases, the inheritors will receive any surplus, once the bank has deducted the loan principal, interest, insurance premium and applicable costs from the proceeds.

We will also allow the elderly to terminate the reverse mortgage at any time and allow their inheritors to have preferential rights to redeem the properties. Such arrangements will inevitably increase the level of premium charged. The HKMC will determine this amount based on prudent commercial principles, striking a balance between risk management and satisfying the needs of the elderly.

In addition, the HKMC will ensure that banks participating in the pilot scheme collect only administrative fees comparable to those for conventional mortgage loans, and no unreasonable charges.

Some people who are concerned about reverse mortgages say we should ensure that the elderly clearly understand their rights and obligations first. We agree, and consider it important that, in the pilot scheme, the terms and conditions have a good degree of transparency.

Many successful schemes elsewhere provide a counselling service for those who are interested. The HKMC is in discussions with the Law Society of Hong Kong to establish an effective counselling mechanism whereby lawyers can help people understand the details before they decide whether to join the scheme.

We understand that reverse mortgage may not suit all elderly homeowners. We also understand that it is customary for Chinese people to leave the family home to their children. However, with Hong Kong's ageing population and the change in family structure, some elderly people may wish to use this scheme to improve their standard of living. This is particularly so for elderly people who do not have children, or whose children have emigrated or have adequate financial means.

Also, some elderly may consider trading their existing property for two of lower values - one for their children, the other for themselves, with which they could apply for a reverse mortgage loan. This would ensure their children have a permanent home while also allowing the elderly person to receive payments to supplement their daily expenses.

We believe the introduction of reverse mortgages in Hong Kong will at least offer elderly people an additional option to make better arrangement for their later years. We will review the features of the pilot scheme from time to time so that it best serves the elderly.

Peter Pang
Executive Director
Hong Kong Mortgage Corporation Limited
6 January 2011

Last revision date: 1 August 2011
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