Friday, August 31, 2007

The Wrinklies

For some fifteen years or more, Adolf has operated as a specialist sector mortgage broker.

Today's headline from The Herald demonstrates his wisdom in eschewing the fascinating and tempting 'reverse mortgage' market. That is, where the retired oldies with bugger all income and a mortgage-free home can trot along to the friendly lender and take out a loan. Interest accrues until their deaths at which time the property will be sold by the estate and the loan and interest repayed. The idea is that they stick the loan proceeds into a savings account and give themselves a few hundred dollars each month to supplement their incomes, gradually using up the capital and it's diminishing interest.

There were and are a few traps and we are about to see one of them. What happens if the lender goes broke and the receiver moves to call up the loans? Where will the then much older wrinklies go to refinance so that the receiver can pay out the debenture holders? Will the receiver be forced to sell up the oldies and tip them out onto the street? If the Wrinklies are lucky, their homes will be sold to investors who will allow them to stay on as tenants. Of course, the real howls of anguish will come from the money grubbing children of the wrinklies who will see their windfall profit from eventual sale of the home disappear.

One of the reasons responsible lenders do not engage in this reverse mortgage market is that they have too much to loose by way of brand damage should they ever be forced to sell up such a security property and be featured on Fair Go, 60 Minutes and every other bleeding heart media circus in the land.

Another trap for the 'olds' of course is that they might live too long and need to go back for another bite of the cherry to maintain their lifestyles, only to find that the accrued interest and plateauing property prices have conspired to render them in a state of negative equity.

That's a polite way of saying 'your debt is bigger than your asset.'

Michael Cullen seems to have absolutely no idea that he is shortly to be over whelmed by an economic tsunami. Professional commentators have predicted it for at least a year. They call it a 'financial storm.' First, the sub prime debacle in the US, then the collapse of the NZ finance company sector, now the pending disintegration of the high risk reverse mortgage market - so who will be next? I don't know but I'm sure there is much more to come. When it get's here this is what it will look like and it will happen very fast.

I'm starting to warm toward the probability of an early election following a lost vote of confidence in the house - probably early in 2008, after the sheeple have suffered a disastrous Christmas of little cheer and good will.


Ashley Clarkson said...

I was interested in it one afternoon so I calculated what would happen if someone borrowed $10,000 and lived for 20 years, using their 5-year fixed interest rate (on the assumption that the rate would remain unchanged). At the end of the 20 year period (when our heroic wrinklies have made it to the ripe old age of 85) their estate on selling the house would owe somewhere in the region of $80,000 (I can't remember the exact number).

If you've got the patience to wait for your return, it's a cash cow.

Adolf Fiinkensein said...

Ashley, try the rule of 72. Compounding at 5% your $10k will double in 14.4 years so I don't think you'll be looking at $80k after 20 years. At 9% it will double in 8 years.

Ashley Clarkson said...

It was 10.5%pa compounding monthly at their five-year fixed rate. I put it through a compounding equation used for determining the future value of an asset.

The big screw (apart from the high interest rate) is the monthly compounding period - this makes the principal+interest to be repaid increase at a much faster rate than if it were compounded annually. It'll also be why your rule of 72 gives a different answer.

Adolf Fiinkensein said...

Sorry I misread your comment to be 5% interest. It's not my rule of 72. It is a well known adage that if you divide 72 by the rate you get the number of years in which a sum will double. For $10k to reach $80k in twenty years, 10.5% sounds about right.

Ashley Clarkson said...

My bad - I should have been clearer in the first instance.

I called it "your" rule of 72 because it wasn't "my" MOFI 201 acquired FV equation. I've never heard of that rule (my father might - he's in the banking sector). State of the education system these days or something. I'll try and store it away in a spare spot in my head somewhere (running out of space - should probably put an extension on to give my ego more room to expand).

Say, you wouldn't be looking for a partner to go into the reverse mortgage business with, would you? :-D Pretty hard to lose if you're willing to wait.

Anonymous said...

So what is the size of this issue. Are there any stats of the number of people that have taken up this option.

Adolf Fiinkensein said...

I have no idea.

Alan B said...

Property Finance was one of the few reputable reverse mortgage companies not funded by a bank (or banks from overseas).

Bluestone is funded by Westpac, and Sentinel by a number of overseas banks (its at work, and i can;t remember).

Troubridge deloitte did a good report on the reverse mortgage sector and while the market is 75B of potential the current market is tiny, with Sentinel having aboutt 96% market share.

once again i have the stats at work :)

Adolf, you going to the NZMBA conference next week? if so, come and say hello, i'm the goateed ginga hanging out with the sovereign guys.

Alan B