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Prepayment risk in reverse mortgages: An intensity-governed surrender model

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  • Shi, Tianxiang
  • Lee, Yung-Tsung
Abstract
Reverse mortgages have been an important financial tool for cash poor seniors to release home equity. In the United States, most reverse mortgages are insured by the Federal Housing Administration (FHA) through the Home Equity Conversion Mortgage (HECM) program. Previous literature on reverse mortgage insurance often considers mortality as the main loan termination risk, and less attention has been paid to terminations due to loan prepayment, such as refinancing, repayment, and move-out. However, prepayment of reverse mortgages presents a significant risk to lenders and the HECM program. The Report to Congressional Requesters (United States Government Accountability Office, 2019) shows that about 28.5% of the total known reverse mortgage terminations in Fiscal Years 2014–2018 were attributed to loan refinancing, repayment, or move-out due to non-health reasons, whereas 48.6% of known terminations were attributed to mortality. In this paper, we employ an exogenous intensity-governed surrender model to study prepayment risk in reverse mortgages. The proposed model captures both macro-economic and non-economic drivers in surrender decisions. This paper complements existing studies of surrender behavior in reverse mortgages and provides a novel approach to incorporate prepayment risk into reverse mortgage pricing.

Suggested Citation

  • Shi, Tianxiang & Lee, Yung-Tsung, 2021. "Prepayment risk in reverse mortgages: An intensity-governed surrender model," Insurance: Mathematics and Economics, Elsevier, vol. 98(C), pages 68-82.
    • Handle: RePEc:eee:insuma:v:98:y:2021:i:c:p:68-82
    DOI: 10.1016/j.insmatheco.2021.02.008
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    References listed on IDEAS

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