Part II: Loan Age vs. Borrower Age
No one takes out a home mortgage loan with the intention of repaying it immediately. A mortgage loan is a long-term loan designed to finance a long-term asset. Some mortgages do payoff quickly, mostly due to unexpected life events or refinancing opportunities. However, prepayments in the first months after mortgage origination tend to be significantly lower than seasoned mortgages, which are often defined as mortgages that have been outstanding for more than two years.
When analyzing mortgage prepayments, the investor should take this into account. It is useful to segregate prepayment rates into seasoned and unseasoned loans, because otherwise the calculated prepayment rates may be artificially low. Also, without controlling for loan seasoning, it becomes more difficult to isolate the impact of other variables, such as borrower age.
Loan Age (or Seasoning) is a well-researched subject for forward mortgages, but for reverse mortgages there is another age that matters even more: the age of the borrower. Borrower Age is a strong driver of prepayment rates, and unlike Loan Age, its importance increases as time passes. FHA’s recent release of all HECM prepayment history from program inception through January 2010, allows for a comprehensive look at prepayment behavior by age cohorts over time. If we look at the borrower age (or age of the youngest borrower, in the case of multiple borrowers), a strong correlation emerges.
For seasoned HECMs, 64 year-old borrowers have prepaid at a rate of 4.3% per year, 74 year-olds at a rate of 6.7% per year, and 84 year-olds at 10.1%. Prepayments for reverse mortgages are the result of loans paid off from borrower Maturity Events. Each of these prepayment percentages is the equivalent of a fraction, the numerator of which is the number of loan payoffs (to the investor) corresponding to the borrower age at the time of payoff, and the denominator of which is equal to the outstanding number of loans corresponding to that borrower age. For example, the 74 year old cohort represents all HECM loans originated to 72-year-old borrowers that were still outstanding after 2 years, plus all HECM loans originated to 71-year-old borrowers that were still outstanding after 3 years, and so on.
The correlation is strongly linear, with each year of borrower age resulting in an approximate 0.3% increase in prepayment speed. This corresponds very closely to the average increase in mortality rates by age cohort in the senior citizen population of the U.S., especially those 70 to 80 years old, which represent the bulk of the observations in our prepayment data.
Of course, there are other factors that affect HECM prepayments. We have included a comprehensive history of HECM and proprietary RM loans side by side on this spreadsheet. The effect of good and bad economic times can be seen, most dramatically during the recent recession, but also during the previous recession in 2001. It is also evident that proprietary reverse mortgage borrowers generally pay much faster than HECMs, likely due to their higher mobility and ability to refinance into other mortgage products.
The Borrower Age correlation is perhaps the most important concept in reverse mortgage prepayments, and a source of value as well. Although most mortgage investors are not accustomed to dealing with actuarial risk, it is worth spending time to understand how the actuarial nature of reverse mortgages reduces prepayment risk.
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