While reverse mortgages may be intriguing, rthey are hardly a significant product for the mortgage industry. After more than 10 years, only about 12,000 have been issued.

But that could change. Older people are the fastest-growing segment of the U.S. population. Many own their homes free and clear, with the equity representing much of their life savings. This equity tends to be highly illiquid. At the same time, their retirement incomes may be skimpy.

So reverse mortgages may become hot products. The reason: They permit older people to stay in their homes while drawing on the pent-up equity.

The arrangement is fairly simple. The homeowner takes out a loan, using the home as collateral. Instead of receiving a lump sum, the borrower gets monthly installments and repays the loan when the house is sold.

The actual products, however, can be quite varied and complex. A hybrid product being developed by Republic Financial Corp., for example, combimes a conventional reverse mortgage with an annuity to overcome problems in the tax laws.

Developing a New Model

Fannie Mae has helped develop a conventional reverse model under a HUD program. At a recent roundable sponsored by Fannie's office of housing research, the agency described its development of a new model. It differs from the HUD mortgage in two key ways: Borrowers could set aside 10% of their equity as part of their estates, and the ability to pay down a loan and reborrow would be restricted.

"Our major challenge is to design a product that meets the consumer's want of flexibility and protection while at the same time having a risk level acceptable to financial institutions and investors," said Steve Deggendorf, a director in Fannie's office of housing initiatives.

The balance between borrower and lender needs all make or break any new version of the reverse mortgage. And the industry continues to try different combinations of features while waiting for a bigger market to emerge. On the investor side, a variety of securitization techniques is being suggested.

Classifying Investors

Peter Chinloy, a professor at American University, Washington, said at the roundtable:

"One alternative is to establish a [pool] with two classes of investors, protected and unprotected. The protected class would hold zero coupon bonds to be paid from prepayments. Fannie Mae, Prudential, and so on could assume protected class status and be guaranteed their money. The unprotected class, on the other hand, would receive a monthly interest payment."

Others said the market for reverse mortgages wasn't limited to older homeowners. "We would expand our horizons and look at more life cycle-related reverse mortgage instruments that people can also use as asset management tools," said James H. Carr, Fannie Mae vice president for housing research.

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