Reverse mortgage investment trusts have become an increasingly popular investment vehicle in recent years. As the aging population grows, demand for reverse mortgages has surged. Reverse mortgage investment trusts purchase reverse mortgage loans and derive income from the interest payments. While these investments can provide attractive yields, they also come with unique risks. This article will explore the pros and cons of investing in reverse mortgage investment trusts.
Higher Yields Compared to Traditional Mortgage Investments
Reverse mortgage investment trusts can offer higher yields compared to investing in traditional mortgage-backed securities. This is because reverse mortgages tend to have higher interest rates given the borrower profile. With traditional mortgage investments, prepayment risk can be high as borrowers refinance or sell their homes. Reverse mortgages have lower prepayment risk as borrowers usually stay in their homes until death.
Diversification Benefits
Investing in reverse mortgage investment trusts can provide diversification for a portfolio. The returns tend not to be highly correlated with traditional fixed income investments like government or corporate bonds. Reverse mortgages may perform well when other assets are declining given the defensive nature of the investment.
Income Stability
Reverse mortgage investment trusts tend to generate stable income streams as borrowers make monthly interest payments on the loans. The principal balance on reverse mortgages generally does not get repaid until the borrower dies, sells the home, or moves out. This provides reliable income flows absent prepayments.
Increased Longevity Risk
A key risk with reverse mortgage investment trusts is increased longevity risk. If borrowers live longer than expected, the loans may not get repaid as quickly as projected. This can reduce returns for investors.
Interest Rate Sensitivity
Reverse mortgage investment trusts invest in fixed income assets, making the funds sensitive to interest rate changes. If rates rise, the value of existing fixed rate mortgages will decline which impacts share prices.
Prepayment Model Risk
These investment trusts rely on prepayment models to project returns. However, modeling reverse mortgage prepayments involves significant uncertainty. Actual prepayments may differ substantially from estimates.
Declining Home Values
Falling home prices can lead to lower recovery values when loans are repaid. This may reduce returns for investors. Geographic concentration also exposes investors to market-specific home price risks.
In summary, reverse mortgage investment trusts can provide attractive yield opportunities but also come with unique risks like longevity, interest rate sensitivity, and prepayment model uncertainty. As with any investment, proper due diligence is essential.