The Inverted Yield Curve’s Potential Effects on Reverse Mortgages

The U.S. stock market fell sharply on Wednesday in response to an “inverted yield curve.” Historically, economists have seen this as a telltale sign that an economic recession is likely to transpire.

“On Wednesday, the U.S. stock market tumbled after a reliable predictor of looming recessions flashed for the first time since the 2008 financial crisis,” reported the Washington Post. That “reliable predictor” is an inverted yield curve.

The inverted yield curve occurs when interest rates on short-term bonds become higher than interest rates paid by long-term bonds, which means that investors are worried enough about the near-term future that they are moving their investment activity toward long-term investments, which are generally safer than shorter-term investments.

Impact on reverse mortgages

Although reverse mortgage rates use a different indices than those primarily affecting the inversion that was recorded on Wednesday, the patterns observed could have implications on the reverse mortgage market according to Dan Hultquist, VP of organizational development at Finance of America Reverse.

“This most recent inversion occurred because the 10-year Treasury yield has been falling in recent weeks. Of course, reverse mortgages use the LIBOR indices instead,” Hultquist tells RMD. “Nevertheless, LIBOR-based rates have followed a similar pattern, with the 10-year SWAP falling to its lowest mark in nearly 3 years.”

A reduction in long-term rates potentially spells positivity on the front of reverse mortgages, Hultquist says.

“There are multiple advantages for the reverse mortgage industry when long-term rates are lower,” he says. “For one, borrowers generally qualify for more money (higher principal limits) when rates are expected to be lower in the future.”

The inversion may also have the possibility of affecting reverse mortgage lines of credit, according to Dr. Wade Pfau, professor of retirement income at the American College of Financial Services.

“[The inversion] could benefit standby lines of credit with the lower expected rate, allowing more initial LOC and the higher relative subsequent LOC growth through the effective rate,” Pfau said in an email to RMD.

There could also be positive ramifications for loans that already exist.

“Some existing HECM loans may benefit as well if rates end up being lower over the next 10 years. Borrowers will accrue less interest, preserving more equity,” Hultquist adds. “This also makes the loan less likely to end up as a loss to FHA’s Mutual Mortgage Insurance (MMI) Fund.”

Broader economic impact

Though an important occurrence, the longer the yield curve remains inverted, the stronger the likelihood becomes that it will be an indicator of an oncoming recession, Hultquist explains.

“Of course, an inverted yield curve occurs periodically when short-term rates are higher than long-term rates,” he says. “While there are many maturities that have been inverted recently, most economists watch for the technical definition of inversion – 2-year treasury yields higher than 10-year treasury yields.”

In terms of the inversion recorded this week, it occurred because the 10-year Treasury yield has been dropping at a fast pace in recent weeks, Hultquist says.

“The reason this is concerning is that an inverted yield curve is one of the best indicators of a pending recession. It is true that an inversion preceded the last seven recessions, but analysts (and former Fed chairs) will debate whether this is a strong indicator this time.”

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