When Should Retirees Tap Their Home Equity?

Abstract

This paper analyzes a household’s optimal demand for a reverse mortgage.
We study a rich life-cycle model that can explain the low demand for reverse mortgages
as observed in US data. We find that the demand for reverse mortgages is particularly
pronounced for cash-poor, house-rich retirees, and households with a strong bequest motive
and low pension income. We analyze the optimal response of a household that is confronted
with a health shock or financial disaster. If an agent suffers from an unexpected health
shock, she reduces the risky portfolio share and is more likely to enter a reverse mortgage.
On the other hand, if there is a large drop in the stock market, she keeps the risky portfolio
share almost constant by buying additional shares of stock. Furthermore, the probability to
take out a reverse mortgage is hardly affected unless her financial wealth is small.

Keywords: reverse mortgage, consumption-portfolio decisions, biometric risks, financial disasters

JEL Classification: D14, E21, G11, G21, J14, R21