Can 'High Costs' Justify Weak Demand for the Home Equity Conversion Mortgage?

Abstract

Home Equity Conversion Mortgages ("HECMs'') implicitly bundle put options on borrowers' homes with non-defaultable credit lines. Put proceeds are bequeathable and insure longevity and home prices. Credit use is elective, so the put's expected net present value bounds HECM's value to borrowers below. Older homeowners' weak demand is commonly attributed to "high costs,'' and the government sets prices intending to avoid subsidy. Simulation results make low demand more puzzling and illustrate risks to federal insurance. HECM has offered many borrowers favorably priced puts, even using backward-looking expectations near the recent price cycle peak and ignoring maintenance and termination options.

Keywords: Mortgages, Economics of the Elderly, Housing Demand, Portfolio Choice, Social Security and Pensions, Governmental Loan Guarantees

JEL Classification: G21, J14, R21, G11, H55, H81