When Should Retirees Tap Their Home Equity?
49 Pages Posted: 8 Sep 2020 Last revised: 30 Mar 2022
Date Written: March 28, 2022
This paper studies a household's optimal demand for a reverse mortgage. In a stylized framework, we first show that the decision to enter a reverse mortgage is mainly driven by the differential between the aggregate appreciation of the house price and the discount the homeowner has to accept to take out a reverse mortgage on the one hand and the funding costs of a household on the other hand. Second, we study a rich life-cycle model. 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. Besides, the probability to take out a reverse mortgage is hardly affected unless her finanical wealth is small.
Keywords: reverse mortgage, consumption-portfolio decisions, optimal stopping, bio-metric risks, financial disasters
JEL Classification: D14, E21, G11, G21, J14, R21
Suggested Citation: Suggested Citation