Selection and Moral Hazard in the Reverse Mortgage Market
44 Pages Posted: 25 Oct 2004
Date Written: October 21, 2004
This paper explains why selection in the US reverse mortgage market to date has been advantageous rather than adverse. Reverse mortgages let "house rich, cash poor" older homeowners transfer wealth from the wealthy period after their home is sold to the impoverished period before. Near absence of demand seems to contradict life cycle consumption theory and has been blamed in part on large up-front fees. These fees, in turn, are justified by adverse selection and moral hazard concerns related to length of stay in the home. In fact, reverse mortgage loan histories and the American Housing Survey reveal that single women who are reverse mortgage borrowers depart from their homes at a rate almost 50 percent greater than observably similar non-participating homeowners. This surprising fact appears to arise from the phenomenon that the types of people who wish to take equity out of their homes through reverse mortgage borrowing are also likely to take out the remaining home equity by selling their homes. This mechanism is similar to the heterogeneity in risk aversion proposed by de Meza and Webb (2001) to rationalize advantageous selection in insurance markets. Further results suggest that future declines in price appreciation may generate sufficient moral hazard as to undermine the advantageous selection seen to date.
Keywords: Life cycle models, saving, insurance, public economics, economics of elderly, market structure, housing demand
JEL Classification: D91, E21, G22, H00, J14, L10, R21
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