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

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  • Thomas Davidoff

Abstract

Home Equity Conversion Mortgages ("HECMs") implicitly bundle nondefaultable credit lines with put options that let borrowers, or their heirs, sell mortgaged homes for the credit line limit when borrowers move or die. The put option's value, net of closing costs, bounds HECM's value to borrowers below. Older homeowners' weak demand is commonly attributed to HECM's "high costs," and the government prices insurance intending to avoid subsidy. However, simulations indicate put value has often exceeded closing costs, even ignoring other embedded options and using backward-looking expectations near the recent price-cycle peak. These results make weak demand more puzzling.

Suggested Citation

  • Thomas Davidoff, 2015. "Can "High Costs" Justify Weak Demand for the Home Equity Conversion Mortgage?," The Review of Financial Studies, Society for Financial Studies, vol. 28(8), pages 2364-2398.
    • Handle: RePEc:oup:rfinst:v:28:y:2015:i:8:p:2364-2398.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhv019
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    Cited by:

    1. John Y. Campbell, 2016. "Restoring Rational Choice: The Challenge of Consumer Financial Regulation," American Economic Review, American Economic Association, vol. 106(5), pages 1-30, May.
    2. Mohammed Ishaq Mohammed & Noralfishah Sulaiman & Dahiru Adamu, 2018. "Dimensionality and Reliability of the Determinants of Reverse Mortgage Use Intention," Traektoriâ Nauki = Path of Science, Altezoro, s.r.o. & Dialog, vol. 4(2), pages 1013-1023, February.
    3. Francisco Gomes & Michael Haliassos & Tarun Ramadorai, 2021. "Household Finance," Journal of Economic Literature, American Economic Association, vol. 59(3), pages 919-1000, September.
    4. Ismael Choinière-Crèvecoeur & Pierre-Carl Michaud, 2023. "Reverse Mortgages and Financial Literacy," CIRANO Working Papers 2023s-06, CIRANO.
    5. Yung-Tsung Lee & Tianxiang Shi, 2022. "Valuation of Reverse Mortgages with Surrender: A Utility Approach," The Journal of Real Estate Finance and Economics, Springer, vol. 65(4), pages 593-621, November.
    6. Shi, Tianxiang & Lee, Yung-Tsung, 2021. "Prepayment risk in reverse mortgages: An intensity-governed surrender model," Insurance: Mathematics and Economics, Elsevier, vol. 98(C), pages 68-82.
    7. Stephanie Moulton & Donald Haurin & Samuel Dodini & Maximilian D. Schmeiser, 2016. "How Home Equity Extraction and Reverse Mortgages Affect the Credit Outcomes of Senior Households," Working Papers wp351, University of Michigan, Michigan Retirement Research Center.
    8. Kuo‐Shing Chen & J. Jimmy Yang, 2020. "Housing Price Dynamics, Mortgage Credit and Reverse Mortgage Demand: Theory and Empirical Evidence," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 48(2), pages 599-632, June.
    9. Hyung-Suk Choi, 2019. "A Numerical Analysis to Study Whether the Early Termination of Reverse Mortgages is Rational," Sustainability, MDPI, vol. 11(23), pages 1-10, December.
    10. Samuel Dodini & Donald R. Haurin & Stephanie Moulton & Maximilian D. Schmeiser, 2015. "How House Price Dynamics and Credit Constraints affect the Equity Extraction of Senior Homeowners," Finance and Economics Discussion Series 2015-70, Board of Governors of the Federal Reserve System (U.S.).
    11. Munnell, Alicia H. & Walters, Abigail N. & Belbase, Anek & Hou, Wenliang, 2020. "Are homeownership patterns stable enough to tap home equity?," The Journal of the Economics of Ageing, Elsevier, vol. 17(C).
    12. Davidoff, Thomas & Gerhard, Patrick & Post, Thomas, 2017. "Reverse mortgages: What homeowners (don’t) know and how it matters," Journal of Economic Behavior & Organization, Elsevier, vol. 133(C), pages 151-171.
    13. Eli Beracha & David H. Downs & Greg MacKinnon, 2017. "The 4% rule: Does real estate make a difference?," Journal of Property Research, Taylor & Francis Journals, vol. 34(3), pages 181-210, July.
    14. Sharma, Tripti & French, Declan & McKillop, Donal, 2022. "The UK equity release market: Views from the regulatory authorities, product providers and advisors," International Review of Financial Analysis, Elsevier, vol. 79(C).
    15. Thomas F. Crossley & Cormac O'Dea & Richard Blundell & Rowena Crawford & Eric French & Gemma Tetlow, 2016. "Comparing Retirement Wealth Trajectories on Both Sides of the Pond," Fiscal Studies, Institute for Fiscal Studies, vol. 37, pages 105-130, March.
    16. Carole Bernard & Adam Kolkiewicz & Junsen Tang, 2023. "Valuation of Reverse Mortgages with Default Risk Models," The Journal of Real Estate Finance and Economics, Springer, vol. 66(4), pages 806-839, May.
    17. Tripti Sharma & Declan French & Donal McKillop, 2022. "Risk and Equity Release Mortgages in the UK," The Journal of Real Estate Finance and Economics, Springer, vol. 64(2), pages 274-297, February.
    18. Jason R. Blevins & Wei Shi & Donald R. Haurin & Stephanie Moulton, 2020. "A Dynamic Discrete Choice Model Of Reverse Mortgage Borrower Behavior," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 61(4), pages 1437-1477, November.
    19. Michaelides, Alexander & Zhang, Yuxin, 2022. "Life-cycle portfolio choice with imperfect predictors," Journal of Banking & Finance, Elsevier, vol. 135(C).
    20. Alejandro del Valle & Tess C. Scharlemann & Stephen H. Shore, 2022. "Household Financial Decision-Making After Natural Disasters: Evidence from Hurricane Harvey," Finance and Economics Discussion Series 2022-015, Board of Governors of the Federal Reserve System (U.S.).
    21. Cocco, Joao F. & Lopes, Paula, 2019. "Aging in place, housing maintenance and reverse mortgages," LSE Research Online Documents on Economics 100835, London School of Economics and Political Science, LSE Library.
    22. Hambel, Christoph & Kraft, Holger & Meyer-Wehmann, André, 2020. "When should retirees tap their home equity?," SAFE Working Paper Series 293, Leibniz Institute for Financial Research SAFE.

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