MORAL HAZARD IN HOME EQUITY CONVERSION: Introduction 4

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Shared Equity Mortgages (SEMs) are similar in effect to the housing partnerships. SEMs are occasionally arranged among family members and sometimes with outside investors. With SEMs, there are three parties to the mortgage contract, the homeowner, an investor, and a mortgage lender. In effect, both the homeowner and the investor buy shares in the home. In some cases the investor and mortgage lender may be the same.

Sale of remainder interest is a pure sale of the home (or portion thereof) to investors who will acquire the (share of the) home after the owner dies or moves out of the home, until which time the owner has a contract allowing him or her to occupy the home. With the Lifetime Security Plan in California, see Goren et al. (1996), sale of remainder is marketed to elderly homeowners who are in need of income. In this sale of remainder interest contract, the homeowner agrees to turn over basic maintenance of the home to the plan sponsors, thus reducing the moral hazard problem.

Reverse mortgages and sale of remainder interest are contracts with special interest to elderly people, who have equity in their home but perhaps little spendable income. In contrast, the other forms of home equity insurance are likely to be of interest to young to middle age homeowners, who wish to hedge some of the risk attendant on buying a home. Here

For all of the above contracts, the homeowners may not always perceive the advantages of the contracts in terms of risk reduction. Those who choose reverse mortgages may, for example, perceive these as merely a way to get liquidity from their homes. Those who choose shared appreciation mortgages may say that they do this just to get a lower mortgage rate. But these consequences in fact are related to the risk reduction that the contract entails, since the risk reduction is related to the costs and benefits of the contract to both the borrower and the lender, and thus also affects the terms the borrower and lender will agree upon. For example, the very fact that reverse mortgages offer a fixed income for life to elderly homeowners is proof that some risk management is an essential part of the contract.