MORAL HAZARD IN HOME EQUITY CONVERSION: Introduction

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Many of the forms of home equity conversion, both those forms that have already been implemented in some places and those that are just in the proposal stage, may result in some serious future losses for the investors. Participating homeowners may fail to take steps to maintain the value of their homes once they know that others are bearing some of the risk of poor home resale value. The risk of such future problems with home equity conversion might be reduced if the contracts are redesigned so that the settlements in the contracts are determined by real estate price indices, rather than in terms of the sale price of the home itself.

We will refer to the failure on the part of the homeowner to take steps to maintain the value of the property when it is sold as “moral hazard/’ in keeping with conventional use of that term, although in fact the word “moral” may be misplaced. Homeowners are presumed to be acting in their own self interest generally within the limits set by the law, though probably not quite the way that investors in home equity conversion forms would like. Here

We use the term home equity conversion to refer to the objective of a number of plans that enable homeowners to convert their illiquid and risky investments in their own homes to other uses, and/or reduce their exposure to real estate risk. We will consider a number of home equity conversion institutions that can achieve risk reduction for homeowners, some of which have actually been implemented (though not on a large scale): 1) reverse mortgages, 2) home equity insurance, 3) shared appreciation mortgages, 4) housing market partnerships, 5) sale of remainder interest, and 6) shared equity mortgages.