MORAL HAZARD IN HOME EQUITY CONVERSION: Selling of Home 2

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Genesove and Mayer (1997) found that Boston condominiums with 100% loan to value ratio sold at prices 4% higher, after controlling for characteristics, than condominiums with 80% loan to value ratio, and stayed on the market 15% longer. Since homeowners with higher loan to value ratio have more incentive to get a good price, this appears to be evidence of the effect of incentives on selling behavior. Glower, Haurin and Hendershott (1997) find that people who say that their job has changed, thereby suggesting an urgency to sell, tend to sell for 11% less than do others.

New kinds of real estate brokerage arrangements are currently being developed: in addition to the traditional broker as representative of the home sellers, there are also buyers’ brokers and dual brokers. Law governing real estate brokers is being changed. We can never be sure that new seller-broker contract forms will be developed that may enable sellers to accept lower offers on their homes. For example, a new arrangement in which the buyers pay the broker’s fee, rather than the sellers, could cause the selling price to go down by the amount of the broker’s fee. Sellers involved in risk-sharing contracts may have an incentive to make such new arrangements. Arrangements can be made that make payments to brokers difficult to untangle.

Under-the-Table Transactions

With existing home equity conversion contract forms, the homeowners have a powerful incentive to hide some of the value of the home. There are very many ways that this can be done. The simplest thing to do is just to sell the home to friends or relatives at a below-market price. There could be an secret buydown from the buyers or a party connected with the buyers. Another way is to remove some advantage that the home has before selling it, such as replacing unique antique chandeliers with common reproductions.

Contract provisions requiring an appraisal of the property can prevent some of the most egregious examples of this. Still, there are potential problems, since appraisal is not an entirely objective science.

Homeowners can sell separately items that they might otherwise have included for sale, and they can refuse concessions such as homeowner warranties, redecorating allowances, or points or buydowns, or seller-offered financing, which would otherwise have boosted the price. There are very many different things that the seller can do to affect the selling price of the home, and all of these things would have to be addressed in a contract, lest they become serious costs for the investors who bear real estate risk.

Dealing with all of these problems creates costs for providers of home equity conversion.