MORAL HAZARD IN HOME EQUITY CONVERSION: Selling of Home

Consider a home that is currently actually worth $200,000 and the value as measured by the index is also $200,000. The homeowners have already relocated to another city due to a job change and must cover all carrying costs themselves. Suppose the carrying costs of the home are $2000 a month. Suppose the homeowners are offered $190,000 for the home. They would figure that with a 50% equity interest in the home, this lowball bid would cost only $5000. They would compare this loss against the possibility of having to wait two and a half months to get a bid of $200,000. They might take the lowball $190,000 bid and thereby cost the investor $5000. If the contract had been settled on the indexed value of $200,000, the investor would not be subject to this loss.

There are other agency problems in selling home as well that might cause the outcome to be bad with some of these risk-sharing contracts. There is an incentive with the risk-sharing contracts for the homeowners to sell the property themselves. Moreover, there is an incentive for the homeowners to negotiate a lower fee with the real estate broker, on the understanding that the homeowners will accept an earlier offer than they otherwise would.

There are many studies that bear on the question whether impatience to sell does in fact have a substantial impact on selling price. Many studies have studied the effect of time on the market on selling price, see for example, Asabere and Huffman (1993) and Haurin (1988), and Zuehlke (1987). But these studies are not very meaningful since a longer time on the market could equally well signal that the homeowners were patient to sell (implying a higher price) or that the home was worth less than expected (implying a lower price). Springer (1996) ran hedonic regressions of log housing price on a number of characteristics variables with also variables reflecting the seller’s eagerness to sell or the seller’s reporting being relocated. Eagerness and relocation were found each to have about a 2% reduction in selling value. In fact his measures of these variables were likely to be poor, and so the effects of urgency to sell are probably larger than this.