Moral Hazard in Home Equity Conversion

Home equity conversion as presently constituted or proposed usually does not deal well with the problem of moral hazard. Once homeowners know that the risk of poor market performance of their homes is borne by investors, they have an incentive to neglect to take steps to maintain the homes values. They may thus create serious future losses for the investors. A calibrated model for assessing this moral‐hazard risk is presented that is suitable for a number of home equity conversion forms: (1) reverse mortgages, (2) home equity insurance, (3) shared‐appreciation mortgages, (4) housing partnerships, (5) shared‐equity mortgages and (6) sale of remainder interest. Modifications of these forms involving real estate price indexes are proposed that might deal better with the problem of moral hazard.