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When should retirees tap their home equity?

Christoph Hambel, Holger Kraft and André Meyer-Wehmann

No 293, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

Abstract: This paper studies a household's optimal demand for a reverse mortgage. These contracts allow homeowners to tap their home equity to finance consumption needs. In stylized frameworks, we show that the decision to enter a reverse mortgage is mainly driven by the differential between the aggregate appreciation of the house price and principal limiting factor on the one hand and the funding costs of a household on the other hand. We also study a rich life-cycle model that can explain the low demand for reverse mortgages as observed in US data. In this model, we analyze the optimal response of a household that is confronted with a health shock or financial disaster. If an agent suffers from an unexpected health shock, she reduces the risky portfolio share and is more likely to enter a reverse mortgage. On the other hand, if there is a large drop in the stock market, she keeps the risky portfolio share almost constant by buying additional shares of stock. Besides, the probability to take out a reverse mortgage is hardly affected.

Keywords: reverse mortgage; consumption-portfolio decisions; optimal stopping; biometric risks; financial disasters (search for similar items in EconPapers)
JEL-codes: D14 E21 G11 G21 J14 R21 (search for similar items in EconPapers)
Date: 2020
New Economics Papers: this item is included in nep-dge, nep-mac and nep-ure
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:safewp:293

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