Can "High Costs" Justify Weak Demand for the Home Equity Conversion Mortgage?

Thomas Davidoff ()

The Review of Financial Studies, 2015, vol. 28, issue 8, 2364-2398

Abstract: Home Equity Conversion Mortgages ("HECMs") implicitly bundle nondefaultable credit lines with put options that let borrowers, or their heirs, sell mortgaged homes for the credit line limit when borrowers move or die. The put option's value, net of closing costs, bounds HECM's value to borrowers below. Older homeowners' weak demand is commonly attributed to HECM's "high costs," and the government prices insurance intending to avoid subsidy. However, simulations indicate put value has often exceeded closing costs, even ignoring other embedded options and using backward-looking expectations near the recent price-cycle peak. These results make weak demand more puzzling.

Date: 2015
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