Behavioral models on reverse mortgages: Understanding reverse mortgages (low) demand

  • Sergio Alessandro Castagnetti Sergio Alessandro Castagnetti

This thesis has been awarded the Netspar Master Thesis Award 2015.

When studying the implications of population ageing on the sustainability of pension systems worldwide, it is apparent that pension systems are to be severely reformed. In fact, in lack of structural reforms, the expenditures burden that ageing will bring forth will cause the whole pension systems to be at risk of a collapse. Nevertheless, even though, from a theoretical perspective, pension reforms should be welcomed and embraced, implementing them is far from easy. This results from the fact that pension reforms involve actions that reduce the wellbeing of people in the short-run, such as increasing the retirement age or reducing the pension benefits of the retirees. As a result, politicians usually do not have the public support to pursue them. Moreover, this result is worsened by the fact that politics intrinsically implies a preference for short-term goals over long-term ones, a sort of myopia that is difficult to overcome. As a consequence, it would not be a surprise that the implementation of pension reforms will be partial or reforms will be continuously postponed, leading to detrimental consequences for intergenerational equity and a never-ending sense of urgency in the pension systems, due to budgetary deficits. There are, however, several developed countries that have already begun the reforming process of the pension systems. Even though the promptness of tackling the negative consequences of an ageing population will increase equity in the system by reducing intergenerational transfers, this will lead to a significant reduction of future pension benefits.
In this bleak picture, financial instruments that can expand the consumption possibilities of the retirees are of vital importance, as they can (partially) offset a fall in future pension benefits. Among such instruments, one that has come to existence in the recent past and that can prove to be extremely useful is the Reverse Mortgage. Reverse Mortgages are a financial instrument that gives elderly homeowners the possibility to borrow against their housing equity. Moreover, the loan repayment is due only when the borrower dies, moves out or sells the house. In other words, the Reverse Mortgage allows the borrowers to consume part of their housing equity while giving them the right to benefit from living in their house until they pass away (or decide to move out or sell the house). In this sense, Reverse Mortgages provide a means through which the elderly can improve their consumption possibilities at virtually no downsides.
More generally, we will see that Reverse Mortgages, if available in the market, can be welfare improving and Decision Makers should consider the possibility of buying this product. Furthermore, by taking into consideration the fact that pension systems are affected by inertia and that future developments might fall short in providing the elderly an appropriate pension benefit, Reverse Mortgages will be even more valuable to the retirees. In particular, to those whose pension benefits fail in providing an adequate level of income. Under this perspective, Reverse Mortgages can be seen as a second source of pension benefits that derives directly from house equity.

Netspar, Network for Studies on Pensions, Aging and Retirement, is een denktank en kennisnetwerk, gewijd aan het bevorderen van een beter begrip van de economische en sociale gevolgen van pensioenen, vergrijzing en ‘de oude dag’ in Nederland en Europa.

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