stments. Mr. George is healthy, but Mrs. George suffers from chronic health problems
Monthly social security: $5,000
Monthly Investment income: $5,000
Average monthly Property
Maintenance: $700
Average Monthly Living expenses:
$5,000
Average Monthly Savings: $2,600
Monthly Home Insurance: $700
Monthly Property Taxes: $1,000
Mr. and Mrs. George consulted a financial advisor regarding Reverse Mortgages. They explained
that although they are comfortable with their financial situation in retirement, they wished to
travel and enjoy some of their favorite activities more fully. They hoped that the payments from
the Reserve Mortgage would give them the extra cash to enjoy their retirement.
They were given an estimate of $10,000 in fees for a formal appraisal, title search, title
insurance, underwriting, and other compliance-related expenses. They were advised that the bank
would consider a reverse mortgage of only 52% of the appraised value, around $420,000 and if
approved, would receive, about $1,800 a month.
Decision: Mr. and Mrs. George decided to apply for the reverse mortgage and received approval
for a tenure loan of $1,800. They did not inform the lender of Mrs. George’s health problems.
Later, a combination of large medical expenses and a recession that depressed home prices
placed severe stress on their financial status. They stayed on track with home insurance and
taxes but failed to maintain their property adequately. The lenders delayed foreclose on the
Georges for fear of reputational risk. Eventually, the Martins lost their home and moved in with
their family.
1. How does adverse selection and/or moral hazard impact borrowers’ decisions to stick by the
terms of the loan when the reverse loan balance exceeds the market value of the house (due
to sharp declines in housing prices)?
2. Explore the moral hazard resulting from potential hesitancy of lenders to foreclose because
of reputational risk.
3. Explore the consequences of asymmetric information that the lender has regarding the
longevity of the borrower.
4. Explore the consequences of adverse selection and/or moral hazard on the borrower resulting
from high initial expenses.
5. Explore the nature of adverse selection and/or moral hazard resulting from tenure loan,
versus cash out?
6. How do the requirements of reverse mortgages mitigate adverse selection and moral hazard
risks for the lender?