Profile: Mr. and Ms. Martin are above 65 years of age. They are both retired. They estimate that
their house would be appraised at $550,000. They have total savings of $250,000 in financial
investments.
Monthly social security: $4,000
Monthly Investment income: $1,000
Average monthly Property
Maintenance: $600
Average Monthly Living expenses:
$3,500
Average Monthly Savings: -$100
Monthly Home Insurance: $400
Monthly Property Taxes: $600
Mr. and Mrs. Martin received a brochure offering Reverse Mortgage and decided the contact the
lender. They hoped that the payments from the Reserve Mortgage would ensure a more secure
financial future.
They were given an estimate of $8,500 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 for only 52% of the appraised value, around $280,000 and if
approved, would receive, about $1,100 a month.
Decision: Mr. and Mrs. Martin decided to apply for the reverse mortgage, but was turned down
by the underwriter for negative monthly savings.
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?