Ms. Jones is not financially shrewd

    Profile: Ms. Jones 63 years old and currently working. She estimates that her house would be appraised at $250,000. Ms. Jones has total savings of $30,000 in her savings account. Monthly take home salary: $3,750 Average monthly Property Maintenance: $400 Average Monthly Living expenses: $2,800 Average Monthly Savings: $300 Monthly Home Insurance: $100 Monthly Property Taxes: $250 Ms. Jones is not financially shrewd. Hearing TV ads on Reverse Mortgage, Ms. Jones decide to apply for a reverse mortgage at the local bank. Her objective was to grow her savings before retirement, using the cash from the reverse mortgage payments. Ms. Jones was given an estimate of total fees of $7,000 for a formal appraisal, title search, insurance, underwriting, and other compliance-related expenses. She was advised that the bank would consider a reverse mortgage for only 52% of the appraised value, around $130,000 and Ms. Jones would receive if approved, about $600 a month. Decision: Ms. Jones decided not to make the application for the reverse mortgage. She felt that the initial fees were too high and would eat away at her current 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?