Utility-based evaluation in retirement: a focus on reverse mortgage

Elderly’s financial status is affected by the stochasticity of lifespan and state of health. The growth of life expectancy in industrialized countries, the inadequacy of pension systems and the high medical costs, shed light on the need to provide adequate solutions for retirees, whose wealth is mostly illiquid and composed by real estate. In this framework, home equity release products may constitute a valid support. Among all, the reverse mortgage (RM) contract allows elder homeowners to borrow money using their home as security for the loan maintaining the right to live in the house. The debt is repaid by the heirs when the borrower moves out or dies. The non- negative equity guarantee ensures that the exceed of the proceeds of the sale of the property is intended for heirs. This product has been widely analyzed, in order to understand the reasons behind the lack of its development in the European market. Uncertainty faced by the lenders is due to house price risk and longevity risk. On the other hand, borrowers cope with trust issues, product complexity and, above all, emotional attachment to the property. In this work, we focus on elders’ point of view, establishing borrowers’ lifetime utility function in order to find optimal choices between contracting or not a RM. In presence of long-term care expenses and house mainteinance costs, reverse mortgage provides an important aid to relieve elder’s pressure on consumptions. In particular, elders receive higher utility gains when contracting a reverse mortgage. Our results are in line with the existing literature and may provide an alternative tool to explain elderly skepticism in buying this kind of product.