Exploring Reverse Mortgage for Italian population: a life-cycle model approach

Elderly’s financial status is affected by stochastic lifespan and states 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 mainly composed by own home. The reverse mortgage (RM) contract allows elder homeowners to borrow money using their home as asset for the loan, maintaining the right to live in the house. The debt is repaid by the heirs when the borrower dies. This contract might constitute a valid support for the spending needs that may arise during retirement. The paper deals with a decision problem of a homeowner who is approaching old age and has to evaluate contracting a reverse mortgage or not. In order to investigate the economic effects of RM on elderly’s consumption behavior, we construct a life cycle model tailored to ”house rich and cash poor” individuals, whose primary wealth asset is constituted by real estate and who has to deal with the uncertainty about lifespan, future health states and the consequent considerable expenses for medical treatments, as well as house maintenance costs. Elders’ lifetime utility functions take into account consumption preferences, lifespan uncertainty and bequest motivations, in order to capture the impact of the attachment to the property on elder’s financial planning. We solve the optimization problem to find the optimal savings allocation, with and without RM. We present three exemplary cases related to different occurrences of health status, focusing on Italian retired males. Through our analysis, we found out that, in presence of long-term care expenses and house maintenance costs, individual’s liquid wealth significantly increases with reverse mortgage. Moreover, homeowner with a higher bequest motivation experiences lower utility gains from contracting RM plan.