REVERSE MORTGAGES AND BORROWER MAINTENANCE RISK

This paper develops a theoretical model of the problem of maintenance risk in reverse mortgages (RMs) and home equity conversion instruments generally, By maintenance risk, we refer to the incentive homeowners will have to reduce maintenance expenditures as their equity in the ho use falls during the term of the RM. The underlying reason for this te ndency is the limited liability feature of RMs, given that a borrower' s obligation to the lender at maturity is limited to the value of the house. The results of the model show that lenders will respond to this problem either by limiting the amount of RM loans to guarantee that m aintenance risk is not a threat, or by charging an interest rate premi um to cover the expected cost of default. Unfortunately, there do not exist data to test the importance of maintenance risk as a possible li mitation on the extent of the RM market.