Overcoming adverse selection in buying an existing home
| Pages | 283-295 |
| Published date | 01 June 2001 |
| DOI | https://doi.org/10.1108/14635780110387628 |
| Date | 01 June 2001 |
| Author | Carl R. Gwin,Seow‐Eng Ong |
| Subject Matter | Property management & built environment |
Academic papers:
Overcoming
adverse selection
283
Journal of Property Investment &
Finance, Vol. 19 No. 3, 2001,
pp. 283-295. #MCB University
Press, 1463-578X
Received February 2000
Revised July 2000
ACADEMIC PAPERS
Overcoming adverse selection
in buying an existing home
Carl R. Gwin
Babson College, Economics Division, Babson Park,
Massachusetts, USA, and
Seow-Eng Ong
National University of Singapore, Department of Real Estate, Singapore
Keywords Property, Buyers, Sellers, Homes
Abstract Existing home sellers may be aware of defects in the home that are not observable to
the untrained eye of a buyer. Sellers may not disclose the defects in order to receive a higher price.
Home warranties for existing homes appear to provide protection against defects. However, it is
not clear how home warranty compares against building inspections and seller disclosure laws. In
an adverse selection model, we study the tools available to buyers to overcome this problem.
Introduction
Home warranty for existing properties is a major business in the USA. Since
1980, millions of homeowners have purchased home warranty coverage to
protect against unforeseen repair bills (HMSnet, 1999). A home warranty
contract, also called a service agreement, pays for the repair or replacement of
an existing home's mechanical systems and major built-in appliances which
may break down due to normal wear and tear (NHWA, 1999).
The systems covered under a home warranty may include central heating
system, air conditioning system, interior plumbing, interior electrical system,
water heater, dishwasher, oven, range and hood, garbage disposal and electric
garage door opener. Home warranties typically do not cover pre-existing
conditions, remedy building code violations, repair foundations, roofs or
structural defects or cover damage to a home or its contents. The annual cost
ranges from US$100 to $450.
Similar protection exists in the UK as well, typically in the form of specific
insurance contracts. For instance, insurance can be taken to cover the electrical
system of a home and another insurance for the plumbing. Home warranties,
however, are becoming more widely accepted. Since 1998, ERA United
Kingdom has started offering the Buyer Warranty Plan
1
(ERA, 1998) that
guarantees that all mechanical devices work at least until one year after the
house is sold. Interestingly, the National Housing Building Council (UK), in
conjunction with National Association of Home Builders (USA), the Housing
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The authors wish to thank the participants at the 6th European Real Estate Society Conference,
Athens, Greece, for their invaluable comments. Two anonymous referees made useful
suggestions. They also wish to thank Patricia Lim for her research assistance. Any errors are
the sole responsibility of the authors.
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