Reverse Mortgage is a loan against security of home (a self occupied house) that gives cash advances to a homeowner, requires no repayment until a future time, and is capped by the value of the home when the loan is repaid. The loan is extended by mortgaging the property and the loan amount is worked out using reverse annuity table based on valuation of the property. Therefore it is called “Reverse Mortgage”.
Conceptually, a ‘reverse mortgage’ is a special type of loan that can be used by the senior citizens to convert the equity in their homes into cash. The money from reverse mortgage can provide senior citizens with the financial security they need to meet their different requirements and lead a decent life.
It is a concept originated in USA & Europe. There are four ways to receive a payment:
• A lump-sum payment,
• A monthly payment,
• A line of credit or
• Some combination of these three.
In most instances, there is no restriction on how the cash is used and it's not subject to income tax.
It’s different from traditional mortgage loans where the loan is paid back in instalments or on lump sum basis. While in case of RM, the repayment of loan is done only when
• Owner dies, or
• Owner sells home or
• Owner no longer use it as its primary residence
whichever comes first. The recovery of loan is done either by selling the property, or the person or its heirs pay back the loan amount.
The amount payable to a person depends on the following factors:
• Age
• The level of interest rates,
• The valuation of house assessed by the lender
• Borrowing limits that are set by lenders.
In case the realized value by sale of property is more than the amount of loan received by the person, the excess amount is given back to either the person if he/she is alive or its legal heirs.
Pros & Cons
On one side, it guarantees a source of money for as long as you need it, even if you live beyond your life expectancy. But you pay for that guarantee however, through interest, higher-than-usual closing costs, and servicing fees and in many cases insurance premiums that protect the lender from the possibility that the loan payments will exceed the value of your home.
All interest on your loan balance is tax-deductible, but you or your estate may only take that deduction when the loan is paid back.
Further in an Indian context, elderly people are emotionally attached to their house with their various memories associated with it. They’ll opt for a reverse mortgage scheme if leaving an inheritance behind is not important; or their adult children wish to see them live in greater comfort today. Since they spend part or all of their home equity before they die, a reverse mortgage reduces what they are able to leave for their heirs.
The Indian Scenario
The budgetary constraints in meeting the Old Age Social and Income Security (OASIS) needs and increasing expectations on quality of life amongst the elderly people have fuelled a massive demand for financial products specially developed for them.
Presently, the senior segment of the population is normally not eligible for availing financial assistance from any Bank/FI as per conventional loan schemes due to lower income/cash flow. Although a lot has been discussed about the Reverse Mortgage Loan Scheme during the last few months in the country, the concept has received impetus following the Budget pronouncement made by Hon. Finance Minister in this regard.
National Housing Bank, a subsidiary of Reserve Bank of India, introduced the concept of Reverse Mortgage in India. In context of Indian market, following points are noteworthy:
1. Lesser availability of old age social security schemes in the country.
2. Lesser urban population.
3. Largely elders are living with their family & hence less scope for RM.
4. Possibility of relatively higher rate of appreciation making RM attractive for lender.
5. Under valuation of real estate properties can cause lesser loan amount receivable.
The following issues regarding the RM loans are there in India which needs to be addressed:
Legal, Regulatory, Taxation and Transaction Cost Related Issues
The specific product features and required supply-side alliances to offer RM loans have to be designed with a thorough understanding of the following:
• Entry restrictions under banking and insurance laws
• Capital adequacy, reporting and provisioning by lenders as required by banking/ insurance regulation.
• Legal protection for the RM lender against claims from other secured creditors and under insolvency laws.
• Tax treatment of interest and capital gains in the hands of borrower and lender.
• Protection to the lender to ensure ‘arm’s length’ pricing at the time of disposal of property.
• Location specific real estate related laws and transaction costs, including title search, property valuation, stamp duties etc.\
• Counselling services to potential borrowers, by independent agencies to protect adverse publicity from legal suits.
• Absence of secondary markets, mortgage backed securitization or insurance for RM loans
Potential Market Segments
The potential market is those home owners
• Who are more than 60 years old, and
• Current levels of income are insufficient to afford their desired standard of living.
Within this segment people with the following characteristics are our target audience:
• Long Tenure at current home
• Lack of other supports
• No significant bequeath motive
• Independence & quality of life.
Conclusions and Suggestions
1. Reverse mortgage offers an attractive option to the elderly to finance their consumption needs on their own, without the necessity of moving out or worrying about indebtedness or repayment.
2. RM, if widely available, might in fact encourage more people in the working population to increase the proportion of their savings invested in housing.
3. This segment is likely to attract increasingly favourable public policy attention, given the projected importance of this segment in the electoral politics of all democratic countries.
4. The actual size of the RM markets is nowhere near its estimated potential, for a variety of reasons.
5. Any interested RM lender in the Indian market must proceed with caution.
6. Psychological issues like emotional attachment with property may be a barrier.
-- Nikhil Vatrana
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