Reverse Mortgage Loan Scheme : Pros & Cons & Requirements

Reverse Mortgage Meaning, Loan Scheme Example with Loan Calculator in India

The life expectancy in India has been rising steadily in the last few decades. However, so have the costs of medical treatment. For senior citizens, who have a lack of regular income or financial support from children, this could lead to a financial crisis. Whenever one speaks or thinks about post-retirement life, the typical problems that come to our mind are proper financial support and lack of regular income for taking care of healthcare, cost of living and other amenities. Most of the senior citizens have a property in their names; however, the same cannot be converted into instant and regular income stream due to its inherent illiquid nature. Further, gone are the days when the elderly lived with their sons and daughters, depending on them for their amenities and medical needs. The reverse mortgage, introduced by the Union Government in 2007, is an answer to such issues faced by senior citizens, giving them a life of dignity.

Let’s assume Mr A, a central government retiree, has been living with his wife in an independent home for the last 35 years. His two sons, both settled in New York, have no intention of moving base to India. Husband and wife, well past in their sixties do not wish to live with their sons in a foreign country. Mr A, a heart patient and his wife a diabetic, have a heft monthly medical expenditure. Not satisfied with his pension, and not wanting to depend on his sons, for household expenditure as well as medical care, he approached his bank for a solution. The bank advised him to opt for Reverse Mortgage, to ease his monthly expenses.

In simple terms, a reverse mortgage is the "opposite" of a conventional home loan. A reverse mortgage enables a senior citizen to receive a regular stream of income from a lender (a bank or a financial institution) against the mortgage of his home. The borrower (i.e. the individual pledging the property), continues to reside in the property till the end of his life and receives a periodic payment on it.

How does a reverse mortgage work?

When the home is pledged, its monetary value is computed by the bank, on the basis of the demand for the property, current property prices, and the condition of the house. The bank then gives out a loan amount to the borrower in the form of periodic payments, after considering a margin for interest costs and price fluctuations. The periodic payments also known as reverse EMI are received by the borrower over the fixed loan tenure. With each payment, whether monthly or quarterly, the equity or the individual's interest in the house decreases.

A reverse mortgage is an ideal option for senior citizens who require regular income, or if the property is of illiquid nature for some reason.

General guidelines for a reverse mortgage

The Reserve Bank of India has formulated the following guidelines for a reverse mortgage.

• The maximum loan amount would be up to 60% of the value of the residential property.
• The maximum tenure of the mortgage is 15 years and the minimum is 10 years. Some banks are now also offering a maximum tenure of 20 years.
• The option of monthly, quarterly, annual or lump sum loan payment.
• Property revaluation to be undertaken by the lender once every 5 years.
• If at such time, the valuation has increased, borrowers have the option of increasing the quantum of the loan. In such a case, they are given the incremental amount in lump-sum.

Amount received through reverse mortgage is a loan and not income. Hence it will not attract any tax. However, a borrower is liable to capital gains tax, at the point of alienation of the mortgaged property by the mortgagee for the purposes of recovering the loan.

Reverse mortgage interest rates could be either fixed or floating. The rate would be determined by the prevailing market interest rates.

Eligibility Criteria for a reverse mortgage

House owners have to be above the age of 60 years. If a spouse is a co-applicant, then she should be above 58 years.

Owners of a self-acquired, self-occupied residential house or flat, located in India. The titles should be clear, indicating the prospective borrower's ownership of the property.

The applicant’s property should be free from any encumbrances.

The life of the property should be of a minimum of 20 years.

Property should be the permanent primary residence of the individuals.

Settlement of a reverse mortgage

A reverse mortgage loan becomes due when the last surviving borrower dies, or if the borrower chooses to sell the house. The bank first gives an option to the next of kin to settle the loan along with accumulated interest, without a sale of the property. If the next of kin are unable to settle the loan, the bank then opts to recover the same from the sale proceeds of the property.

Any extra amount, after the settlement of the loan with accrued interest and expenses, through the sale of the property, will be passed on to the legal heirs. If the sale proceeds are lower than the accrued principal plus interest amount, the loss is borne by the bank. This loss could happen in cases where the banks' original estimation is not in line with the real estate market movement.

Pros

Boosts cash:

Many seniors experience significant income reduction when they retire. Monthly mortgage payments are the biggest expense for many. A senior with sufficient home equity, however, can refinance, pay off an existing regular mortgage, and even pull cash from the property with a reverse mortgage.

The applicant doesn’t have to move:

According to AARP, “between 50 and 60 per cent of adults age 18-49 say they want to remain in their communities and homes as they age, while nearly 80 per cent of adults age 50 and older indicate this same desire.” Rather than move, a reverse mortgage may allow seniors to age in place and be near friends and family. Also, because there are costs associated with selling, moving and resettling, the result is less equity because of the expenses involved.

Costs may be lower:

There is a cost to reverse mortgages, but it may be cheaper to get a reverse mortgage than to move. You can get a good sense of reverse mortgage expenses by using the National Reverse Mortgage Lenders Association calculator. Alternatively, to move means expenses to sell the home, move household goods and either buy a replacement residence or rent in a new location.

The money from a reverse mortgage is not taxable:

Reverse mortgage payments are considered loan proceeds and not income. The lender pays you, the borrower, loan proceeds (in a lump sum, a monthly advance, a line of credit, or a combination of all three) while you continue to live in your home. Reverse mortgage interest isn’t deductible until you actually pay it (usually when you pay off the loan in full).

No claim against heirs:

Because a reverse mortgage balance will grow in size, it’s possible that reverse mortgage debt can exceed the fair market value of the property over time. However, the responsibility to repay the debt can never exceed the property’s value. That’s because a reverse mortgage is an example of “non-recourse” financing. The result is that lenders have no claims against other assets or heirs.

Continue to own the home:

Reverse mortgages can be paid off by borrowers but typically end when individuals move, sell or pass away. In an estate situation, heirs have several choices: First, they can sell the property to repay the debt and keep any equity above the loan balance. Second, they can keep the home and refinance the reverse mortgage balance if the property’s value is sufficient. Third, if the debt exceeds the value of the property, heirs can settle the loan by giving the title back to the lender. The lender can then file a claim for any unpaid balance with the insurer, almost always the FHA.

Cons

Reverse financing is not free:

Reverse mortgages have costs that include lender fees, FHA insurance charges and closing costs. These costs can be added to the loan balance; however, that means the borrower has more debt and less equity. The NRMLA calculator illustrates the costs reverse mortgage borrowers can face.

Interest rates:

HECMs are structured so that both adjustable-rate and fixed-rate financing options are available. If you want fixed-rate financing, the amount of equity you can access will be smaller than a reverse mortgage with adjustable-rate interest. The NRMLA calculator shows both fixed-rate and adjustable-rate options.

Program violations:

A reverse mortgage may cause borrowers to violate asset restrictions for the Medicaid and Supplemental Security Income (SSI) programs. This is complicated stuff, so be sure to speak with an attorney who specializes in elder law or a legal clinic before searching for a reverse mortgage program. If fees are a concern, see if pro-bono legal help is available in your community.

Homes can be foreclosed:

Since reverse mortgages do not have required monthly payments for principal and interest, it might seem as though foreclosure is impossible. Not so. Seniors can have their homes foreclosed if they do not pay property taxes, maintain property insurance, fail to pay HOA bills, etc.

The popularity of the scheme in India

Though introduced in 2007, Reverse Mortgage has not gained much popularity in India for the following reasons.

Inadequate marketing of the product. Recent reports indicate that many of the senior citizens are not aware of the existence of such a product. 

Indians consider owned property as a family asset to be inherited by future generations. Although reverse mortgages have existed since 2007, factors like the cap on the maximum loan amount and ineffective marketing have led to people being wary about reverse mortgages. The loan amount is capped at Rs 50 lakh to Rs 1 cr which is not very lucrative if the borrower lives in one of the metros where property prices range from over Rs 1 cr to Rs 3 cr. 

Reverse Mortgage is a relatively new concept in India. It would take some time for a change in mind set of individuals to accept it. As a financial tool, Reverse Mortgage is ideal to augment a senior citizen's income in his years ahead. Despite all its shortcomings in India, it could make good the shortfall in one's pension or income to live a quality life ahead.

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