Once a person has crossed his (her) earning years, but has not planned for the retirement years, or financial planning has gone awry due to heavy unforeseen expenses/losses, or inflation has taken away the purchasing power of savings etc., what does he (she) do to live the remaining years on this planet without seeking handouts from near and dear ones? Even if one bites the bullet and seeks financial assistance from his own children, whether they will respond positively is a moot point in this age of nuclear families.
If you had the good sense to invest in a residential property instead of say making fixed deposits in a bank, there is a retail banking product called Reverse Mortgage (RM) which can provide you financial security in your twilight years. The idea is not new. Even though this product has not taken off here in India, despite the pioneering work done by National Housing Bank (NHB), it does not take away the merits of this product. Banks have not been very aggressive in marketing this product and many people are not even aware of RM. Actually, this product has more relevance to India where there is no social security net. Surprisingly, this product originated in developed countries and in USA, for example, there are dedicated reverse mortgage companies.
RM is also a loan against property. But it is not the same as a loan against property. The basic difference between the two is summarized below.
- Loan against property is normally not extended by banks to senior citizens. But RM is specifically targeted at senior citizens. Only senior citizens are eligible for RM.
- Loan against property by way of housing loan is extended to acquire a property. But RM is extended against a property which is already owned.
- Loan against property needs to be repaid in EMI over agreed tenure. But in RM, the proceeds of the loan are paid to the customer in installments or lump sum as agreed. There is no EMI.
- RM is cleared out of foreclosure or repayment. There is no EMI. Loan against property is to be cleared in EMI, and foreclosure is the last resort when loan is not repaid.
The Concept
In a traditional house mortgage transaction, there is an EMI fixed and payment of your EMI increases your equity in the property. Reverse mortgage, as the name suggests, does the opposite. You start with say 100% equity in the property and when loan disbursal starts, your equity in the property goes on decreasing. The target group for RM are the senior citizens owning house property either singly or jointly without any encumbrance on it. Abroad, one can take a RM loan on an encumbered property also, provided it can be paid off from part proceeds of the RM and sufficient equity is available. The collateral is the property itself. In other words, when processing an application for such type of facility, the market value of the property is taken into account rather than the repayment capacity of the borrower. The loan generally does not have to be repaid until the last surviving homeowner permanently moves out of the property or passes away. But banks generally fix a long tenure. The estate (i.e., heirs to the property) has approximately 2 months to repay the balance of the reverse mortgage or sell the home to pay off the balance. Any remaining equity is inherited by the estate. The estate is not personally liable if the home sells for less than the balance of the reverse mortgage. That is why when arriving at the quantum of the reverse mortgage loan, sufficient cushioning by way of margin is stipulated. The age of the homeowner at the time of making the RM loan available and remaining life expectancy is another aspect which needs to be looked in to. A 70 year old applicant is eligible for a, higher quantum of loan on a property with same market value compared to say a 60 year old applicant. The property offered as collateral needs to be evaluated by a qualified engineer approved by the bank not only for assessing the current condition but also the residual life. The property taxes, insurance are to be serviced by the home owners along with general maintenance.
The Product
Let us now look at the RM product offered by some of the leading Indian Banks. The guidelines to Indian banks on RM have been framed by NHB, an entity which came into being through an act of parliament. It’s capital is 100% contributed by RBI. Some of the guidelines are mandatory and need to be followed by lending institutions like commercial banks and housing finance companies registered with NHB.
- Eligible borrowers should be senior citizens, that is 60+ years old. The property offered should be a self-acquired, self-occupied residential property free of any type of encumbrances with clear title, and all taxes paid till date. In the event of financing a couple, one should be a senior citizen and the other should be at least 55 years of age. The residual life of the property, as certified by lender’s valuer, should be minimum 20 years.
- The quantum of loan shall depend on the value of property, age of the borrower, residual life of the property, rate of interest, requirement of a margin of not less than 10% throughout the life of the loan, and maximum tenure of 20 years. Property needs to be revalued once in 5 years and it is to be ensured that such revaluation does not bring down minimum margin of 10%. If the property value falls during the tenure, then the quantum of RM will need to be reduced.
- RM can be disbursed in agreed installments, in lump sum or tranches or through committed line of credit (LOC). The installment is currently capped at ₹50,000 per month. Lump sum payments are restricted to medical exigencies and capped at 50% of amount eligible with maximum quantum being pegged at ₹15 lakhs.
- Interest rate on loans may be floating or fixed and no ceiling has been prescribed. In other words the interest rate shall be market determined.
- The disbursements under RM shall not attract any income tax. Basically, RM disbursement is loan disbursement and not an income.
Advantages and disadvantages of RM
Advantages It provides a stream of payments and provides financial security when a senior citizen has no other source of income or source of income is inadequate. The disbursals are tax free. There is no repayment involved as property is sold and loan is adjusted. One can receive disbursements as per his convenience. Instead of taking RM loan if one sells the house, then he needs to pay capital gains tax and also move out of the house. If sale proceeds are invested, then the income from investments may be subject to income tax. The borrower/legal heir shall not be held liable to lender if sale proceeds are less than the amount owed under RM.
Disadvantages Interest on RM is not subject to any tax rebate. The disbursement proceeds need to be used for specified purposes only. If one outlives the tenure of RM, one is at the mercy of lender. If the borrower passes away, the property will be sold by lender, unless legal heirs arrange to repay the loan. Mortgaged properties, when sold by banks, do not fetch the actual market value. There is no system of RM counseling before availing the loan, and as a result one may be in for unpleasant surprises later on. When you have acquired the property with your hard earned money with some sacrifices, it is difficult to contemplate it being sold by the bank. When property is sold to repay the loan, the proceeds will attract capital gains tax.
Conclusion
Perhaps, because of the sentiments attached to the property, senior citizens may find it difficult to accept the idea of property being sold if they outlive the tenure of the loan. Helpage India provides counseling for RM to senior citizens, but most people are not aware of it. The life expectancy has grown due to better medicare. There may be hardly any equity available after property is sold and loan is cleared, for a senior citizen to survive financially in the remaining life span. There are a number of issues including taxation which needs to be addressed before the product can have universal acceptance. Even though, at the nudging of NHB, many commercial banks in public and private sector have this product in their portfolio, actual assets in this category may be one or two per bank! Perhaps it may be worthwhile for RBI to encourage establishment of RM companies, after ironing out some of the taxation issues with finance ministry.