A back-up for retirement?

“The National Housing Bank (NHB) will shortly introduce a novel product for senior citizens: a ‘reverse mortgage’ under which a senior citizen who is the owner of a house can avail of a monthly stream of income against the mortgage of his/her house, while remaining the owner and occupying the house throughout his/her lifetime, without repayment or servicing of the loan…”

P. Chidambaram, the then Finance Minister, in his Budget speech on February 28, 2007

If you want an additional stream of income in your retirement, you might be tempted to check out a reverse mortgage.

It’s a scheme that’s designed for senior citizens to help them tide over their golden years with ease. They can re-mortgage their house— their most valuable asset—and get a regular income. Money is taken in the form of a loan, but no repayment is made until the house is sold. Despite its advantages, the scheme has not done well in India.

The problem is that many senior citizens have not included reverse mortgage as part of their retirement plans. According to NHB, the re-financier for housing finance companies, barely 2,800 loans amounting to Rs 550 crore over the last two years had been sanctioned till December 2008. Says Nanda Kumaran, Head (Personal Banking), State Bank of India: “Unlike western countries where reverse mortgage is an accepted idea, people here find reverse mortgage out-of-the-ordinary and complex. In India, your whole life goes into building a dream home for yourself. So, you have a strong emotional bonding with that property. It will take some time for banks to break this psychology.”

There are other reasons why reverse mortgage has not caught on here. Most people have a keen sense of saving for the future. “Saving habits are perhaps the primary reason why most Indians retire with sufficient money to fund a comfortable lifestyle after retirement.

 

Inside the Mortgage All you need to know how the mortgage works. The borrower should be staying at a self-acquired and self-owned house/ flat as his permanent primary residence with valid proof of residence The lender assesses the value of the property, which should have a life of at least 20 years for a single borrower and 25 years for a couple below 60 years of age Based on the borrower's age and the value of the property, the lender takes a call on the tenure and the value of the loan If the borrower agrees, he/she fills out loan application and selects payment option: fixed monthly installments, quarterly installments or lump sum payment. Typically, the interest rate charges range between 10 and 12 per cent Any time during the tenure of the loan, the borrower can prepay the loan without incurring any penalty charges

And those who don’t fall into this category have a family to take care of them,” says Nikunj Kedia, Director, PARK Financial Advisors. Another reason has been a lack of clarity on its tax treatment. “Until last year, there was confusion over tax treatment. But a recent Central Board of Direct Taxes ruling has exempted the scheme from both income tax and capital gains tax,” says Kumaran.

Financial institutions, too, are not pushing reverse mortgage products with great enthusiasm. “It is a very difficult product to take to the Indian market. The main worry is the social stigma attached to borrowing, especially for individuals aged over 60 years. Banks are currently targeting only limited segments, including those in the top bracket (individuals or couples having premium property) or those who have not made significant pension investments,” says Sachin Khandelwal, Head (Cards Group), ICICI Bank. He thinks that changes in the social fabric will alter the perception towards such products in the near future.

So, how does reverse mortgage really work? It allows senior citizens to unlock the value of their home during a cash crunch. They can use the money and continue to live in the house until their demise. “By the time individuals retire, their net worth is largely divided into house (60-70 per cent of the total worth), investments (15-30 per cent) and cash (5-10 per cent). Since the bulk of the savings at retirement is typically locked in home equity, a reverse mortgage loan is a powerful device to increase the incomes of the elderly,” says Kedia.

Who all are eligible for a reverse mortgage loan? It is meant for people above 60 years of age in case of single borrowers. Married people are eligible as joint borrowers, provided at least one of them is above 60 years of age and the other is not below 55. The quantum of loan depends on the borrower’s age and the property’s market value. Loan values are usually around 70 per cent of the property value. For example, on a Rs 1 crore house, a bank will sanction a loan up to Rs 70 lakh. With a rate of interest of 11 per cent for a 15-year period, the monthly annuity will work out to Rs 15,395. Says Kumaran: “The borrower can use the cash flow for any purpose, including livelihood, medical bills, repairs and even travel.” However, experts believe that since the risk involved is high, lenders may try to keep the loan value quite low.

The loan is settled only after the death of the borrower and his/her spouse or when they cease to occupy the home as their primary residence. Legal heirs have the option to repay the debt along with the interest accrued and retain the property or alternatively sell the property and repay the borrower. Any surplus belongs to legal heirs.

There are a lot of procedural drawbacks, however. Loan costs are high, and the accrued interest can tot up to a tidy sum. Still, a reverse mortgage can lend a hand to those who are asset-rich. But for many senior citizens, it’s best to sign up only as the last resort.

Weigh your options Before you apply, take a careful look at the advantages and limitations of a reverse mortgage. Pros It allows senior citizens with inadequate income sources and higher credit risks to arrange for an additional source of income The proceeds are exempted from all kinds of taxes.income tax, capital gains tax and wealth tax The borrower can use the cash flows for any purpose he chooses. medical expenses, travel, or to meet day-to-day expenses Under any circumstances, the repayment obligation for you or your heirs does not exceed the value of the home Cons If the borrower decides to reallocate to other place, then he/she will be required to repay the loan. This could limit borrower's freedom of choice When the borrower and co-borrower pass away, anyone else living with the owner may be prevented from remaining in the house In order to reduce their risk and liabilities, banks often evaluate the value of the house lower than its actual cost During the loan period, the borrower needs to pay all expenses related to maintenance, insurance and taxes