The 2007-2008 Union Budget has introduced a novel product for the elderly called a ‘reverse mortgage’ and has asked the National Housing Bank (NHB) to draw up the Guidelines. The Guidelines have already been framed and issued by the NHB and many banks/financial institutions are scheduled to introduce the ‘Reverse Mortgage Scheme’ in the coming months. The Budget Speech For, 89 says:
“The National Housing Bank (NHB) will shortly be introducing a novel product for older people: a ‘reverse mortgage’ whereby an older person who owns a home can draw on a monthly stream of income against the mortgage of your home, owning and occupying the home for your entire life, without repayment or servicing of the loan.
Relatively a new concept for the Indian financial services industry, the introduction of this scheme is expected to lead to financial innovation and an opportunity to count on senior citizens making their physical asset i.e. property a hen that lays golden eggs.
Scheme Concept:
In a regular mortgage, a borrower mortgages their new/existing home with the lender in exchange for the loan amount (which they in turn use to finance the property); it is charged at a particular interest rate and runs for a predetermined tenure. The borrower then has to repay the loan amount in the form of EMI (Equivalent Monthly Installments), which is made up of principal and interest amounts. The property is used as collateral to cover the risk of default by the borrower. The reverse mortgage is the exact opposite of the regular mortgage. The payment stream flows from the housing finance company to the borrower, which is the opposite of a conventional mortgage.
In this scheme, a senior citizen 60 years of age or older, who owns a home, can receive a loan for up to a fixed amount calculated based on the percentage of the market value of the home owned and given in mortgage. The loan would mature and be payable only upon the death of the last surviving owner. The liquidation of the disbursed loan, together with the accrued interest, will be covered with the proceeds of the sale of the house. If the borrowers’ heirs so choose, they can keep the property after paying off the loan amount and any interest owed. If the borrower wants to pay off the loan before 15 years, he can do it too.
Scheduled Commercial Banks and Housing Finance Companies are expected to be the main agencies to carry out the implementation and commercialization of this scheme.
Reverse mortgage in the United States and Australia:
The ‘reverse mortgage’ scheme has been around in Western countries and is particularly famous and quite successful in the United States of America. It can be said that this concept has been taken from America and is being customized to suit the needs of India. In the US, the National Reverse Mortgage Lenders Association (NRMLA) was established in 1997. NRMLA is the national voice for lenders and investors involved in the reverse mortgage business. NRMLA performs several functions, including educating consumers about the opportunity to use reverse mortgages, training lenders to be sensitive to the needs of older Americans, developing best practices, and enforcing a code of conduct to ensure that lenders who participate in the program treat older people with respect. and the promotion of reverse mortgages in the media. However, since there are already established social security benefits for US citizens, the proportion of reverse mortgage loans in the US is relatively lower compared to the general population.
In Australia, reverse mortgages were tried in the 1990s, but the concept was withdrawn due to a lack of consumer demand. But now the reverse mortgage market in Australia is over $1.1 billion as of June 30, 2006.
Advantages of the scheme
(i) The house can remain occupied by the mortgagee or his spouse during the period of their lives.
(ii) The loan, in the form of a lump sum or monthly installments, does not need to be repaid during the life of the person who mortgages the house or their spouse.
(iii) The provision in the home equity review regime every five years when the market value increases may allow the mortgagee to obtain a larger amount (as a loan or installments) if the value increases.
(iv) The mortgage will be for 15 years. If the mortgagee or spouse survives beyond this period, they will not be evicted but will continue to live in the home until the last of the spouses survives. Of course, in the meantime, interest will continue to be charged on the loan amount. However, if the loan installment system is chosen, the installments will stop after 15 years.
(v) If the borrower or spouse dies prematurely, that is, before the age of 15, the amount to be recovered would only be that which has been delivered to the borrower or spouse in the form of a loan or in installments.
(vi) If a surplus remains after the sale of the mortgaged property after adjustment of the loan amounts and interest, the balance will be reimbursed to the heirs of the mortgagee.
(vii) The heirs, if they want to keep the property, can do so by paying the loan amount with interest to the lending bank.
Taxes:
The Central Board of Direct Taxes (CBDT) is yet to clarify whether payments received by the mortgagee (elderly person) should be treated as ‘loan’ ‘income’. In many countries, the payment received is considered a ‘loan’ and not ‘income’ from a tax point of view. It would be beneficial if ‘payments’ could be treated as ‘Income’ and exempted from tax under Section 10 of the Income Tax Act 1961, bearing in mind the very limited scope of earning investment returns for individuals greater.
Furthermore, there remains an ambiguity and anomaly regarding the “age” at which a person should be treated as a “senior citizen.” The Income Tax Law considers a senior citizen as a person over 65 years of age, however this scheme says that citizens over 60 years of age are eligible. This aspect needs to be corrected and uniformity is much needed as soon as possible.
Indian scenario:
Dewan Housing Finance Limited (DHFL) was the first to launch the reverse mortgage ‘Saksham Scheme’ in September 2006.
Seniors, particularly from metropolitan and Tier I cities, are expected to take advantage of this scheme.
Since there is no defined Social Security program in India, this scheme benefits ‘asset rich but cash poor’ senior citizens. The Reverse Mortgage can surely be considered as a derivative instrument to cover the risk that arises from retirement and the inability to work due to old age. Considering the population of India, a small proportion of elderly people are a great potential for this scheme. In general, the reverse mortgage can be successful in India.
Risks:
Property price fluctuations, particularly in metropolitan and Tier I cities, are one of the main risks for lenders. If the value of the property falls to the point of being less than the loan amount, lenders face the risk of loss.
Interest rate risks and inflation risks are other risks. Legal risks may arise if the lender is unable to sell the underlying property, due to litigation and longer court proceedings.
It goes without saying that such a scheme should have a plethora of disclaimers and fine print, which if not read carefully, pose a risk to the borrower i.e. the senior citizen.