It is a very common sight whereby a person invests majority of his savings into his home which acts as a shelter for him and his family. With the rising real estate prices where by an average property costing over 30-40 lacs (an around 1 crore in larger cities), a person would definitely end up parking a significant chunk of their saving into their home. This saving then gets locked for ever and as the retirement age approaches, a person is though lucky to have just a house with, but extremely unlucky having no income to support his monthly expenses. Hence, even though the ageing body approaching the retirement stage is not physically supporting the person to earn a livelihood, the challenge to meet the basic needs forces him to go out on the job in order to pay THE BILLS. You may want to read our other article Your House – A Drain on Your Finances before continuing ahead with this post.
If the same person is even more unlucky, his children consider him as a liability and do not fully support for the living expenses, including the ballooning medical bills which come with an ageing human body. This brings the scene of the movie ‘Baghban‘ into my mind where Mr. Bachchan faces the same issue with his kids. It is probably here where a financial product know as ‘Reverse Mortgage’ may come handy to help unlock the savings invested in the house and provide a monthly income until death.
How Reverse Mortgage Works
The objective of a Reverse mortgage is to provide elderly people, a regular source of income in the form of a loan to help them in maintaining their standard of living and sustaining any medical costs. In order to do so, the banks do the following :
1. The house is hypothecated with the lending bank.
2. Ownership and possession of the house remains with the borrower.
3. The borrower enjoys the so called monthly income till the duration of the reverse mortgage. He also continues to reside in the home.
4. Upon the death of the borrower, the house can be sold off by the bank or the legal heirs can repay the loan amount to take the possession of the house.
5. Any capital appreciation associated with the house vests with the owner / legal heirs of the owner. Bank only gets principal they paid to the borrower plus interest accrued there on.
A simpler presentation of the above points can be reflected in the form of the following diagram :
Cash Flows Associated with Mortgage
Reverse Mortgage, as the name denotes, is a reversal of Mortgage. In order to understand Reverse Mortgage, lets first look into a Mortgage (commonly known as Housing Loan in India). In case of a mortgage, a person takes an upfront loan from a bank and starts repaying it back to the bank on a monthly basis over the duration of the loan. Hence, there is an upfront lumpsum cash inflow for a person and monthly mortgage outflows (home loan EMIs). Over a period of time, the loan outstanding decreases with every monthly mortgage payments till it becomes zero with the final payment. If we look into the chart of mortgage payments, it would look something like this :
In the above example, the house valued 50 lacs was purchased by Thomas. Thomas took a loan of Rs. 45 lacs with a monthly mortgage payment of around Rs. 40,000. With each monthly mortgage payment, the outstanding loan balance falls from Rs. 45 lacs to zero in 25 years. In the same time, the house value increased from 50 lacs to Rs. 5.4 crore over 25 years (assuming 10% growth year on year). Once the mortgage / home loan amount is zero, Thomas can comfortably sit on his sofa for not needing to pay the monthly home loan EMIs.
A striking observation in the above graph is that the house price tends to grow over a period of time. However, it is of no use if you can’t encash it for your benefit. Lets see how we can make this to work in your favour.
Cashflows associated with Reverse Mortgage
The cash flows associated with the Reverse Mortgage can be reflected in the below mentioned charts. The following assumptions were used for the chart :
- Matt is 60 years of age and has a house worth 50 lacs which he wants to take a reverse mortgage on.
- Bank offers him 15 years Reverse Mortgage, whereby they agree to pay him Rs. 18,400 per month for next 15 years at an interest rate of 12.5%.
In the above graph, you may notice that the house price rose up sharply from 5o lacs to over 5.5 crores. The monthly amount paid by the bank over 15 years to Matt totalled to 33 lacs Rupees. After 15 years, Matt survived for another 10 years when he finally died. After 25 years, the Total loan outstanding against the property gradually increased to Rs. 2.26 crores due to interest element. The interest component out of this Rs. 2.26 Rupees balance was Rs. 1.95 crores. When the property was sold, the value which the property fetched was Rs. 5.5 crores, which was used to pay off the total loan outstanding. The balance amount of Rs. 3.24 crores was paid off to the legal heirs.
Are you Eligible to Apply for a Reverse Mortgage Loan ?
Owing to the unique characteristics associated with the Reverse Mortgage whereby the lending Bank would be waiting upto the death of the borrower, only a specific set of home owners can apply for this product. The eligibility criterias and specific terms which are generally a part of a reverse mortgage are as follows :
- The primary borrower should be of 60 years or more. If a spouse is associated with the ownership of the property, the minimum age of the spouse should be 58 years;
- The borrower should be residing in the house (primary residence).
- The house shall be mortgaged to the bank providing Reverse Mortgage. Any existing mortgage / encumbrances prevailing on the house should be paid in full at the time of taking Reverse Mortgage.
- If the borrower wishes to sell the house or shift his permanent residence, the bank would recover the loan from the sale proceeds of the house.
- Borrowers can prepay the loan. Generally there is no prepayment penalty on such loans.
- Interest rate applicable to such loans is generally marginally higher than home loans. At the time of writing this article, the loan rate is between 11.5 – 12.75 %.
- The legal heirs are not responsible to pay of the balance on the loan if the value of the loan is more than the value of the property.
There is no tax associated with the Reverse Mortgage. If you look into the product, it is essentially a loan which the bank advances against the security of a house. The only difference in this loan is that the bank provides the amount monthly over a period of time. And hence, taking a loan is not inviting any taxes.
Though it may sound very easy to take a Reverse Mortgage, it is one of the most difficult product to opt for. Not that the banks would deter a person to take such a loan, but because of social and family pressures a person would not want to put his house again on a loan to maintain his standard of living. Further, the sheer thought about selling a house which would potentially result in snatching away the shelter from a person’s dependents may get classed as unacceptable. However, it is worth to know that such a product exists. It is better to use such a product then to live a miserable standard of life !