and Reverse mortgage is one of several financial instruments that convert home equity into cash. There is already a fairly developed market for such products in the United States and other developed countries, but, so far, it has been introduced in India by only two entities – the country’s second largest home finance company, Dewan Housing Finance Corporation LimitedPunjab National Bank. A host of other banks are also planning to introduce similar products. In the US, these products are a big rage among the elderly and those nearing retirement. But then, what is reverse mortgage? This article provides an overview.
Home equity conversion products are useful to all those who are “house-rich but cash-poor” and they need not necessarily be only the elderly. There are many types of such products and where the market has attained some maturity, as in the United States, standard reverse mortgage products often incorporate one or more of these variations as options. Some of these options are:
- Reverse Mortgage: discussed in detail in later paragraphs
- Home Reversion / Sale and Lease Back: The homeowner sells his house outright now, but retains the right to live in it for life for a nominal/reduced rent. The sale proceeds may be paid in a lump sum or as an annuity. This could very well be an intra-family transaction.
- Interest-only Mortgage: This could be useful to those who are in need of an immediate lump sum, but still have only limited loan-servicing capacity. During the tenure of the loan, the borrower is required to make only interest payments. The principal is due only on maturity or death or a permanent move or sale.
- Mortgage Annuity/ Home Income: This is suitable for the very old for whom life annuity rates are more attractive. The loan amount is used to buy a life annuity. The mortgage interest is deducted from the annuity and the balance is paid as periodic income. The principal is repaid on death or sale of the house. The attraction is that the annuity will continue even if the borrower sells the house or moves out permanently
- Shared Appreciation Mortgage: This provides loans at a below market interest rate. The loan is repaid at death or moving or sale. In return, the lender gets a pre-agreed share in any appreciation in the property value over the accumulated value of the loan.
As must be obvious from the above, the basic idea of home equity conversion products is to enable those having a house property but not enough cash to get cash against the property without having to bear the burden of repayment of the cash received. The idea is that after the death of the home owner, the house property is owned by the lending institution which sells it off to recover the loan amount and the interest where the interest rate is similar to housing loan interest rates.
Reverse mortgage, specifically, works like this: in a conventional mortgage loan, the borrower starts with a large loan and low equity in his/her house and as he/she repays the loan through monthly instalments, the borrower reduces his/her outstanding loan amount and increases his/her house equity.
In reverse mortgage, on the other hand, the borrower starts with a very high equity in his house. The lender extends a non-recourse loan secured by the house property. The borrower may choose to receive the proceeds through:
- A lump sum at the beginning
- Monthly payments till a fixed term or a life-long annuity
- Establishing a credit-line with or without accrual of interest on credit balance
- A combination of the above
The borrower need not move out of the house or make any payment to the lender, as long he is alive and continues to live in the house or does not sell it. Therefore the loan and interest accumulates till maturity. There is no credit or income requirement to be satisfied. Even if the accumulated loan and interest goes above the realizable value of the house at disposal, the repayment is capped at that value only. Hence RM is a case of ‘raising debt, falling equity’.
Usually, the amount of loan is determined by:
- Age of the borrower and any co-applicant (life expectancy/ mortality risks)
- The current value of the property and expected property appreciation rate (real estate market risk)
- The current interest rate and interest rate volatility (interest rate risk)
- Closure and servicing costs
- Specific features chosen: fixed or floating interest; shared appreciation; interest earning credit-line; and mortgage insurance, if any
There is conceptually nothing in the reverse mortgage idea to restrict it only to the elderly. But the product is particularly suited for old people in fact, the older a person is, the more attractive reverse mortgage (RM) is. The reasons are:
- RM requires near total equity ownership of the house – more likely for ages above 50 (unless the property is inherited)
- It is attractive only to people with insufficient current income and little financial savings – by implication, retired persons
- For a given property value, the lower the life expectancy (older the person is), higher is the additional income through an RM.
- Public policy support including tax incentives is more likely if the borrowers are the elderly.
- The elderly are particularly likely to attach significant psychological/ emotional/ sentimental value to ‘ageing in place’ without moving out. In fact, the longer they have stayed in their current home, the more valuable this is likely to be, considering the benefits of a familiar neighbourhood.
With more and more instances of elderly people being thrown out of their homes by their children being reported in the newspapers, perhaps the time has come for introducing RM in India in a big way!