What is Reverse Mortgage Loan

What is Mortgage?

We understood the fundamentals on mortgage in one of earlier posts titled : "Understanding Mortgage" . I would suggest you to go through the details of Mortgage before getting in to understand about Reverse Mortgage.

In layman's definition, a mortgage is a loan to finance the purchase of one's home. This is clearly the biggest debt that you would ever get into in your life.

Literally, The word mortgage is a French Law term meaning "death contract", meaning that the pledge ends (dies) when either the obligation is fulfilled or the property is taken through foreclosure.

What is Reverse Mortgage Loan (RML) ?

Reverse mortgage is a loan that enables home owners above 60 years of age to convert a part of their self-owned home equity into income without having to sell it.
Under the scheme, the bank determines the value of the property and fixes a percentage of its current value as loan amount. This is based on various parameters e.g. likely lifespan of the senior citizen and his spouse.

Typically, the loan amount is 60-70% of the market value of the property. The applicants have the option of taking the loan as a lump sum or a fixed monthly amount. After the death of the senior citizen, the surviving spouse can continue to occupy the property till his/her demise. The value of the property is periodically re-evaluated by both the parties, the owner and the bank. If the valuation has increased, the applicants are given the option of increasing the quantum of the loan.

However, one should be prepared to shell out money for charges like processing, valuation, as well as legal fees for availing of the loan. The maximum limit for processing charges is Rs 10,000. The valuation and legal charges may add up to between Rs 5,000 and Rs 10,000 depending on the loan amount.

How is the Reverse mortgage loan paid back?

With a reverse home mortgage, no payments are made during the life of the borrower(s), unless you want to pre-pay and cancel the reverse mortgage contract. 

The loan has to be paid only after both the borrower and spouse die.  Since no payments are made during the term of the reverse home mortgage loan, the loan balance rises over time. In most areas, where the appreciation is good, the value of the home grows at a much faster rate than the loan balance. Therefore, the remaining equity continues to grow.

When both, the borrower and spouse pass away, the ownership of the home is then passed to the estate or directed by a living will or will to the beneficiaries. The beneficiaries now own the home and have to sell the home or pay off the loan. If the home is sold, the reverse home mortgage lender is paid off and the beneficiaries keep the remains.

Renting out a Reverse Mortgaged property

One of the clauses in a reverse mortgage agreement is that the property in question should be a house that is being used by the borrowers as their principle residence. This implies that renting or leasing the property is not legally possible.

Selling a Reverse Mortgaged Property

Selling a reverse mortgaged property is legally permitted. But one must consider the following before going ahead:

1) Compare the total debt incurred (because of the monthly principle and interest that the bank is accruing as per the reverse mortgage agreement) with that of the house's market value. If the amount owed to the bank is more or less the same as the current market value of the property, or if the positive difference is minimal, it may not make too much sense to sell the property.

2) In fact, you may not be able to sell the property if you owe an amount to the bank that is close to the value of the property and do not have the financial resources to cover the costs associated with selling the home.

What happens if property prices go down?

If the current value of the property is less than accrued principal and interest amount, the bank suffers a loss. This is a risk that the bank is taking while signing a reverse mortgage agreement with you. This could happen if the real estate market has not moved up in the manner that the bank had initially estimated. 

In that case, you are either required to pay back the principle + interest to the bank and take possession of your property or you may decide not to do so, in which case bank owns the property. Since the property price is less than principle+interest, bank might suffer a loss.

Tax Implication of selling a reverse mortgaged property

1) The borrower will have to pay capital gains tax on the profit generated from the sale of the property.

2) However, banks don't need to pay anything as the property is held as a security or a collateral for the loan that it has provided.

3) Another crucial consideration is that the loan borrower should have an alternative accommodation before he plans to sell his house. A rule of thumb is to opt for a sale only if the proceeds are large enough to facilitate another accommodation after repaying the loan to the bank. Besides, the transaction should yield enough amount so that it can be invested to fetch reasonable monthly returns.

How to foreclose a RML?

1) A senior citizen who has reverse mortgaged his property can easily claim ownership by paying the outstanding sum to the bank. 

2) The pay structure of a reverse mortgage is such that you owe only what you have received of the loan amount till date, along with the interest payable and any fees that the lender may charge. According to bank officials, the institution calculates the interest till the day the principal amount is to be paid. So the interest is calculated on the money taken till date. Many public-sector banks don't even have a foreclosure charge while some may have.

When to consider taking Reverse Mortgage ?

Even though Reverse Mortgage seems like a nice idea, it should not be the primary tool to fund one’s retirement expenses. It should not be used to fund the shortfall in the retirement income. 
It should be used in exceptional cases like if one does not have any legal heirs or leaving money to/for them after death, is not a high priority. There are many old people who have assets of high worth, but they do not have a proper, steady stream of income. One can use reverse mortgage in that case.

Quick Recap on Reverse Mortgage Loan

1. Reverse Mortgage is available to Senior Citizens only. Any house owner over 60 years of age is eligible for a reverse mortgage. If wife is a co-applicant, she  should be above 58.

2. The maximum loan is up to 60 per cent of the value of the residential property subject to maximum of Rs 50 Lacs.

3. The maximum period of property mortgage is 15 years. Minimum tenure will be 10 years. Some banks like PNB offer a Reverse Mortgage Loan for 20 years also.

4. The borrower can opt for monthly, quarterly, annual or lump sum payments at any point, as per his or her discretion.

5. The revaluation of the property has to be undertaken by the bank every 5 years. 

6. The amount received through reverse mortgage is considered as loan and not income; hence the same will not attract any tax liability. 

7. Reverse mortgage rates will vary according to market conditions depending on the wheather borrower has chosen Fixed or Floating interest rate. 

8. One can prepay the loan along with the interest any time during the loan tenure. Typically, there is no pre-payment penalty.

Cheers

Manoj Arora