The Hindu Business Line : The case for reverse mortgage

One of the chief worries of the elderly is that they will outlive their savings, and this is especially true of the Indian middle-class, often called asset-rich but income-poor. Reverse mortgage is a way to borrow against one's house to create a regular stream of retirement income while continuing to live in that house. Subasri Sitaraman explains how it works and recommends it as a useful, if unconventional, retirement tool.

ALL over the world, one of the chief concerns of the elderly is that they will outlive their savings. Seniors in India are no exception. While the rich face no such difficulty and the problem for the poor is entirely of a different dimension, for the middle-class, this is a cause for worry, particularly as they near retirement. A lack of sufficient income can affect their retired life substantially, unless their children take on the responsibility of supporting them, fully or partly.

Although old values still prevail in India and children do support the parents in many instances, this is fast changing in a system where nuclear families are becoming the order of the day.

Improved health care and better nutrition have been primarily responsible for increased life expectancy. Today, those who cross the age of 60 are expected to live till 75 and beyond.

According to the 1991 census reports, India has an estimated 314 million workers, of which a mere 11 per cent are covered by the formal pension system. For the majority, personal savings are their only source of retirement income.

Let us consider a hypothetical example of a retired couple living in their own flat (valued at Rs 10 lakh) but not receiving any pension income. Further, let us assume that their requirement towards living expenses is, on an average, Rs 10,000 a month.

A 9 per cent return on investment (the rate guaranteed by the Government under the Senior Citizens Saving Scheme) means they should have investments and personal savings exceeding Rs 13 lakh to achieve this monthly return.

Considering the host of other important factors, such as inflation and capital expenditures, the investment requirements would only go much higher. Most retirees are unlikely to have such big savings.

This situation is not unique to the Indian middle-class, who are often called "asset-rich, but income-poor" at retirement, meaning that they are by no means penniless, but that their wealth is tied up in their homes. For a number of years, policy-makers and retirement specialists in many countries have been analysing various options to generate retirement income from private houses.

Reverse mortgage is one such option, which is gaining popularity in the United States and a few other developed nations, but is almost unheard of in India.

Reverse mortgage is a way to borrow against one's house to create a regular stream of income while continuing to live in that house. The difference between a reverse mortgage and a conventional loan, where the house is offered as a collateral security, is that one would still have to make monthly repayments towards a loan.

With a reverse mortgage, all that is required is to pay property tax and insurance and maintain the house so that the value is retained. No repayment is required till the owner continues to live in the house and the full amount becomes due only on the death of the last surviving spouse, or when the house is sold, whichever is earlier.

Reverse mortgages are so called because instead of paying the monthly housing loan instalments, the borrower actually receives money from the lender.

How does this work? The amount available is based on several factors, such as the applicant's age, appraised value of the house, projected rate of house price appreciation and the current interest rates. In addition there are other costs involved, which can go up to 5 per cent of the value of the house.

Generally speaking, the higher the age of the retiree, the higher the value of the house, and the more the money available. Studies in different countries have indicated that based on benchmark scenarios, reverse mortgages are likely to achieve about 50 per cent income replacement ratios.

In the earlier example, this would mean that using this option the retiree can generate approximately Rs 5,000 a month. Taking another approach, if the assessed value of the flat in the above example, eligible for reverse mortgage loan is Rs 8 lakh (assuming 80 per cent of market value), and a monthly payout option is selected, this would yield approximately Rs 5,752 per month starting age 61 (see Table). This is based on the immediate annuity rates, in the absence of reverse mortgage tables.

This amount is paid every month till life. On the death of the last surviving spouse, the loan amount (principal and interest) needs to be repaid to the lender.

The bank/financial institution can sell the house; take what is owed and pay the excess, if any, to the heirs.

In the rare case when the value of the property does drop below the amount owed on the reverse mortgage, the lender must absorb the loss. The heirs, however, have the option to pay off the bank directly and keep the house themselves. In the above example, (assuming payments are made for 15 years), amount to be repaid would be approximately Rs 17.38 lakh — Rs 10.35 lakh towards principal and Rs 7.03 lakh towards interest thereon (assuming an interest rate of 9 per cent).

Considering the present trend in real estate appreciation, it would not be unrealistic to presume that property values will double in 15 years, even in non-metropolitan locations. If this trend continues, it is very likely that even after repaying the mortgage amount there would be still be something left for the heirs.

It would be a profitable proposition for the lenders too since they would be able to get their expected return on capital invested. Why is there no such product in the Indian market? In many ways, reverse mortgage is an unconventional retirement tool. Even in countries where it has been around for quite a while, acceptance has been very cautious.

In India, the housing finance market is booming and, therefore, financial institutions do not see the need to launch innovative products.

Also there are other issues such as pricing which can be extremely complex as it involves a number of uncertainties, such as future value of houses, life expectancy, and interest rate risks.

On the borrower's side the biggest challenge would be balancing the need for supplementing retirement income and the desire and wish to bequeath homes to children.

Compounded with the natural reluctance of many seniors, who have worked a lifetime to pay off a housing loan to go back into debt, irrespective of the merits of the scheme, the psychological acceptance of this concept in itself would, no doubt, be difficult.

Nevertheless, there are a number of advantages that could act as incentives. Chief among them are:

Reverse mortgage can supplement retirement income. Particularly when there is a shortage of monthly income, this equity reduction may be preferable to a reduction in the standard of living.

Also with the burgeoning real estate market in India there is a good possibility of the value of the house appreciating more rapidly than the mortgage loan increasing. In such a scenario, there could be some equity left over for heirs.

There is no upper age limit for getting the benefit of the reverse mortgage facility. On the contrary, the older one is, the easier it would be to get the loan.

From the retirees' perspective, this is a good option, particularly if they are comfortable during the initial years of retirement, and may wish to opt for this in their latter years, when their savings have dwindled or are inadequate to cater to their needs on account of increased cost of living due to inflation.

For the lender, it is definitely more profitable to offer mortgages to older people due to reduced life expectancy.

It is a non-recourse loan, which means the bank/financial institution can never come after any person or estate for repayment of the loan. The lender can only receive payment of the loan from the value of the home.

At the macro level, implementation of reverse mortgage schemes could reduce the burden on the Government and employers who are paying pensions, whether in the public or in the private sector, and would thus be an indirect measure to bring in pension reforms.

With the changing social milieu in India and the collapse of the joint family system, introduction of reverse mortgage products could be a worthwhile experiment.

Instead of being dependent on their children for monetary support this would be a good option for the elderly to continue with a graceful lifestyle.

(The author is a Senior Consultant, Insurance, Infosys Technologies.)

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