Due Diligence. Why reverse mortgage is a damp squib

Reverse mortgage schemes enable seniors who own a house to get a regular income by pledging the home with a bank. While the idea is no doubt good, the product has not met with much success. There are at least four financial reasons why seniors have given a cold shoulder to reverse mortgages.

One main reason for the poor response is the way the original product was structured. Reverse mortgages have a fixed tenure of 5-20 years during which the senior citizen homeowner will receive monthly payments. After the loan term, the payment will stop, though the owner can continue to occupy the home. The concern naturally is how to manage without cash payments after the loan term.

Two, the loan amount you get can be quite low compared to the value of your house. The value too is decided based on guideline values set by the government. For instance, if the homeowner is 60-69 years old, the loan amount is only 60 per cent of the assessed home value. So the loan amount may be a small fraction of the price you may get if you opt to sell it.

Three, the actual monthly payments you will receive in a reverse mortgage loan is quite low compared to market interest rates. Say, the home is valued at ₹50 lakh and you can get a loan for 60 per cent of the value. For a 20-year tenure loan at 10.5 per cent, the monthly payment is merely ₹3,700 (using the calculator in the NHB website).

If the interest rate were lower, say 5 per cent, the payment nearly doubles and the scheme may look appealing. Why does the payment change with interest rate? The current value of the home is discounted to a future value of zero during the life of the mortgage. Given the fixed tenure, lower the interest rate, higher the payment. 

You can get a one-time payment too. But the maximum amount is capped at ₹15 lakh. Other fees to be borne by the home owner include origination fee, appraisal fee, assessment fee, documentation fee and commitment fee.

Four, the property will be assessed periodically and the payments adjusted based on the existing value of the house. While we are used to property prices only going up, it is also possible that the value may fall. The owner will bear the brunt of this as the payments may reduce a few years later.

To overcome some of these problems, the National Housing Board introduced an annuity product called the reverse mortgage loan-enabled annuity (RMLeA). In this scheme, the reverse mortgage loan is provided by a bank to an insurance provider who issues a lifetime annuity. The annuity payments are higher compared to what you get with a normal loan scheme.

For example, the same reverse mortgaged property could fetch ₹16,000 per month, if you are 60 (and even more if you are older).

How is this higher? The main reason is because annuities offer attractive payouts in a high interest rate environment.

But the main drawback of the original RMLeA scheme was that the annuities were taxable. It was then made tax-free, but the reduction in interest rates may lower the benefits. Also, the complexity of the product — reverse mortgage which is not widely understood plus annuity — makes it difficult to evaluate the financial benefits.

Even if seniors do make a financial compromise, there are other restrictions.

For example, the house against which the reverse mortgage loan is taken must have been self-purchased and occupied by the borrower. What it means is that inherited property or those that are rented out are not eligible. Likewise, the home must have at least 20 years of life.

It is offered generally only on buildings less than 17 years old and when there is re-development of the housing unit, the owner may not know how to handle it, says PV Subramanyam, a financial consultant.

The owner cannot rent out the home and move out when the loan is outstanding. This can lead to the loan being foreclosed. In the case of taking an annuity, you are locked-in and have to stick with the terms of the annuity scheme through your lifetime.

The lender may also ask the owner to register a Will stating that a reverse mortgage loan has been taken against the property and the lender is entitled to the recover the outstanding amount from the sale proceeds. The legal procedures required to take the loan from a lender also tend to be quite lengthy and onerous.

Additionally, while the legal heirs can pay back the loan and claim the property, the amount of outstanding loan increases over the years. Say, the loan taken was ₹30 lakh at 10 per cent interest rate. After 15 years, the amount to be repaid will be ₹1.3 crore because that is the value of the original loan escalated at 10 per cent annually. Bequeathing the property may not be desirable due to the need to repay such large amounts.

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