Senior Citizens or retired personnel face many constraints that people in their 20s and 30s can’t even imagine. They have no salary to bank upon. They have to rely on their savings and pension to meet their monthly expenses. There is little ability to recover from an unplanned major expense.
Advances in healthcare have ensured that the retirements are longer. Your pension may not be sufficient to counter inflation. Moreover, a prolonged hospitalization can make a dent in your savings. You realize your monthly pension and interest income cannot make up for the monthly expenses. You need some regular income for somewhere.
What do you do?
You can’t sell the house you are staying in or you will have one more thing (monthly rent) to worry about. A loan is not an option since the bank wouldn’t lend to you as your repayment ability is compromised during retirement.
It is in such cases that Reverse Mortgage Loans can come to your rescue. Under the Reverse Mortgage Scheme, you mortgage your home to a lender. The lender, in turn, makes periodic payments to you for a fixed number of years. You can continue to live in that house as long as you are around.
The important part is that you are not required to pay anything to the bank during your lifetime. After the demise of the borrower, the lender can sell the residential property to square off the loan.
This way, you can generate cash flow from your house without renting it and continue to stay in the house during your lifetime.
In this post, I will discuss the Reverse Mortgage Loan Scheme in detail.
What are your rights as a borrower?
What is the lender’s discretion?
What is the tax treatment of income from Reverse Mortgage Loan (RML) schemes?
Does it make sense to opt for such schemes?
Who can apply for Reverse Mortgage Scheme?
The applicant should be a Senior Citizen i.e. above 60 years of age.
Married couples can apply as joint borrowers. The age criterion for the couple depends on the lending institution (banks and housing finance companies). At least one of them should be above 60 and the other should not be below 55.
You must be the owner of the mortgaged property (goes without saying). The residential property must also be self-occupied. You cannot offer a let-out residential property for reverse mortgage.
You must be using the proposed property as your permanent primary residence. The lender will use factors such as your general correspondence, utility bills, property taxes, bank account statements, income tax return etc. to assess if the residential property under discussion is indeed your permanent primary address.
The residential property should be free of encumbrances.
The residual life of the property should be at least 20 years.
Other important Features of Reverse Mortgage Loan (RML) Scheme
Your income is not considered while offering you the loan. Hence, your repayment ability does not come into picture during sanction of these reverse mortgage loans. The market value of your house is important. This is a sharp deviation from other loans where your repayment ability is the determining factor.
Commercial property is not eligible for Reverse Mortgage Loan Scheme.
RML loans have no-recourse guarantee. This means you (the borrower) never owe more than the realizable value of the property. Even if market value of the house goes down and is not enough to settle the loan, the lender cannot force you to pay a single extra penny. Therefore, the lender bears the risk.
For detailed guidelines on Reverse Mortgage Loans, please go through the guidelines on Reverse Mortgage Loans on National Housing Board’s website. You can also refer to Notification on Reverse Mortgage Scheme, 2008 by Central Board of Direct Taxes.
Who offers Reverse Mortgage loans?
Scheduled commercial banks and housing finance companies are permitted to offer Reverse Mortgage loans.
How much loan can I get under RML scheme?
The amount of loan depends on the market value of residential property, the age of the borrower and the prevalent interest rate. The lender exercises a lot of discretion in this matter.
Let’s try to understand this with the help of an illustration.
I will base my calculations based on the Reversed Mortgage Loan scheme offered by Punjab National Bank (PNB). The scheme is PNB Baghban.
Under the scheme, the bank keeps a margin of 20%. For instance, if the value of your residential property is Rs. 1 crore, you will get a loan equivalent of Rs 80 lacs.
The margin may vary across banks based on your age and the location of your house.
You won’t get Rs 80 lacs as lump sum. You will get the amount in monthly installments.
Let’s find out how much you will get per month. Here is the amount based on PNB website.
If you opt for loan disbursement tenor of 20 years, you will Rs 8,000 per month (Rs 80 lacs X Rs 100 per month per lac). Note you will get only Rs 8,000 per month X 12 months per year x 20 years = Rs 19.2 lacs during these 20 years. This is nowhere close to Rs 80 lacs. Well, banks never indulge in charity!!!
The accumulated interest on the loan takes the loan amount to Rs 80 lacs at the end of the term.
If you opt for loan disbursement tenor of 10 years, you will get Rs 34,560 per month (Rs 80 lacs X 432 per month per lac).
Shorter the loan disbursement tenor, greater the monthly income.
Do note the monthly amount per lac is based on Rate of Interest. If the rate of interest changes, the amount (per lac) will also change.
As per PNB website, the current rate of interest is Base Rate + 2.5% p.a. At current base rate of 9.6% p.a., this comes out to 12.1% p.a.
These are no random numbers. Rs 8,000 per month at 12.1% p.a. for 20 years will compound to Rs 80 lacs (no surprise) in 20 years. Rs 34,560 per month at 12.1% p.a. for 10 years will compound to Rs 80 lacs at the end of 10 years. No surprises again!!!
Point to Note
The market value of the house is subject to fluctuations. The bank/HFC will re-value the mortgaged property periodically (at least once in 5 years). The quantum of loan may undergo revision based on the assessed value. It is entirely the lender’s discretion.
If the lender feels that the value of your property has gone down, it will recalculate the loan amount.
Continuing with the example in the previous section, your loan eligibility was Rs 80 lacs. You opted for 20 year tenor. Monthly income was Rs 8,000.
After 10 years, the value of the house is reassessed at Rs 70 lacs (for whatever reason). For the first ten years, you received income of Rs 8,000 per month. Post revaluation, the monthly income will go down to Rs ~3,585.
This is one risk that the borrower bears.
How is the loan given?
The loan can be taken in any or combination of the following:
- Periodic payment (monthly, quarterly, semi-annual or annual) as agreed upon between you and the lender. Maximum is Rs 50,000 per month.
- Lump sum payment. The maximum lump sum payment is restricted to 50% of the eligible loan amount subject to a cap of Rs 15 lacs. You can request lump sum payment only for medical treatment of self, spouse and dependants. The balance loan amount is eligible for periodic payments.
- Committed line of credit with an availability period (Lenders agrees to pay as and when you demand)
What is the Maximum Loan disbursement tenor?
The lender can make you payment under the scheme for not more than 20 years. Please understand this is the term during which the lender will make the payment.
This does not mean you have to repay the loan after 20 years.
You can still stay in the house at the end of 20 years (till such time you are alive). It is just that the banks/housing finance company cannot make any lump sum or periodic payment after 20 years.
You have got to make financial arrangements for the time when the disbursement period gets over.
How is loan repaid?
No repayment is required as long as the borrower is alive. The loan becomes payable only when the last surviving borrower dies or wants to sell the house or permanently moves out of the property for old age home or to stay with a relative. Permanent move means the borrower has not stayed in the house continuously for more than 1 year and does not intend to live there.
As far as the repayment is concerned, there are multiple options.
- You have the option to prepay the loan at any time during the tenor of the loan. There is no prepayment penalty for such payment. It is your choice. The lender cannot force you. However, if you have funds and want to take back the control over the house, you can repay the loan.
- Your legal heir can repay the loan after your demise and take back possession of the house. If they choose to sell the house, the proceeds from the sale of the house will be used to repay the loan. The excess amount will go to the legal heirs.
- You or your legal heir have the first right to settle the loan along with accumulated interest before the sale of the property. This means the lender cannot sell the property at its discretion if you or your legal heirs are willing to settle the loan.
Is the payout from the lender under Reverse Mortgage scheme taxed?
The payout from the bank/housing finance company is exempt from income tax (or capital gains tax) in the hands of the borrower.
All payments under the Reverse Mortgage Loan scheme are exempt under Section 10(43) of the Income Tax Act.
The rationale is that the payout from the bank/housing finance company is not your income. It is merely a loan.
Rights of the Lender under RML Scheme
Since the lenders’ only recourse is your mortgaged property, it has the rights to safeguard its interest in the following manner.
- Insist on the purchase of property insurance. The lender may deduct the insurance premium from the payout.
- Insist on proofs of payment for taxes, electricity and water charges and any other statutory charges.
- Inspect the residential property on a periodic basis.
- If you are not paying statutory taxes or not maintaining the property in good condition (quite subjective), the lender has the right to foreclose the loan. In such a case, you can repay the loan or else the lender will sell the property to square off the loan.
- There are other conditions of default defined too under clause 18 of the RML scheme guidelines. You are advised to go through the loan agreement properly.
What are the other costs associated with loans under RML scheme?
Just like any other loan, there may be processing fees, appraisal fees, documentation fees and commitment fee (for the undrawn amount). You are advised to understand all the charges before you sign the dotted line.
What are the issues?
For most of us, the house has an immense emotional value. We plan to pass the house to the next generation. Even though you have the option to take back the house by repaying the loan, it is a bit impractical. If you had funds to repay the loan, you wouldn’t have taken the loan in the first place. Even your heirs have the option to repay loan and take back the house.
The lender will make the payment only for a maximum of 20 years. What will you do after 20 years? You have to plan for the years after disbursement tenor ends. If there was no restriction on the loan tenor, more people would have found the plan interesting. However, do note, as the disbursement tenor grows, the monthly amount per lac of rupees (loan amount) will go down even further.
The maximum loan value is typically Rs 50 lacs –Rs 2 crores. Under PNB Scheme, it is Rs 1 crore. With Union Bank RML Scheme, it is Rs 1 crore. With IDBI Bank, it is Rs 2 crores. As seen in PNB Bandhan scheme example, residential property worth Rs 1 crore (Rs 80 lac loan equivalent) fetched a monthly income of Rs 8,000 per month. Taking it further, residential property worth Rs 2.5 crores will get you a monthly income of Rs 20,000 per month.
For some, it may make sense to sell the house and purchase a smaller house in the same city or similar house in a smaller city. For instance, you sell your house worth Rs 2.5 crores in Mumbai. You purchase a similar house in Pune for Rs 1 crore and invest the remaining Rs 1.5 crores (ignoring capital gains tax on sale of house) in fixed deposit offering monthly interest. If the fixed deposit is at 7%, you will earn Rs 87,500 per month. Even if you deduct 30% tax, you will get Rs 61,250 per month.
Rs 61,250 per month vs. Rs 20,000 per month. Moreover, even at the time of death, you can pass your Pune house and Rs 1.5 crore (fixed deposit) to your legal heirs. In case of reverse mortgage loan, your legal heirs get nothing.
With reverse mortgage, the payout is for maximum 20 years. With the option, you get interest income for life (and not just 20 years).
So, it makes sense to evaluate this option before deciding to go for reverse mortgage scheme.
RML is different from loan against Residential Property
Under loan against residential property, you have to repay the loan. You make monthly payments to the lender and the outstanding balance keeps going down.
Under Reverse Mortgage loans, the lender make monthly (periodic payments) to you and the outstanding principal amount keeps increasing.
In one of the examples, for a residential property valued at Rs 1 crore, you got an income of Rs 8,000 per month for 20 years. Rs 8,000 per month make it Rs 96,000 per annum. That’s yield of 0.96% p.a.
Quite low. Rental yield is easily in the range of 2-3% per annum. But you can’t rent the house you are staying in. If you rent your house, where will you stay?
I don’t have any grudge against banks. They have to safeguard their interest. And the calculations were fairly crisp and unambiguous. For the fans of Systematic Investment Plans, this is the power of compounding working in reverse. Over 20 years, you receive only Rs 8,000 per month (Rs 19.2 lacs in total) and have a loan of Rs 80 lacs outstanding at the end of 20 years.
The banks/housing finance companies are taking the risk of your longevity. They are taking risk on the market value of your property. You take the loan at age of 60 for 20 years and get regular payment till the age of 80. You happen to live till the age of 100. The bank cannot come and ask you for money. All they have to settle with is your house.
Does such a scheme make sense for you?
RML schemes are typically the last resort. If you are struggling with cash flows, it is an option you can explore. At that age, you wouldn’t have too many options. Given the emotional attachment we have with our houses, if you are even thinking about RML, RML is probably your only option.
Keep your emotions out. If you can’t count on your kids for help during your retirement, there is no reason you should worry about bequeathing the property to them. You have to be fair to yourself. You have worked hard all your life. Probably, you didn’t make good investment choices while you were working. Probably, some of your assumptions went wrong. Probably, you had your share of bad luck. But that’s past. You have got to enjoy life in those golden years.
It is not that only those in need of money during retirement should opt for Reverse Mortgage Loans. If you do not want to pass on the house to the next generation, you can consider reverse mortgage loans and enjoy your life even more.
RML should be your last resort. Explore other options (such as the sale of house and purchase of a smaller house or in a smaller city) before taking the call. However, if push comes to shove, go for reverse mortgage loan.
Additional Read: FAQs on Reverse Mortgage Loan Schemes
The post was first published in Feb, 2016.