Sunday, March 2, 2008

Reverse Mortgages Explained

Today’s Business Standard carries a column by Stanley Pinto that looks at reasons why reverse mortgages have failed in India. More importantly, it contains a lucid explanation of the concept:

“The reverse mortgage facility allows senior citizens to unlock the value of their most valuable asset, their home, by mortgaging it and enjoying the use of the money in their lifetime while continuing to live in it until their deaths. It is a well-entrenched idea in many developed countries in the West where its terms are such that only home-owners above a given age (typically 60-65 years) may apply. The bank makes an evaluation of the current value of the home, decides the likely lifespan of the applicant home-owner (and his/her spouse), and, decides what percentage of the current value they are willing to loan them. The bank also fixes the interest rate it wishes to apply.

Typically, the loan amount seldom is lower than 60-70 per cent of the market value of the property. The applicants have the option of taking the loan principal in a single lump-sum amount or by a fixed monthly amount instead. From time to time, the value of the property is re-visited by both parties. If the valuation has increased, the applicants are given the option of increasing the quantum of the loan, and should they do so, are given the incremental amount in lump-sum. If they have opted for the monthly payment scheme, this amount is appropriately increased. The principal plus interest charges accrue at the bank while the applicants live on in the home for the lengths of their lives — or until they decide to sell the home, whichever comes earlier.

If they choose to sell it, they have to pay the bank all the accrued amounts. On the death of the second of the two spouses, the heirs to the property decide either to redeem the loan and keep the property, or sell the property and take the residual amount that may accrue from the sale after settling with the bank. Should the sale proceeds be lower than the accrued principal plus interest amount, the bank takes the loss. (This could happen if the real estate market has not moved up in the manner the bank had estimated originally. However experience of the past indicates that the banks seldom lose, as they factor this likelihood in setting the percentage of the current value they loan the applicants.)”

This year’s Budget has conferred benefits on reverse mortgage schemes. It is proposed that reverse mortgages would not amount to “transfer”, and the stream of revenue received by the senior citizen would not be “income”.

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