INDIA: Reverse Mortgages Help in Golden Years

MUMBAI (The Financial Express), March 4, 2007: The Union Budget proposals of 2007-08 announced on February 28, included the introduction of 'reverse mortgages' in Indian markets, notes Devendra Nevgi in this journal's column Viewpoint today. The mortgage market in India is reasonably large. Its estimated size is around $33-39 billion, which is around 5% of the GDP. In other emerging countries such as China, the mortgage to GDP ratio is around 11% and in a developed country like the US, it is 52%. The Indian mortgage market is dominated by institutions such as HDFC and banks such as ICICI Bank. In the past few years, higher affordability, low interest rates and easy availability of credit have helped the mortgage market to grow at more than 20-25% pa. The real estate prices have also moved up by 100-300% in the past few years. What exactly is a reverse mortgage? In a regular mortgage, a borrower will get a loan from the lender at a particular interest rate and tenor, mortgaging his new or existing house. The borrower will then repay the loan in the form of equated monthly installments (EMIs), where a portion of the principal and the interest is repaid monthly. Usually, as time progresses, the share of principal in the EMI comes down and the share of interest rises. In a typical 'reverse mortgage', an existing home owner can generate cash flows (loan) from his house without selling it and continue to stay in it as along as he is alive. The borrower need not bother to repay it, till his death or till he sells the house. There is no question of the credit assessment of the borrower. So, is this an ideal situation? Well not always… Reverse mortgages are very popular abroad. Elderly and senior citizens, who are home owners, often use reverse mortgages to generate either lumpsum or regular cash flows to finance various expenses such as medical, travel, or any other. An existing mortgage on the house (if any) can be repaid with the proceeds. Reverse mortgages help 'cash poor, house rich' seniors to meet their financial obligations during their golden years, and yet continue to live in their house. In the US, to be eligible for a reverse mortgage, one has to be a house owner above 62 years of age. Additionally, the proceeds out of reverse mortgages are usually tax free. The loans are given based on the borrower's age, the prevailing interest rates and the value of the house. The borrower can structure his borrowings as a lumpsum or as a monthly annuity. He can even opt for discretionary drawdowns of the loan amounts as and when required. The loan can be repaid when the owner sells off the house or no longer lives there, or dies (lender sells off). But there is no free lunch anywhere in the world. Reverse mortgage structures have their own drawbacks for the owner (borrower) of the house. Some of the aspects to be considered are: * Unlike a regular mortgage where the principal of the loan reduces with time; in a reverse mortgage the principal amount of the loan grows with time and so does the interest on the outstanding higher principal. * Reverse mortgage may be fixed or variable, which makes it exposed to interest rate risks. In a rising rate scenario a floating rate reverse mortgage would multiply the owner's liabilities. * A non recourse clause usually included in a reverse mortgage agreement prevents the legal heirs of the deceased owner to take control over the house to the extent of the value of the loan outstanding. * The owner of the house continues to remain responsible for the maintenance and other charges of the house such as insurance. On the positive side, there is no chance of a default and the owner losing his home in reverse mortgage. Though the product remains a good tool for financial planning and a source for cash generation for senior house owners who do not have heirs, Indian senior citizens should be wary of the cost of acquiring the same too. © 2005: Indian Express Newspapers (Bombay) Ltd.