INDIA: Reverse mortgage shade for elderly

The scheme helps senior citizens earn some additional income while staying in their own home MUMBAI (DNA Money), March 10, 2008: Ramesh Sangli had just started his retired life with wife Suman. Ramesh had been a government employee throughout. His retirement benefits and other small-time savings, after settling their children, had mostly gone into the construction of a house. Ramesh did not want to take debt at this stage of his life, and, therefore, settled for something which fitted his budget. The couple had always taken pride in the fact that they had managed to stay within their means throughout the last few decades. At the same time, they also imparted good education to both their children, who are now independent. A few months into their retired life, Ramesh and Suman started feeling the pinch. The pension amount was insufficient and both of them were now thinking of generating regular additional income. A part-time job in a nearby school, a crèche in their own home and constructing a first floor for monthly rentals were the options before them. However, they realised that every option carried a threat to the freedom they enjoyed now. It was then that Ramesh came to know about reverse mortgage — a scheme under which his bank would provide him money, either lump sum or in regular monthly cash flows, against the mortgage of his residential property. ‘It cannot be that simple’ is what Ramesh thought. At first look, it did not seem to have any restrictions. The couple hurriedly made enquiries with their bank and were pleased to learn a few more details about reverse mortgage. Reverse mortgage The bank manager explained that reverse mortgage allows senior citizens to borrow against their homes (SBI has offered the plan to all owners above 60 years). They receive the loan amount in the form of regular monthly payments from the lender (a scheduled bank or a housing finance company). During their lifetime, they can continue to live in their house and supplement their monthly income. Upon death, the property is sold off and the bank settles the outstanding loan amount. This way, reverse mortgage is aimed at ensuring the financial security of senior citizens. Reverse mortgage is a widely used instrument in the developed world by the elderly for regular cash flows. The popularity of the instrument lies in that it converts an illiquid asset — a house — into liquid cash flows for the owner, typically a senior citizen. A more attractive feature is that senior citizens can continue to live in that house even after drawing cash flows from it. From the bank’s or housing finance company’s perspective, the mortgage ensures that there is no scope for default. Some key features of the scheme: 1. In terms of receiving the loan amount, the borrower can opt for monthly, quarterly, annual or lumpsum payments or at any period as per his discretion. 2. A revaluation of the property is undertaken by the bank periodically and consequent to the revaluation, necessary changes will be made to the loan amount. 3. The lender will recover the loan, along with the accumulated interest, by selling the house after the death of the borrower or earlier, if the borrower leaves the mortgaged residential property permanently. Any excess amount will be remitted to the borrower or his heirs. However, before resorting to sale of the house, preference will be given to the owner or his heirs to repay or prepay the loan amount, along with the interest, and to get the mortgaged property released. 4. Currently, the maximum loan tenure can be 15 years. So, if the borrower outlives the loan tenure, he can continue to stay in the house. However, he will no longer be eligible for any payments from the bank. 5. The legal heirs of the owner are not entitled to take control over the mortgaged property up to the extent of the outstanding loan. They are required to first repay the outstanding loan amount along with the interest to stake a claim on the property. 6. If the borrower or his heirs wish to prepay the loan amount, they may have to bear an additional cost. Tax issues of reverse mortgage The reverse mortgage scheme was announced in the last budget. However, it did not get the expected response for want of clarity on tax treatment. Budget 2008-09 has clarified the tax issues by providing that: - the loan amount i.e., the stream of revenue received by senior citizens would not be treated as ‘income’ and would thus be exempt from income tax in the hands of the borrower - receipt of a loan upon mortgage of a property will not constitute a ‘transfer’ under the Income-Tax Act and will, therefore, not subject to capital gains tax. A borrower will, however, be liable to income tax only on sale of property by the bank for the recovery of the loan. Summary Senior citizens can now relax. Not only will they get the benefit of the revised tax slabs but also tend to benefit when they reverse mortgage their residential property as there would be absolutely no tax liability or capital gains tax at the inception nor any recurring tax on the series of receipts. Simply put, in case of Mr and Mrs Sangli, if they were to opt for reverse mortgage for 15 years, they will get annuity (the reverse EMI) from bank for 15 years. After that, the annuity payments stop. However, they continue to live in the house. Assuming Ramesh dies after 15 years, Suman can still live in the house till she is alive. After her death, their heirs have two options — settle the overall outstanding loan and retain the house or the bank will sell the house, use the proceeds to settle the outstanding loan and give the rest back to them. Coupled with his income from pension, Ramesh and Suman can continue to live comfortably with no cutback on lifestyle once they avail the benefits of this new financial product. By Alok Kumar, CFP and seniormanager, knowledge management, FPSB India. © 2005-2008 Diligent Media Corporation Ltd.