What is a Reverse Mortgage?
Reverse mortgages enable house owners to access the money they have built up as equity in their houses. Unlike an ordinary mortgage, which involves payments by the borrower to the lender, a reverse mortgage involves payments by the lender to the borrower. It is an arrangement whereby house owners get cash (usually in the form of monthly payments or a lump sum) in return for a mortgage on their house. This mortgage is used as security against the loan. This is a strategy is basically used by retired house owners who need to supplement their income. A reverse mortgage is one way of tapping into the value of a house.
A borrower can choose to receive the money from a reverse mortgage all at once as a lump sum, fixed monthly payments either for a set term or for as long as you live in the house, as a line of credit, or a combination of these. The most popular option – chosen by more than 60 percent of borrowers – is the line of credit, which allows you to draw on the loan proceeds at any time
How Reverse Mortgages Work
A reverse mortgage is a loan: where the lender pays the borrower n a lump sum, a monthly advance, a line of credit, or a combination of all three. The borrower continues to live in his house. To qualify for a reverse mortgage the borrower must own the hoe. The amount he or she eligible to borrow generally is based on borrower’s age, the equity in the house, and the interest rate the lender is charging. Funds received from a reverse mortgage may be used for any purpose.
With a reverse mortgage, the borrower retains title to his house. The borrower is responsible for maintaining the house and paying all real estate taxes. Depending on the plan selected, the reverse mortgage becomes due with interest when the borrower moves, sell the house, reach the end of a pre-selected loan period, or die. When the borrower dies, the lender does not take title to his house, but his heirs must pay off the loan. Usually, selling the house or refinancing the property repays the debt.
Facts to Consider about Reverse Mortgages
- Reverse mortgages are rising-debt loans. The interest is added to the principal loan balance each month, because it is not paid on a current basis. The amount borrower owes increases over time as the interest compounds. Some reverse mortgages have fixed rate interest; others have adjustable rates that can change over the lifetime of the loan.
- Reverse mortgages use up some or all the equity in borrower’s house, leaving fewer assets for him and his heirs.
- There are three types of reverse mortgages: FHA-insured, lender-insured, and uninsured and they vary according to their costs and terms. (Source: US Dept. of Housing and Urban Development: www.hud.gov)
- Reverse mortgages typically charge loan-origination fees and closing costs. Insured plans charge insurance premiums; some plans have mortgage servicing fees. Borrower may be able to finance these costs if he wants to avoid paying them in cash. But, if borrower finances the costs, they will be added to his loan amount and he will pay interest on them.
- The borrower’s legal obligation to repay the loan is limited by the value of the house at the time the loan is repaid. This could include any appreciation in the value of the house after the loan begins.
Benefits of reverse mortgage
The Benefits of a Reverse Mortgage include:
- Tax-free funds for as long as the borrower live in his house.
- No loan repayment for as long as the borrower live in his house
- No income, medical or credit requirements for obtaining reverse mortgage
- The borrower can retain ownership of his house for life; this is guaranteed as long as he maintains the house, and pays insurance and real estate taxes
- The borrower can choose a cash flow plan tailored to his needs
- There is no restrictions on the manner in which the fund is used
Reverse Mortgage In India
The concept of Reverse Mortgage is new to India. Recently National Housing Bank has come up with a plan to introduce reverse mortgage in India. The facility will be made available by banks to people aged 62 years and above. National Housing Bank will do the re-financing. The loan will be for up to 15 years. The value unlocked will be a function of borrower’s age and value of the house. The interest will be based on the prevailing rate.
National Housing Bank is currently sorting out issues with CBDT that the finance received by senior citizens is treated as a loan and not income. The bank is also trying to build in a mechanism where the loan amount could flow beyond 15 years.
To qualify for a reverse mortgage the borrower will have to approach a housing finance company (HFC) or a bank and express his interest in pledging his home for the reverse mortgage scheme. The HFC will asses the value of the house and, depending on the age of borrower and the prevailing interest rate, the amount of loan payable to him will be decided upon.
The value of the house will be determined by independent valuation through the generally accepted property valuation methodology in the industry. The loan amount will be fixed on the basis of current value and not on possible future appreciation.
However, the most critical factor in deciding the amount will be age. The older the borrower, the more are the chances of getting a higher value. This is because the lender will have to typically provide the loan for a lesser number of years. The interest rate at which the loan will be given will typically be marginally higher than the prevailing interest rates as the lending company will receive its money when the borrower dies. However, currently on the basis of present actuarial analysis, the loan to value ratio is fixed at 45-60 per cent of the value of the property based on the age.
NHB on Reverse Mortgage
Under the present recommendations of the NHB, a borrower need to be 62 years of age and the tenure of the loan is fixed at 15 years. However there have been recommendations to lower the age to 60 as people usually retire at that age. The primary lenders shall however have the discretion to consider shorter/longer tenure. Incase the borrower outlives the tenure of the loan, he will not be asked to move out of the house. In such a case payments made to the borrower will stop after 15 years, but the interest will keep accumulating till the accounts are finally settled. There are also suggestions of adding insurance to reverse mortgage. The premium for that will be deducted from the payment made to the borrower. The corpus accumulated at the end of 15 years will be used to fund the years that the borrowers outlive the loan tenure. NHB has also recommended that a certain portion from the payments be parked in bank fixed deposits to fund the years that borrower outlive the loan. The accounts will be settled by the HFC only after borrower’s death or if he chooses to vacate the property. The settlement of the outstanding loan amount, along with the accumulated interest, will be met by the proceeds of the sale. In the event of borrower’s death, the spouse can continue to occupy the property until his/her demise, and he/she usually made a co-borrower.
NHB is working towards speedy introduction of this concept. As the apex financial institution for housing in the country, NHB has designed the product on ready-to-deliver mode based on specific needs of the asset-rich but cash-poor senior citizens. It will endeavor to popularize reverse mortgage as one of an array of post-retirement financing options. NHB will not provide retail loans but it can refinance reverse mortgage to banks and HFCs. And in the event of a borrower seeking additional assurance that the bank/HFC will continue to provide payments under reverse mortgage for the contracted period, NHB can guarantee such obligations.