A comfortable life after retirement is the least that hard-working individuals deserve, but the reality can be stark and difficult for most. It is common to see senior citizens financially impacted by the nuclear family system, the ever-increasing cost of living, insufficient regular income, lack of financial support from children, medical contingencies, etc. More often than not, retirees think they have saved enough only to see the corpus erode in a few years. Then, there is the risk of investing in risky assets like equity, which can often have calamitous effect on their savings. What the retirees need in such cases is a safe and assured source of income without losing out on their savings.
This is where reverse mortgage helps senior citizens meet their financial needs without parting with their house. The system is the exact opposite of home loan: it enables a senior citizen to receive a regular stream of income from a lender (bank or other approved financial institution) against the mortgage of his/her home. The loan amount is arrived at after considering various parameters such as the market value & life of the property, age of the borrower(s), etc. The loan amount is paid in either lump sum or periodical payments (including option of annuity payment).
The maximum tenure of mortgage under the reverse mortgage scheme is 20 years. Nevertheless, if the borrower outlives the tenure of the loan, he can continue to stay in the house. However, they will not receive any periodic payments after 20 years unless they choose the annuity payment option. Further, if one the spouses dies, the other can continue to live in the house. The settlement of loan will take place when both husband and wife die.
The other advantage of reverse mortgage is there are no repayments involved. Senior citizens are not required to repay the loan along with interest. It is also a tax-friendly scheme. The lump sum or periodic amount/annuity received under the reverse mortgage is considered as a loan and not income for tax purpose. Further, capital gains tax will be attracted only when the property that is mortgaged is sold to repay the loan.
The lender recovers the amount by disposing of the mortgaged property after giving an option to legal heirs of the deceased borrowers to release the said property after settling the loan. In case the property is sold by the lender, any surplus on account of such sale is to be passed on to legal heirs. Deficit, if any, is borne by the lender. Such surplus is taxed as capital gains in the hands of legal heirs and calculated in accordance with the income tax law.
The system is not, however, free from pitfalls. First, there is the case of banks capping the maximum mortgage loan amount. Second, the property should be used only for self-occupation during the tenure of the mortgage. Third, there is no provision to increase the payment amount to meet contingencies, and various other costs such as legal fee, loan origination fee, charges relating to property survey, valuation, title examination, stamp duty and registration, etc, could be recovered from the borrower.
So, while the monthly payment may suffice in the beginning, senior citizens might feel the pinch at a later stage in their lives. But despite these shortcomings, reverse mortgage can be a lifeline for senior citizens and serve as a financial tool which enables them to live independently by retaining a home during the sunset phase of their life and by monetising an illiquid asset - house property.
(The author, Homi Mistry, is a partner at Deloitte Haskins & SellsLLP.)