Unlocking your home’s equity: How a reverse mortgage can secure your retirement

This financial tool offers a unique solution for elderly homeowners who may have significant home equity but few liquid assets. However, it also presents challenges and potential pitfalls that must be carefully considered before diving in. Let us explore the concept of reverse mortgages, their potential benefits and downsides in the context of the Indian housing market.

How does it work?

A reverse mortgage is a loan available to senior citizens that allows them to borrow against the value of their home. Unlike a traditional mortgage, in which borrowers make monthly payments to the lender, a reverse mortgage allows the homeowner to receive payments, either as a lump sum or in regular instalments. The loan is repaid when the homeowner sells the house, moves out, or passes away, at which point the lender typically sells the property to recover the loan amount.

The National Housing Bank (NHB) introduced reverse mortgages in India in 2007, primarily targeting senior citizens who own a house but don’t have enough savings for retirement. The loan amount is based on the property’s market value, the borrower’s age, and the interest rate. Various banks and lenders offer reverse mortgages under various schemes.

Also read: Could Sebi’s new curbs for investment advisers choke financial planning in India?

In India, these mortgages are available to individuals aged 60 or above who own a self-occupied residential property. Typically, borrowers receive monthly payouts from the lender for a specified tenure, which can range from 10 to 20 years. The payout is a percentage of the property’s current market value, subject to a maximum cap.

The homeowner can continue to live in the house during the tenure of the loan without an obligation to repay it. Upon the death of the borrower (and the spouse, if included in the agreement), the lender will sell the property to recover the loan and accumulated interest. Any remaining value after the loan is settled is passed on to the legal heirs. Alternatively, the heirs may choose to repay the loan and retain the property.

What are the benefits?

Financial independence for senior citizens:One of the main advantages of a reverse mortgage is that it provides a steady source of income for senior citizens who might otherwise struggle to meet their financial needs. In India, where a large portion of the population depends on fixed pensions or savings, a reverse mortgage can be a lifeline for retirees who lack sufficient income to cover their living expenses. It allows them to tap into their home equity without selling the property, ensuring that they can continue living in familiar surroundings.

No loan repayment during lifetime:Unlike traditional loans, reverse mortgages do not require monthly repayments during the borrower’s lifetime. This provides financial relief for retirees who may not have the ability to make regular payments. The loan is only repaid when the property is sold, either after the borrower’s death or when they permanently vacate the home.

Also read | Retirement planning: It’s better to be roughly right than precisely wrong

Continued ownership of property: In a reverse mortgage, the borrower retains ownership of the property and is free to live in it for as he wishes, provided he adheres to the terms of the loan. This offers security to senior citizens as they are not forced to relocate. The psychological benefit of living in one’s own home during retirement is a strong motivator for many who avail of these loans.

Tax-free income: The monthly payouts or lump-sum payments received under a reverse mortgage are not considered taxable income in India. This offers senior citizens another significant benefit.

What are the drawbacks?

Limited payout amount:One of the main downsides to a reverse mortgage in India is the relatively low payout. The loan available under a reverse mortgage is typically capped at 60-80% of the property’s value, depending on the lender’s policies. Additionally, because of property value fluctuations and the lender’s risk assessment, the payout may be less than what the borrower expects. This may not be a big issue for those with high-value properties, but for middle-income individuals it may provide only limited relief.

Effect on heirs:A major concern associated with reverse mortgages is that the property used as collateral is often sold after the borrower’s death to repay the loan. This can create complications for the heirs, who may expect to inherit the property. Although they can repay the loan with interest to retain the house, this may not always be possible, especially if the accumulated interest is significant. This issue is particularly important in India, where homes are often passed down through generations as a form of family wealth.

Also read: Why most retirees don’t find refuge in reverse mortgage

Potential loss of property:A reverse mortgage creates the risk of losing the property if the loan amount exceeds the value of the house at the time of repayment. Though this is an extreme scenario, property values can fluctuate, and the accumulated interest on the loan can grow over time. In case the sale of the property does not cover the loan, the lender could repossess it, leaving the surviving spouse or heirs or without a home.

Complex terms:Reverse mortgages are complex financial products, and it’s crucial for borrowers to understand the fine print. Senior citizens may find it difficult to grasp the intricacies of the agreement, particularly the interest accumulation, tenure conditions, and repayment terms. The complexity of reverse mortgages can lead to misunderstandings, and borrowers may unintentionally violate terms, resulting in penalties or foreclosure.

Limited awareness and availability:Despite being available for over a decade, reverse mortgages remain relatively unpopular in India. Many Indian families prefer to hold on to property as a long-term asset for future generations. This cultural mindset, combined with a lack of knowledge about how reverse mortgages work, has led to slower adoption than in Western countries.

Is it a viable option?

For senior citizens with limited retirement savings and no sources of income, a reverse mortgage can offer a valuable financial cushion. However, it is essential that prospective borrowers fully understand the implications of such a loan, especially when it comes to the future of their property and the impact on their heirs.

Proper counselling, transparency from lenders, and increased awareness could help reverse mortgages find a more secure place in the Indian housing market. Ultimately, while this may not be a one-size-fits-all solution, it does offer a flexible option for those looking to unlock the value of their home equity during their twilight years.

Anuj Sharma is chief operations officer of India Mortgage Guarantee Corporation.