Posted in Finance Articles, Total Reads: 6456
, Published on 30 October 2010
There are sections of ageing population in India who do not have regular source of income but may have assets which may not be providing any income. They are either dependent on their children to support them or depend on retirement savings which may not be sufficient to support their lifestyle. In order to support this section of population, The National Housing Bank, apex body on housing finance in India, came out with the guidelines on reverse mortgage in early 2007.
“A reverse mortgage is a loan available to senior citizens and is used to release the home equity in the property as one lump sum or multiple payments. The homeowner's obligation to repay the loan is deferred until the owner dies, the home is sold, or the owner leaves (e.g., into aged care).
A reverse mortgage helps senior citizen above age of 60 years to avail of periodical payments from lender against the mortgage of his/her house. Borrower can continue to occupy his house as long as he lives but the periodical payments will cease after duration of loan. Some of the basic features of reverse mortgage loans are:
• The loan is available only to senior citizen owning a home. • The loan can of the form of lumpsum payments of periodic payments like annuity. • Homeowner does not have obligation to repay the loan until the house is his prime residence i.e. he is the owner and currently residing at that place. • The payback is done once the owner leaves the house or dies. The loaned amount along with the accrued interest is recovered through the proceeds of the sale of house. The residual amount that might accrue from the sale after settling with the bank is transferred to their heirs. • If the sales proceeds is less than the accrued principal and interest then bank takes the hit. • The borrower or their heirs has the option of prepaying the amount and accrued interest without attracting any prepayment penalty. • At the end of tenure, heirs can also prepay the loan with accumulated interest and have the mortgage released without resorting to sale of property. • Every five years the valuation of the property is revisited. If the valuation is increased then applicants are given the option of increasing the quantum of loan.
The various considerations while pricing such type of products are: • Age of the borrower: If the loan is a joint loan then age of younger borrower is considered. • Value of property: The value of property plays a very important role in determining reverse mortgage loan • Expected interest rate: Current and expected interest rate also plays an important role in pricing the product. Risk inherent in reverse mortgage: • Longevity Risk: The lender gets the money back only after the borrower dies or move into another residence. As the life expectancy increases, risk of late recovery of loans for the banks also increases. This may result into asset liability mismatch for the banks. • Interest Rate Risk: The payments to the borrower are fixed but the cashflows to the lender are not fixed and depends on the interest rates prevalent in the market. Thus the lender runs the risk that interest rates in the market moves in the opposite direction of anticipated rates. • Market Risk (Property Value Risk): Lender runs the risk of losing money if the sale proceeds from selling the house is not sufficient to cover the principal and accrued interest. This may be result of adverse price movements in the housing sector. Lender does not have any recourse to any other asset of the borrower. • Early Redemption Risk: Lender is also exposed to early redemption risk as the borrower will pay back the loan when it is most beneficial to him. This may result into asset liability mismatch. • Adverse selection and moral hazard risk: Reverse mortgage products also have problem of adverse selection with people with higher longevity going for this product. Also the borrower has no incentive to keep the house in good condition which may lead to depreciation of value of property.
Despite the product being tailor-made for senior citizens, it has failed to pick up in India though successful worldwide. In India people prefer passing their ancestral home to their next generation even if they have to live in relative indigence during their old age because of small income. The psyche of an average Indian does not make him comfortable with the idea of selling the home. Its highly unlikely that this psyche will change very soon. In the west the social and parent child behavior dictates that parents live off their very last penny before they die and that’s the reason why reverse mortgage has proliferated there. But in India also the demographic and psychographic data indicate that there are few takers in the millions that are likely candidates of reverse mortgage idea. When reverse mortgage loan will be seen as full fledged product remains to be seen.
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