One-eighth of the world’s elderly population lives in India. The ratio of the 60-plus to working population is around 15%, but this ratio is likely to go up to 40% in another 25 years, when many of us would be retiring or already retired.
Most of the elderly are not covered by a formal pension system. They have to rely on their own earnings or transfers from children. Nearly 50% of elderly households depend on transfers and 40% continue to work even after they turn 60. As the population ages, the challenge of providing income security to the elderly will rise.
A large part of household wealth is invested in housing. During their lifecycle, households distort consumption by saving a significantly large component of their income to invest in housing. When cash income declines after retirement, unlocking this equity to supplement consumption is difficult.
To allow senior citizens to unlock their home equity, reverse mortgages as a financial product have been introduced in this year’s Union Budget. A reverse mortgage allows senior citizens to borrow against the value of their property, thereby generating an additional income stream. The loan principal and the interest accrued are recovered by the lender by selling the property—either after the owner’s demise or the owner’s permanent relocation or on sale of the property by the owner. In the case of demise, the balance is left to the heirs, who can pay off the dues to the lender and regain rights to the property.
This scheme is attractive to senior citizens who want to supplement their inadequate pensions and improve their standard of living without having to forego living in their house during their lifetime. The borrower (senior citizens availing the reverse mortgage) could get either a lump sum at the beginning of the loan term or monthly payments for a fixed term or a combination of both. Further, since there is no loan-servicing requirement from the borrower, there is no credit-worthiness or minimum-income-level hurdles to be crossed to avail of this loan.
The borrower need not make any payment to the lenders; the loan and interest accrued accumulate till maturity (which is subject to a maximum of 15 years in India). In case of the primary owner’s death, the spouse (usually a co-borrower) continues to receive payment until death or permanent change of residence. The borrower continues to own and occupy the home until her demise or permanent change in residence, even if she outlives the loan period and the payments stop.
There are several advantages: Senior citizens can explore this option to pay for health-care expenses, generate monthly income to improve their quality of life or finance a home improvement. It also allows the elderly homeowner to convert a single, risky asset into a liquid, diversifiable asset that adds security to his wealth portfolio.
Another positive outcome is that a reverse mortgage safeguards senior citizens from the psychological and financial burden of relocation, which is harder to acclimatize to, as one grows older.
There are also risks that the borrower must understand: The homeowner may be subjected to mental and psychological hardship if the lender defaults on the loan payments and files for bankruptcy. If the borrower had taken a lump-sum payment, then this situation may not affect him, but if he had opted for an annuity cash flow, the creditworthiness of the lender will be a key factor in determining the future security of his cash stream.
The reverse-mortgage concept is complex and it may be difficult to reliably convey all relevant and important information satisfactorily to the potential borrower, thereby increasing the borrower’s chances of basing his decision on unclear information. Elderly homeowners need to be aware of the compounding aspect of the loan over time and realize that their repayment exposure is not just limited to the ‘principal’, but also includes the ‘interest’ that accrues over the period till the loan is repaid by the sale of the property. If the terms are not clearly conveyed, they may not even realize that they are effectively entering into a binding agreement to hand over possession of their house to the lender after their demise.
The heirs of elderly homeowners may not approve of their parents converting part or all of their home equity to finance their consumption as that will mean that the heirs will receive less of a bequest if the house is bound by a reverse-mortgage loan.
Given that many elderly homeowners who opt for reverse mortgage are those looking to supplement their poor income streams, the upfront transaction costs (costs associated with valuation and other information acquisition related) of reverse mortgage may add an unwelcome burden on their already strained incomes.
Key to the efficacy of reverse mortgages is the development of a strong financial and regulatory infrastructure within the country that will minimize loopholes, prevent fraud, and make this product successful in serving the needs of the senior citizens in India.
Piyush Tiwari is senior lecturer, University of Aberdeen, Scotland. Komal Datta Sanghera is research associate, Indian School of Business, Hyderabad. Comment at firstname.lastname@example.org