Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

The wrinkles in reverse mortgage

It's a pension product that needs to be understood both by the seller and buyer

There are broadly three pillars on which the pension system of any country stands: state funded, employer funded and self-funded pensions. Different countries use different combinations of these pillars to create their pension system. In India, for the majority of the workforce, the first two pillars are almost non-existent. Neither the state nor their jobs contribute to their retirement income. It wobbles on the unsteady support of just one pillar—self-funded corpus that they need to cobble together themselves.

Given the lack of preparedness of the urban mass affluent Indians for self-funded pensions, a chunk of them find themselves asset rich but cash poor in old age. The home was the only asset they built and due to rising real estate prices, they find themselves sitting on high value properties but very little cash flow towards living costs. A new road opened for such people where they have an option to convert home equity into pension money by mortgaging it. Called reverse mortgage, the product is akin to a loan taken with the property as collateral, but instead of a lump sum, the borrowed amount is staggered into monthly instalments. Developed markets have had a mixed history with this product though it has been in the market for over two decades. The product in India is still less than a decade old, but we haven’t seen any serious efforts by the sellers (banks) or the National Housing Bank (NHB), the regulator for the product, to demystify the product let alone reach out to the potential market size of more than 20,000 crore.

In fact, the first cut of the product had some very unattractive features. It capped the payout tenor to 20 years. If the borrower outlived the tenor, she would have no income and a house that was mortgaged to the bank. In order to offer lifetime payments, NHB roped in a life insurance company and created reverse mortgage loan enabled annuity, RMLeA. RMLeA is a marriage between the regular reverse mortgage and annuities, a pension product that pays for lifetime, provided by life insurance companies.

So the bank instead of breaking up the loan in instalments, gives it out to the insurance company. The insurer then annuitizes the corpus and gives you pension money for the rest of your life. Not only does it offer lifetime income, it also puts more in your pocket vis-a-vis the regular mortgage product. So far only two banks, Central Bank of India and Union Bank of India offer RMLeA with Star Union Dai-ichi Life Insurance Co. Ltd as their insurance partner. According to NHB chairman and managing director, R. V. Verma, RMLeA did not take off because of the tax incentives.

Until a month back, payouts from the regular mortgage product were tax free, but payouts from RMLeA were taxable. In order to address the discrepancy, the government notified the Reverse Mortgage (Amendment) Scheme, 2013 that made payments from RMLeA tax-free as well. This is expected to give the product the much needed push. Mint Money tracked the developments and in the process came to realize that mainstreaming reverse mortgage is still a far cry given the abysmally low levels of enthusiasm and awareness among the sellers.

To start with, the operational guidelines on RMLeA on NHB’s website are still not updated for the tax-exempt status even after a month (http://www.nhb.org.in/RML/operational_guidelines.php). But what worries is the shoddy knowledge and scanty information on the product.

According to the guidelines, regular reverse mortgage allows the borrower to live in the house even after the loan tenor is over, but a Central Bank of India official that I spoke to for the story said otherwise. The reason was simple—why would a bank take longevity risk and defer the recovery of the loan?

The next layer of confusion was with regards to calculating the payouts from the reverse mortgage scheme. We got three different answers from NHB and two banks in terms of calculating the payouts. In fact an online portal for loans that I approached for examples on the payouts found it extremely difficult to source the numbers. Finally we got a comparison from Union Bank of India and the numbers revealed a critical aspect of RMLeA.

RMLeA is a superior product as far as the payment benefits are concerned, but the payback can cost dear. Under RMLeA, the bank makes a lump sum payment to the insurer and levies interest on the entire amount upfront which it recovers later on. This interest overtime snowballs into a huge corpus that you or your legal heirs will need to payback in order to stake a claim on the house. This is bound to have repercussions on estate planning and therefore needs to be explained upfront by the seller. In fact, counselling sessions on reverse mortgage is par for the course in developed markets, even NHB has initiated counselling centers, but given the dearth of interest, its efficacy is questionable.

Sellers need to keep in mind that reverse mortgage is not a loan that senior citizens take, but a pension product with serious ramifications to their estate planning. Hence, the product needs to be understood by the seller first and explained out in full to the customers.

Making RMLeA tax-exempt is the first step at making the product popular, but what will go a long way is when a senior citizen walks home with a crystal clear understanding of the payouts, payback and how to manage the expectations of his legal heirs.

deepti.bh@livemint.com

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