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Business News/ Money / Personal Finance/  Retirement planning: What is a reverse mortgage and how does it work? MintGenie explains
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Retirement planning: What is a reverse mortgage and how does it work? MintGenie explains

A reverse mortgage is a loan available to homeowners aged 62 or older, allowing them to convert part of the equity in their homes into cash.

In a reverse mortgage, the homeowner receives payments from the lender.Premium
In a reverse mortgage, the homeowner receives payments from the lender.

Retirement planning has become a crucial consideration for individuals in the ever-changing Indian landscape. With demographic shifts and an ageing population, strategic retirement planning holds even greater importance. To assist these individuals, the State Bank of India (SBI) offers a scheme for reverse mortgage loans so that they can sustain themselves financially. Through this scheme, the bank offers payments to borrowers in exchange for the mortgage of their residential property.

It is particularly beneficial for those senior citizens who require a consistent income source since the loan amount is not required to be repaid until the borrower either sells their home or moves out.

What is a reverse mortgage?

A reverse mortgage is a loan available to homeowners aged 62 or older, allowing them to convert part of the equity in their homes into cash. Unlike traditional mortgages, where homeowners pay the lender, in a reverse mortgage, the lender pays the homeowner. The beauty of this system lies in its flexibility and the fact that the loan does not have to be repaid until the homeowner moves out or passes away.

How does a reverse mortgage loan work?

A reverse mortgage loan is specially designed to help senior citizens avail of periodical payments from a lender against the mortgage of their house, all while retaining ownership and living in the house. However, individual banks have specific requirements that borrowers must meet to apply for this loan. 

Here are the eligibility criteria that need to be fulfilled to qualify for this loan:

  1. The borrower must be at least 60 years old. If applying jointly with a spouse, the spouse must be at least 55 years old. There is no maximum age limit to apply for this loan.
  2. The property owned by the borrower must not have any outstanding loans or other financial obligations.
  3. The age of the mortgaged property should not be more than 20 years old.
  4. The property used to secure the loan must have been the borrower's primary self-occupied residence for at least the past year.
  5. The loan amount that can be availed under this scheme is a minimum of 3 lakh and a maximum of 1 crore.
  6. In case the individual has availed of a home loan against the concerned property, then it is mandatory to take a no-objection certificate (NOC) — the property must be free from any impediment or burden.

These and other eligibility criteria, such as the condition of the property and the maximum loan amount, are determined by lenders on a case-by-case basis.

Features of reverse mortgages loans

Low processing fees: The processing fee for reverse mortgages is 0.50% of the loan amount. However, the bank sets a minimum fee of 2,000 and a maximum fee of 20,000.

Tenure of up to 15 years: To assist borrowers, the bank offers a maximum loan tenure of up to 15 years, depending on the borrower's age.

No prepayment penalty: Senior citizens can prepay their reverse mortgage loan without incurring any charges or penalties.

Benefit from reverse mortgage loans

Senior citizens can enjoy several advantages with reverse mortgages:

Versatility: With reverse mortgage payments, you can use the funds to cover everyday household expenses, travel costs, and medical bills. There are no restrictions on how the money is used, except for lump sum payments.

Tax benefits: According to Section 10(43) of the Income Tax Act, 1961, reverse mortgage payments are not considered as income. This means that borrowers are exempt from paying taxes on these funds. Additionally, any amount spent on home renovations using reverse mortgage funds may be eligible for tax deductions.

No loan repayment required: Repaying loans during old age can be extremely challenging. With a reverse mortgage, the bank has the right to sell the property to recover the loan amount after the borrower's demise. As a result, borrowers are not required to repay the loan themselves.

Taxation treatment

As stated in section 47(xvi) of the Income Tax Act 1961, any transfer of a capital asset in a reverse mortgage transaction under a scheme established and announced by the Central Government is eligible for exemption. Section 10(43) specifies that any amount received as a loan, whether in a lump sum or instalments, in a reverse mortgage transaction is exempt from taxation. This means that the loan amount does not count as income for the senior citizen, even though it is considered a capital receipt. The exemption of income is intended to encourage the promotion of the reverse mortgage scheme.

In conclusion, while reverse mortgages can benefit senior citizens by providing them with a steady income, there are certain factors that individuals opting for this scheme should take into account. Often, the amount received is lower than the interest charged. The interest rates are exorbitant, resulting in a substantial repayment amount compared to the initial loan granted.

A reverse mortgage is inherently a form of debt and is considered the costliest type of credit due to its high interest rates. This financial arrangement remains beneficial only as long as the homeowner continues to live on the property. However, if the homeowner vacates the property for more than 12 months, the loan becomes due and may potentially leave the elderly individual without a home.

Additionally, failure to pay property taxes, insurance premiums, or other related fees, as well as neglecting to maintain the property, can result in default. In such cases, the lender has the authority to foreclose on the property, potentially purchasing it at a nominal price and then selling it at a much higher value, thus making a substantial profit. Therefore, it is crucial for senior citizens to carefully consider their decision to remain in the same property before opting for a reverse mortgage.

Atul Monga, CEO and C0-Founder, Basic Home loan

 

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Published: 19 Feb 2024, 11:22 AM IST
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